Introduction
Reed Saxon/Associated Press
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In his column on Monday, Paul Krugman said that the Obama administration has done almost nothing to help troubled homeowners. Of $46 billion set aside for mortgage relief, less than $2 billion has been spent.
It has been more than six months since a bipartisan Congressional report called the government's effort -- called the Home Affordable Modification Program -- "a failure."
Since then, new foreclosure filings have slowed significantly -- down by a third nationally -- because of a large backlog in cases, greater caution by lenders after the "robosigning'' scandals and more aggressive defenses by homeowners whose mortgages are in jeopardy because they lost their job.
But housing experts expect the pace of foreclosures to pick up again. What changes can be made in the program to make it work more efficiently -- for homeowners, mortgage holders and taxpayers?
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How We All Suffer
July 11, 2011
Kim Luu is the editor of Money and Risk and a principal at an independent brokerage firm specializing in retirement and 401(k)s.
The federal Home Affordable Modification Program was badly designed, overly complicated and poorly communicated. Borrowers suffered through horrendous paperwork for months and years. People ran through their retirement savings during the process, and then lost their homes anyway. Meanwhile, banks are saddled with billions of dollars in losses and inventory that still need to be auctioned.
Bank loan losses translate into lower stock prices and lower retirement account values for everyone.
For the thousands of homeowners dropping out of or failing to qualify for HAMP, it has obviously not been a success. People in foreclosure are not the only ones affected. We all suffer because bank loan losses translate into reduced stock prices and lower retirement account values.
If we are asked to pay billions for another rescue, we need a simple-to-execute program that protects the homeowners, the banks and the investors.
The solution doesn't have to be radical. I'm not a proponent of lowering the mortgage amount. When someone enters into a contract to borrow money, it is a commitment to be honored. They should be held responsible for paying it back as the money that they borrowed came from the bank deposits of their neighbors. Cutting mortgage debt because home value dropped encourages speculation now and in the future.
Adjust the payment schedule to the individual's specific situation without absolving responsibility for the debts.
The primary issue for troubled borrowers is variable payment size -- not variable interest or loan amount. Whether they went into a low starter payment to buy a house that they knew full well they could never afford, or whether they are 50 years old and got laid off and now making 50 percent less, HAMP should have addressed this issue with a meaningful solution.
Here's one proposal: adjust the payment schedule to the individual's specific situation without absolving responsibility for the debts. There is nothing wrong with a 40-year amortization if you plan to live in your home for life. Review the loans periodically and adjusted rates and payments back to market as income improves. Homeowners can request a review for adjustment up at any time. During unemployment, payments are deferred on negative amortization or are switched to interest only.
Give people the chance to work through financial distress with personal dignity and pride. Help those who are committed to staying in their homes. Let the speculators suffer foreclosure.
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The Cost of Delaying Foreclosures
July 11, 2011
R. Kelley Pace is the director of the Real Estate Research Institute and a professor in the E.J. Ourso College of Business at Louisiana State University. Shuang Zhu is a doctoral candidate in the department of finance there.
Providing cost effective and useful aid to struggling borrowers, while not creating any unintended adverse consequences, is the holy grail of foreclosure prevention programs. Even if a program's design achieves this goal, the actual performance depends on its implementation.
Prolonging the process provides additional free rent to defaulting borrowers and thus increases the benefit of default.
For example, a program seeking to reduce strategic default (a borrower with sufficient income who defaults because the mortgage balance exceeds the house price) might rely on an estimated house price (appraisal). However, appraisals are performed by appraisers who not long ago were cast as villains.
As villains they were biased and inaccurate. Now when working for the program, these heroes will be unbiased and accurate. In reality, appraisers also encounter difficulties in estimating prices for imperfect houses in low volume markets.
In a study of New Orleans foreclosures, we estimated that unspecialized, licensed appraisers might have an average error rate of around 10 percent. This means that about 4 percent of the properties would have appraisals that are either 20 percent too high or too low. Such appraisal inaccuracies could result in random borrower qualification and aid amounts.
