HAMP had an undeniable surface populist appeal. If the federal government can insulate lenders from the consequences of bad investment decisions, supporters asserted, certainly it can support financially-strapped homeowners, many of whom naively signed loan agreements they didn’t understand. A loan modification program to cut monthly payments ostensibly would accomplish two goals: 1) put troubled borrowers on sound footing; and 2) avail lenders of having to accumulate large inventories of foreclosed properties they can’t unload except at bargain basement prices. HAMP ostensibly would stabilize the housing market.
The program would cover first mortgages (soon extended to second mortgages) on primary residences originated prior to 2009 and delinquent for more than 30 days. The outstanding balance on a first mortgage would have to conform to the Fannie Mae/Freddie Mac purchase ceiling of $729,750. Applicants could enter the program any time through 2012, subject to income and other restrictions. A participating homeowner would go through two stages. The “trial modification” stage would last 90 days, or three timely payments. After completing this phase, the homeowner would be eligible for a “permanent modification,” in which the mortgage payment (including property tax, property insurance and homeowner association dues) would be lowered to 31 percent of pretax monthly household income, an arrangement good for five years.
To encourage timely payments, HAMP would offer monetary rewards to borrowers and servicers alike. Homeowners who pay on schedule would be eligible for up to $1,000 in principle reduction for each year up to five years. Mortgage servicers would receive an up-front fee of $1,000 per modification, plus an annual “pay for success” bounty of $1,000 on performing loans. Were that not enough, the program would provide a one-time bonus of $1,500 to lenders/investors and $500 to servicers for modifications put in place while a borrower remained current. It’s a sweet deal. Despite its promise, the results have inspired little confidence. Since its launch in April 2009, HAMP’s touted win-win arrangement hasn’t produced too many winners this side of fast-buck artists. A progress report issued this August by the Treasury Department indicated that of the 1.3 million trial modifications approved, 616,000 had been cancelled. In other words, close to half of all participating homeowners had been unable – or unwilling – to make three consecutive timely payments even on highly favorable terms. Some 434,000 borrowers received permanent modifications, with 421,000 still active. That last figure isn’t bad, but Treasury officials admit the trial modifications may offset it. “The number of new cancellations is expected to exceed the number of permanent modifications for the next few months as servicers clear their backlog of aged trials,” noted the department.
Because loan modifications can be lucrative for lenders, HAMP has created a new pattern of aggressive – and at times ethically-challenged – behavior among major banks who themselves have been TARP beneficiaries. And it may be that some of the trial modifications have “failed” for a disturbing reason. Lawsuits seeking class-action status recently have been filed against mortgage servicers such as Bank of America, JPMorgan Chase and Wells Fargo, alleging the lenders broke the terms of trial modification agreements by not upgrading them to permanent status despite homeowners making payments on time. “This litigation is spreading all across the country,” remarks Kevin Costello, a lawyer with the Boston firm of Roddy Klein & Ryan representing plaintiffs in some of these cases. “People have been relying on a promise all along, and then they get a denial. Then they find themselves in that much worse of a hole.”
Adding to the litigation possibilities is race. Given that a disproportionate number of defaults during the mortgage meltdown occurred among black and Hispanic homeowners, HAMP now must reach these “underserved” groups. The program’s new guidebook mandates that mortgage servicers identify all mortgage applicants by race even if customers don’t volunteer such information. Should a borrower decline to identify his or her racial affiliation, “the servicer should…provide the information based on visual observation, information learned from the borrower or surname.” One only can wonder about the legal consequences of “too many” black or Hispanic homeowners dropping out of the program.
HAMP amounts to wealth redistribution. As such, its inability to prevent mass foreclosures is almost a given. It reflects the notion that standards of sound risk evaluation should be cast aside in order to maximize homeownership – precisely the view that got us into this jam in the first place. And its true potential cost may be well beyond $75 billion. Think about it. By allowing troubled borrowers to repay a loan at a slower rate – and that’s the point of any loan modification – the program ensures equity buildup will be slower as well. This in turn may cause homeowners, seeking wealth-making opportunities elsewhere, to go into voluntary foreclosure. Lenders, however, fearful of being stuck with properties they can’t sell, may be unwilling to assume possession. The result is a stalemate in which banks wink at borrowers not making payments.
Evidence suggests this scenario isn’t far-fetched. Equifax this past March released data concluding that once HAMP had been put into effect, owner-occupants of primary residences exhibited a rise in the default rate relative to that of investor/speculator owners. And David Rosenberg, chief economist for Gluskin Sheff, estimates that lenders haven’t enforced foreclosure rules on about a fourth of all households, whether HAMP participants or not, who are two years behind on payments. In other words, massive as the number of foreclosures has been, it is plausible there have been too few. HAMP, not to mention the special first-time homebuyer tax credit of up to $8,000 (which expired three months ago), has propped up demand in the short run, creating another real estate bubble and collapse. While some lenders performing trial modifications may be prematurely foreclosing without justification, many outside the program are willing to refrain from foreclosing until the housing market fully comes back.
They may have to wait a while. Despite aggressive homeownership promotion by Washington, the housing market remains in recession. Mortgage applications have reached their lowest point in more than a dozen years despite fixed-rate, 30-year mortgage interest rates now having dropped below 4.5 percent. Home occupancy costs have fallen from around 25 percent to 15 percent of family income. Median existing home price nationwide fell from $217,900 to $166,400 during 2007 through First Quarter 2010.
On one level, this is cause for celebration. Housing for sale has become more affordable. And affordability is the goal, right? Yet there are some real downsides. For example, price deflation shrinks home equity, the main source of household net worth. A recent study by Goldman, Sachs concluded that a 1 percent decline in home prices depresses household wealth by around $170 billion. Deflation also causes dwellings to stay on the market longer. The inventory backlog, normally about six months for existing homes for sale, is now up to at least one year. Housing, like the larger economy, goes through an inevitable boom-and-bust cycle. It’s now in bust mode. Artificial stimulants like the Home Affordable Modification Program merely ensure the next downturn will be more severe. Even if HAMP were succeeding on its own terms – that is, if it kept all participants in their homes and avoided defaults – it still would constitute a major wealth transfer. The program rests on the assumption that homeowners behind on their mortgage payments are entitled to a subsidy from homeowners either current on their payments or titleholders free and clear. It is a false assumption. A successful bailout is still a bailout.
HAMP is set to cease operations by December 31, 2012. But the Obama administration and its supporters in Congress, their egalitarian worldview intact, can be counted on to find other ways to promote easy mortgage credit. The Federal Housing Administration is one vehicle. FHA-insured mortgages, which are meant for first-time buyers and are inherently riskier than conventional loans, now account for around 30 percent of all new originations, way up from 2 percent just a few years ago. Much of this reflects a deliberate effort by FHA, part of the Department of Housing and Urban Development, to reach high-risk borrowers. An article in the September 20 edition of Investor’s Business Daily puts it this way: “The subprime market as we knew it might be dead and buried. But it hasn’t really gone away. It’s just wearing new clothes – government-issued, by the Federal Housing Administration.”
The ongoing mortgage industry rescue, whether focused on the supply or the demand side, reflects a lack of understanding of moral hazard. This is the idea that eliminating the consequences of risky behavior unwittingly encourages more of such behavior. The Home Affordable Modification Program is a prime example of why the never-ending quest for market “stability” is destabilizing over the long run. Minimizing business risk can be risky for a nation.
Carl F. Horowitz is director of the Organized Labor Accountability Project of the National Legal and Policy Center, a Townhall.com Gold Partner organization dedicated to promoting ethics in American public life.
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