Tuesday, March 29, 2011

5-Part Series, Digging Out of America's Foreclosure Mess; Part 2, Failed Government Intervention

Photo Credit - Flickr Common
In March 2009, the Obama administration launched the Home Affordable Modification Program (HAMP) promising it would keep 3-4 million struggling families in their home. To date, the HAMP program actually helped about half a million. Treasury Secretary Timothy Geithner has acquiesced the program will not meet the numbers promised.

On March 16, 2011, the Congressional Oversight Panel (COP) released its final report.

Within the specific report “A Review of Treasury’s Foreclosure Prevention Programs” released December 14, 2010, the COP reported, “In April 2010, in its most recent report on Treasury’s foreclosure prevention programs, the Panel raised serious concerns about the timeliness, accountability, and sustainability of Treasury’s efforts. As the Panel noted at the time, “It now seems clear that Treasury’s programs, even when they are fully operational, will not reach the overwhelming majority of homeowners in trouble…. Treasury is still struggling to get its foreclosure programs off the ground as the crisis continues unabated.”

The report’s conclusion of the success of the HAMP was brutal yet honest. “The Panel now estimates that, if current trends hold, HAMP will prevent only 700,000 to 800,000 foreclosures – far fewer than the 3 to 4 million foreclosures that Treasury initially aimed to stop, and vastly fewer than the 8 to 13 million foreclosures expected by 2012.”

The COP puts the blame squarely on the shoulders of the Treasury even though they noted the economic logic may have initially been strong. The HAMP issues the COP cites include:

*Insufficient initial understanding of the real world financial incentives of lenders and servicers

* Ineffective program design with no requirement of lender participation

*Inadequate management of Fannie Mae and Freddie Mac conflict of interest element

*Poor communication to homeowners of availability

*Limited process for homeowner application

*Deficient program data collection and analysis

*Deficient monitoring of program execution.

In detail from the COP report, “In particular, banks typically hire loan servicers to handle the day-to-day management of a mortgage loan, and the servicer’s interests may at times sharply conflict with those of lenders and borrowers.”

“For example, although lenders suffer significant losses in foreclosures, servicers can turn a substantial profit from foreclosure-related fees. As such, it may be in the servicer’s interest to move a delinquent loan to foreclosure as soon as possible.”

It continues, “HAMP attempted to correct this market distortion by offering incentive payments to loan servicers, but the effort appears to have fallen short, in part because servicers were not required to participate.”

“Another major obstacle is that many borrowers have second mortgages from lenders who may stand to profit by blocking the modification of a first mortgage. For these reasons among many others, HAMP’s straightforward plan to encourage modifications has proven ineffective in practice.”

The report provides an answer to why most HAMP applicants could testify to having the same paperwork requested several times by the same lender during their loan modification approval process without reasonable explanation.

These applicants may now realize what perhaps the real problem may have been with their HAMP approval process with this conclusion from the COP report. “Treasury has also failed to hold loan servicers accountable when they have repeatedly lost borrower paperwork or refused to perform loan modifications.”

“Treasury has essentially outsourced the responsibility for overseeing servicers to Fannie Mae and Freddie Mac, but both companies have critical business relationships with the very same servicers, calling into question their willingness to conduct stringent oversight.”

“Freddie Mac in particular has hesitated to enforce some of its contractual rights related to the foreclosure process, arguing that doing so ‘may negatively impact our relationships with these seller/servicers, some of which are among our largest sources of mortgage loans.’ Treasury bears the ultimate responsibility for preventing such conflicts of interest, and it should ensure that loan servicers are penalized when they fail to complete loan modifications appropriately.”

The COP communicated several concerns and made many suggestions to the Treasury during its oversight tenure for improvements. This feedback was ignored. COP concluded, “Absent a dramatic and unexpected increase in HAMP enrollment, many billions of dollars set aside for foreclosure mitigation may well be left unused. As a result, an untold number of borrowers may go without help – all because Treasury failed to acknowledge HAMP’s shortcomings in time.”

The COP offers now that at least there should be learning from mistakes in developing any further programs. “Future policymakers should be mindful that the incentives of mortgage servicers are different from those of the government, and design any foreclosure mitigation program with that reality in mind.”

Truer words could not have been spoken by the COP. Those that work in housing related industries do understand the problem from the perspective of real world everyday business workings unlike those with layers of insulation making policy in meetings in the buildings in Washington D.C.

Our series working experts are Massachusetts professionals Elliott Topkins, a real estate attorney with Topkins & Bevans and author of the Realtors Resource Blog and lender and asset manager Bryan Ganz, CEO of Scudder Bay Capital, LLC.

Elliott believes the HAMP has not worked, because “It was poorly envisioned. There were not enough incentives for the lenders. I would like to have seen write-downs of mortgages to the current fair market value of the home in hardship situations. Lenders should have been given tax credits for the markdowns.”

