Homeowners across the country facing foreclosure are still having a difficult time getting help with their mortgages despite the Obama administration’s efforts to reduce home foreclosures through its Home Affordable Modification Program. That’s why representatives from the nation’s top mortgage servicing companies will be called to the carpet later today by senior officials from the departments of the Treasury, Housing, and Urban Development to defend their performance record under the HAMP program.
The invitation to the meeting, described by The New York Times as an ultimatum, was sent as a joint letter signed by Treasury Secretary Timothy Geithner and HUD Secretary Shaun Donovan expressing not-so-veiled frustration with servicers’ lack of effective mortgage modification action to date. Nor are Geithner and Donovan the only ones who are disappointed. At a recent Senate Banking Committee hearing, the frustration was bipartisan.
Indeed, today’s meeting comes none too soon. As of mid-July, there were 160,000 trial mortgage modifications made by servicing companies, with another 165,000 offers outstanding. This number pales in comparison to the more than 1.5 million properties that received a default or foreclosure notice in the first half of the year. Foreclosure activity in the second quarter reached new highs even as the program was under way.
Back in March, when the details of HAMP were first released, the Center for American Progress called for establishing a benchmark of 750,000 modifications in the first six months. We warned at the time that it will not be “entirely predictable how such a large and diverse market involving many different financial institutions and millions of borrowers in a variety of circumstances will respond to a program encouraging modifications.” Unfortunately, while embattled homeowners did respond—MakingHomeAffordable.gov has had 27 million page views—servicers promised to participate but seemingly failed to deliver.
Absent significant further ramping up of modification activity by mortgage servicers, we are unlikely to meet that 750,000 goal by September. That leaves the Obama administration with two options moving forward—each of which should be aggressively pursued. The first is to improve mortgage modification outcomes under HAMP. And the second is to lay the groundwork for additional policies to prevent unnecessary foreclosures.
In order to improve HAMP outcomes, we need to understand why modifications aren’t happening at the rate we would like. Unfortunately, the lack of transparency in the program makes it difficult to determine where the points of failure lie. A Government Accountability Office report released last week, for example, found “The lack of adequate documentation and specification of the assumptions makes it difficult to assess the reliability of Treasury’s estimates and, going forward, may hinder efforts to evaluate how well the program is meeting its objectives.”
At the heart of HAMP is a net present value model that calculates whether a modification is more valuable to the mortgage holder than proceeding to foreclosure. Problem is, the model is not publicly available, which limits everyone’s ability to determine and debate whether certain choices and assumptions built into the model are appropriate. This lack of transparency also severely curtails our ability to understand how potential changes to the program might affect outcomes.
There is a growing chorus of consumer advocates, academics, and investors who are interested in seeing a change in HAMP to promote principal reductions over interest rate cuts. The monthly payment on a mortgage can be lowered to 31 percent of income by reducing principal just the same as by reducing the interest rate. Since negative equity in the property is highly correlated with default, principal reductions should reduce default risk on the modified mortgages and make modification the preferred alternative to foreclosure.
Since the HAMP net present value model is not public, however, there may be other interactions in the model that would make principal reductions appear to be more costly than foreclosure. A fruitful discussion about possible shortcomings without a transparent model is like trying to diagnose why a car won’t start without looking under the hood.
In trying to understand why more modifications aren’t happening, many roads lead back to the mortgage servicing companies. Banks have increased staff levels in their servicing departments, but servicer capacity and training seem to be the biggest roadblocks to success. Next week the first of monthly scheduled reports from Treasury will break out modification activity by servicer and will allow us to determine whether there are flaws in the program itself—if servicers across the board have low rates of modification—or whether individual servicers are lagging behind.
Unfortunately, enforcement is another area where expectations for HAMP are falling short. Treasury recently announced it is working with Freddie Mac to develop a “second look” program to make sure that borrowers are not wrongly (or wrongfully) turned down for a modification. Early indications are that the second look at rejected applications is flagging far too many cases where a modification should have been offered.
Even so, the program lacks a formal appeals process. Borrowers who get rejected from the program often get no explanation of why they were turned down, which is itself a potential violation of the Fair Credit Reporting Act. There is no opportunity to challenge any of the servicer’s assumptions, such as the value of the property or the accuracy of the homeowner’s credit score, both of which have tremendous bearing on the outcome of the net present value test.
The Center strongly believes that requiring mediation prior to foreclosure for all loans serviced by HAMP participants will improve program outcomes. By getting borrowers and servicers to share their information face to face, HAMP compliance can be improved. When it is clear to both parties that a modification cannot be offered, the mediation sessions then also provide an opportunity to fairly negotiate a short sale or deed-in-lieu of foreclosure—elements of HAMP that have not been fully implemented as yet.
Improving HAMP processes may only get us so far, however. Should it become clear from the forthcoming reports that certain servicers lag far behind their peers in modifying mortgages, then it will be necessary to act more aggressively. While participation in HAMP is voluntary, and changes to the terms of the contract allow servicers to opt out of the program, Treasury still has the upper hand in most cases.
The largest servicers are all recipients of the $700 billion Troubled Asset Relief Program, and many of them are looking to pay back the TARP funds to get out from under the government’s thumb. In addition to paying back the TARP money with interest, there are also outstanding warrants whose value is open to negotiation. Treasury can use those negotiations over the value of the warrants as an opportunity to improve HAMP without fear of servicers opting out by accepting a lower valuation on the warrants in exchange for a stronger HAMP contract.
One possible change to the HAMP contract would be to allow Treasury to buy out (at a discount) the servicing rights of underperforming servicers or even acquire them outright in exchange for some of the outstanding warrants. Treasury could then resell those rights to the servicers who have demonstrated capacity to do modifications.
When the crisis began, CAP proposed a program to get troubled mortgages out of the hands of the existing owners and into the hands of those who are willing to restructure the mortgages. Ironically, today, it is not the owners of the mortgages who are unwilling. Investors in the most secure tranches support modifications; it is their agents, the servicers, who appear to be failing to act.
Congressional action can also be brought to bear to reduce foreclosures. Insofar as servicer capacity or willingness is a barrier to modifications, revisiting the ability of judges to restructure mortgage debt in bankruptcy is another stick that can be brought to the problem. While some borrowers may seek relief through bankruptcy, the very threat of bankruptcy itself may be sufficient to move intransigent servicers to modify mortgages.
Bankruptcy reform is not the only avenue for congressional action. As of the end of last year, half of all seriously delinquent mortgages were in privately issued mortgage-backed securities, despite being only 15 percent of the outstanding mortgages. By way of comparison, Fannie Mae and Freddie Mac had a combined 56-percent market share but only 20 percent of the delinquencies. Mortgage-backed securities are issued by special trusts known as Real Estate Mortgage Investment Conduits, or REMICS, which have no tax liabilities. Congress could change the tax code to eliminate that valuable benefit for any REMIC holding more than a certain percentage of defaulted mortgages. This would provide a strong incentive to either modify mortgages or allow borrowers to refinance into Hope for Homeowners, a program designed to allow underwater borrowers to refinance into Federal Home Administration mortgages based on the current value of the property.
HAMP is falling short of expectations that we and others had set out for the program. Changes to the program from within (with appropriate transparency to allow public oversight) and additional pressure brought to bear from without can improve the opportunities homeowners have to avoid foreclosure. The magnitude of the economic crisis underscores the need for quick, decisive action to prevent additional foreclosures. Economists and policymakers alike have recognized that solving the housing crisis is the key to economic recovery, and HAMP lies at the center of those efforts.
Andrew Jakabovics is the Associate Director for Housing and Economics at American Progress.