A relatively low "cost" means of preventing foreclosures is to add delays to the process. For example, Massachusetts added a 90 day right-to-cure period as part of a revamp of their foreclosure rules. However, foreclosure delays provide additional free rent to defaulting borrowers and thus increase the benefit of default.
Actual foreclosure delays have been increasing. In 2003, none of the 16 states that we examined had over 12 months of delay. By 2008 (still before the documentation crisis), 50 percent of the states had a delay of over one year. In our research on this topic, we found that foreclosure delays had a statistically and economically significant impact on default.
For higher risk loans, imposing a three-month foreclosure delay had almost the same effect as increasing the average loan-to-value by 10 percent. Although increasing delays reduce the explicit cost of foreclosure prevention programs, they do impose costs on investors. By raising the risk of owning residential mortgages, mandated foreclosure delays potentially affect the access and cost of credit.
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The Unemployment Factor
July 11, 2011
Morris A. Davis is the academic director of the James A. Graaskamp Center for Real Estate at the University of Wisconsin-Madison.
The Home Affordable Modification Program is designed to prevent foreclosures caused by mortgages with exploding payments. The program creates incentives for banks to refinance these mortgages.
Don't reduce the principal -- that only rewards people who took on the most debt. Extend loans to unemployed homeowners instead.
The past two years of data suggest exploding mortgage payments are not the cause of the foreclosure crisis. Prime mortgages account for the majority of mortgage defaults. Instead, there are two “triggers” that cause foreclosures.
The first is when the value of the house is less than the mortgage amount, and homeowners cannot sell their house (unless they write a check at closing). The second trigger is when the homeowner experiences some disruption to income, like unemployment. Why? In most states, maximum monthly unemployment benefits are less than or not much larger than average mortgage payments. In a recent survey from Freddie Mac, the most frequently cited reason for “hardship” among borrowers was “Unemployment or Curtailment of Income” at 57 percent.
HAMP continues to fail because it does not address the root causes of foreclosures. Twenty percent of all residential properties with mortgages are under water; unemployment rates are high; and no one forecasts a quick recovery to house prices or employment. An effective foreclosure-prevention policy would directly address one of the two triggers. Some proposals under discussion require that banks write down mortgage principal. Other proposals suggest direct assistance to unemployed homeowners to help them make their mortgage payments.
I dislike the idea of principal reduction because it transfers wealth to people that took on the largest amount of mortgage debt relative to their home value. I would instead recommend the federal government institute the Boston Fed plan, which extends loans to unemployed homeowners. Homeowners would be offered a loan for a certain number of months while unemployed and would repay the loan over time once employed.
I like the Boston Fed plan because it directly addresses the unemployment trigger, and it is a loan which mitigates some moral hazard issues. Further, the program might directly benefit all U.S. taxpayers. After a foreclosure, the average loss to the holder of the mortgage is about $100,000. Fannie Mae and Freddie Mac insure against these losses on many mortgages. Any program that reduces foreclosures also reduces losses incurred by Fannie Mae and Freddie Mac, whose costs are now covered by U.S. taxpayers.
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How We All Suffer
July 11, 2011
Kim Luu is the editor of Money and Risk and a principal at an independent brokerage firm specializing in retirement and 401(k)s.
The federal Home Affordable Modification Program was badly designed, overly complicated and poorly communicated. Borrowers suffered through horrendous paperwork for months and years. People ran through their retirement savings during the process, and then lost their homes anyway. Meanwhile, banks are saddled with billions of dollars in losses and inventory that still need to be auctioned.
Bank loan losses translate into lower stock prices and lower retirement account values for everyone.
For the thousands of homeowners dropping out of or failing to qualify for HAMP, it has obviously not been a success. People in foreclosure are not the only ones affected. We all suffer because bank loan losses translate into reduced stock prices and lower retirement account values.
If we are asked to pay billions for another rescue, we need a simple-to-execute program that protects the homeowners, the banks and the investors.