Bryan details, “While the federal government has made much of the moral imperative that financial institutions have to modify loans, the fact is the federal government penalizes any institution that actually agrees to reduce a borrower’s principal amount or even lower their interest rate.”

He explains further, “It used to be the case that when a financial institution purchased a mortgage on the secondary market and modified the loan, the homeowner was taxed on the debt that was forgiven, and the financial institution was taxed on the difference between the purchase price of the loan and the new modified face amount. As a result, mortgages were rarely, if ever, modified.”

Bryan notes, “In response to the housing crisis, the tax on homeowners was eliminated, but the tax on the financial institution was left untouched. Since almost all nonperforming loans have been sold at a discount on the secondary market, these taxes on ‘phantom income’ serves as a very real deterrent to modification, particularly as almost half of all mortgages modified since 2005 have re-defaulted within a year of modification.”

He offers, “It is asking much of these institutions to pay an upfront tax on a 30 year stream of future payments when these payments so often cease within a year of the modification. It only stands to reason that if this tax is eliminated, the number of modifications will increase, and the number of foreclosures will decrease. Moreover, this change to the tax code would be revenue neutral over time as the tax would still be due when the lender actually receives the payments.”

Looking at the bigger picture of the real estate industry as a whole, what do our experts believe are the largest mistakes being made by the real estate professionals and industry as a whole in this crisis period?

Elliott answers with questions of his own. “A big mistake has been accepting the status quo and making “short sales” a new flavor of choice. What happens to the people who have an approved short sale? Where are they going? Why can’t we figure out a way to keep these people in their homes? Of course, I mean the worthy ones. I mean the ones who are looking for a fresh start.”

Bryan answers, “I think the most serious and egregious errors were made in the loan origination process with loans being made with no regard for the borrower’s ability to pay. The mistakes being made now, such as robo-signing and filing foreclosure proceedings before loans have been “assigned”, are more technical in nature. Frankly, I believe they are being overstated by the media.”

He notes, “These problems are simply due to the enormous quantity of bad loans the banks and servicers must deal with now. At Scudder Bay, we handle only a few dozen loans a year, so we can take a hands-on, personal approach. In fact, we meet with every homeowner face-to-face. This is simply not possible for the large banks and servicers. Consequently, the biggest mistake being made today is not devoting adequate resources to the problem.”

What do our industry experts believe are the best efforts being made by the real estate professionals and industry as whole in this crisis period?

Elliott shares his personal feelings. “Other than the isolated Bryan Ganz’s, I cannot see much. The industry needs to take some kind of a stand to prevent suffering and pain for families who are stuck. I want to see modifications which permit people to grow equity in their homes. I want to see people stop worrying about being thrown out of their homes.”

Bryan speaks to the bigger picture, “Once again, due to the enormous scope of the problem, it will be hard for the large servicers to really take the hands-on approach needed to resolve the current crisis in a manner that is best for both their shareholders and society as a whole.”

Bryan wants Washington and homeowners to understand, “The truth is the banks and servicers really don’t want to take title to the homes. They already have a glut of unsold homes. They would vastly prefer to figure out a way to keep people in their homes and get the loan performing again. This takes a lot of time and personal attention however.”

He laments, “Unlike past financial problems, the mortgage crisis cannot be dealt with wholesale. It must be dealt with retail – one borrower at a time. This is what makes this problem so difficult to deal with. The banks simply don’t have the resources. If there is one thing that the large banks and servicers should do, it is to devote more resources to resolve their problem loans.”

Bryan advises, “The current proposal from the Obama administration to have the banks commit $20 billion to loan modification misses the point. It is not a question of money. These loans are already underwater by many hundreds of billions of dollars, for the value of the collateral supporting these loans is far below the unpaid principal amount of the loans.”

“The issue is that the banks and servicers simply don’t have the resources to meet with each homeowner and evaluate their ability (and willingness) to pay. The answer is for the banks to devote sufficient resources to this effort or to sell the loans to firms that are willing and able to deal with the problem one loan at a time. This is what my company specializes in.”

Bryan summarizes, “There are things that can be done. We first need to change the way we approach the problem. The federal government’s “one size fits all” approach to the problem is not only wrongheaded, it is ineffective. It is not necessary to over complicate the matter.”

“The truth is two sizes will fit all. By that I mean, in order to come up with a workable plan for resolving today’s foreclosure crisis, we must first distinguish between those homeowners that can actually afford to stay in their homes and those that cannot. While this may seem obvious, it is a distinction that seems to have been lost upon policymakers in Washington.”

Visit tomorrow for Part 3, New Government Programs

Part 1 - Prolonged Pain

Part 3 - New Government Programs

Part 4 – Socially Conscious Private Investment

Part 5 – Working Investor Solution

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