Fighting foreclosure

Sunday, February 28, 2010; A14

THE OPTIMUM policy for the home foreclosure crisis is to modify the loans of as many distressed homeowners as possible. Making mortgage terms more affordable by mutual agreement enables families to stay in their houses, props up neighborhood home values and saves banks the huge costs of seizing and selling property at a loss. Turns out there is just one problem. It's not feasible to modify nearly enough loans to keep pace with foreclosures.

The Obama administration launched its Home Affordable Modification Program (HAMP) about a year ago. Funded with up to $75 billion from the Troubled Asset Relief Program (TARP), HAMP was aimed at cutting monthly mortgage payments to no more than 31 percent of eligible homeowners' income. To address the twin threats of lender resistance and borrower incapacity, the program offered cash to participating mortgage lenders but targeted only "families who have played by the rules and acted responsibly," in President Obama's words.

Yet after its first 11 months, HAMP is lagging. Of 1.7 million cases thought to be eligible in the first year, only 116,000 have received permanent loan modifications through January -- well below half what the administration had anticipated. The modifications are far outstripped by foreclosure starts, which totaled 316,000 in January alone, according to RealtyTrac. Lender resistance or incapacity explains only part of the shortfall; many borrowers failed to supply required documentation because it might show they had overstated their income to get a loan -- i.e., that they had not, indeed, "played by the rules."

Meanwhile, because of stubbornly high unemployment, the rate of redefault on modified loans is likely to be high -- 70 percent based on recent experience, according to a recent report by Standard & Poor's. The upshot is the buildup of a huge "shadow inventory" of perhaps 1.75 million properties that HAMP and other modification efforts spared from foreclosure for the last year or so but which are about to foreclose and come on the market, further depressing prices. Loan modifications "may simply have delayed the inevitable," the S&P report observes.

HAMP's problems have prompted calls for even more drastic modifications, including mandatory write-downs of loan principal. Bad idea. Slashing principal, presumably at taxpayer expense, might help some borrowers but comes with no guarantee that they won't end up defaulting anyway. What it would guarantee is moral hazard -- other homeowners would demand the same break -- and a stampede of private capital out of mortgage finance.

The silver lining is that HAMP and other loan modification efforts at least prevented a cascade of foreclosures at the height of the recession. Things are more stable now, so the economy can probably handle the "shadow inventory" better than it would have a year ago. To be sure, this relatively benign outcome depends on two big ifs: continued moderate interest rates and stable or declining unemployment rates.

HAMP has saved fewer homeowners than hoped, but to the extent it helped the housing market make a soft landing, it might even go down in history as a net plus. You could almost call it a successful failure.

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