The solution doesn't have to be radical. I'm not a proponent of lowering the mortgage amount. When someone enters into a contract to borrow money, it is a commitment to be honored. They should be held responsible for paying it back as the money that they borrowed came from the bank deposits of their neighbors. Cutting mortgage debt because home value dropped encourages speculation now and in the future.
Adjust the payment schedule to the individual's specific situation without absolving responsibility for the debts.
The primary issue for troubled borrowers is variable payment size -- not variable interest or loan amount. Whether they went into a low starter payment to buy a house that they knew full well they could never afford, or whether they are 50 years old and got laid off and now making 50 percent less, HAMP should have addressed this issue with a meaningful solution.
Here's one proposal: adjust the payment schedule to the individual's specific situation without absolving responsibility for the debts. There is nothing wrong with a 40-year amortization if you plan to live in your home for life. Review the loans periodically and adjusted rates and payments back to market as income improves. Homeowners can request a review for adjustment up at any time. During unemployment, payments are deferred on negative amortization or are switched to interest only.
Give people the chance to work through financial distress with personal dignity and pride. Help those who are committed to staying in their homes. Let the speculators suffer foreclosure.
==================================================================================
Broken Promises
July 11, 2011
Neil Barofsky is an adjunct professor at New York University School of Law. He was the special inspector general of the Troubled Asset Relief Program from 2008 to 2011.
The Home Affordable Modification Program, announced in February 2009 after Treasury abandoned its original promise to use Troubled Asset Relief Program funds to purchase and then modify up to $700 billion in mortgages, has been a failure.
At the time, President Obama promised that through incentive payments to mortgage servicers, investors and borrowers, HAMP would help three to four million American families stay in their homes through permanent, sustainable mortgage modifications. Nearly two and a half years later, that promise lies in tatters, with far more failures than successes, and estimates that, at best, the program will achieve only one-fifth of the upper end of its goal.
The Treasury Department has engaged in nothing more than political theater in addressing the universal criticism of its failed mortgage relief program.
Even if it is now too late to meet the president’s original promise, the lull in both HAMP modifications (with a six-month average monthly net addition of fewer than 21,000 permanent modifications) and foreclosures (which have been delayed following discovery of widespread documentation failures by mortgage servicers) present Treasury with an opportunity to respond to the program’s failures. Treasury should use this time – and the tens of billions of TARP dollars still obligated to HAMP – to improve the program before the next wave of anticipated foreclosures hits.
Unfortunately, Treasury has showed no willingness to address the program’s deep structural flaws. Despite Secretary Geithner’s concession to Congress earlier this year that its incentive payments to the mortgage servicers who effectively run the program have “not been powerful enough” to maximize participation, Treasury has done nothing to address this defect.
Similarly, although acknowledging the “abysmal” performance of those same mortgage servicers, Treasury refuses to sanction them meaningfully, portraying itself as impotent in the face of the servicers’ willful disregard of their contractual obligations.
Instead, in an obvious attempt to blunt near universal criticism of its velvet glove approach, last month Treasury took largely meaningless action against just three of the servicers by temporarily withholding payments until they stop violating the program's rules -- something to which they had largely already committed in a previous unrelated settlement with their regulators -- and then paying them in full. This action, which one servicer said “mean[t] very little” to it, is not even a slap on the wrist; it is political theater.
Although the president recently acknowledged that the housing efforts to date have been "not enough" and promised to go back to the "drawing board," Treasury has thus far shown no interest in trying to fix the program (a senior official of the Troubled Asset Relief Program promised a room full of cheering mortgage servicers earlier this year that it would only “tweak” HAMP around the edges), it could and should take steps to make the program more effective.
First, it should re-examine its incentive structure to fix the problems acknowledged by Secretary Geithner. Second, it should adopt a recommendation SIGTARP made last year, and make principal reduction mandatory in instances where it results in the best economic outcome for both the borrower and the owner of the mortgage. Finally, Treasury should live up to a promise it made in November 2009 to impose meaningful “monetary penalties and sanctions” on servicers, both to compensate for past violations and to ensure better compliance going forward.
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