I get frequent questions about loan modifications and resources for learning more about available programs. Those interested in learning more about this subject at the heart of the current financial crisis should start with the Wikipedia page entitled “Loan Modification in the United States.”
The page traces a brief history of the use of loan modifications during the Great Depression, then launches into a more substantive explanation of the factors that brought about the housing crisis in the late 2000s and the legislative efforts that have been made to use loan modifications to mitigate the effects of this crisis. Unfortunately, the page leaves out any mention of the many failed programs by which the government has sought to encourage modifications, such as the Helping Families Save Their Homes Act, which attempted to shore up the equally ineffective Hope For Homeowners Act. Moreover, the brief section entitled “Analysis of the results of the government-sponsored programs” gives little indication of the abject failure of these programs to reduce foreclosures.
Indeed, even the cash incentives in the Helping Families Save Their Homes Act have not compelled banks to perform as many modifications as Washington would like. As discussed in a recent article in The Huffington Post, Treasury Secretary Michael Barr said last week that, “The banks are not doing a good enough job. Some of the firms ought to be embarrassed, and they will be.” So, the Treasury’s solution is to compel action by public shaming? What Barr fails to discuss or maybe even recognize is that regulators have been pursuing this tactic for some time now, apparently without much success.
The alternative that was originally suggested as part of the initial government bailout, and which I have been advocating for months now, is to use TARP funds to create a new version of the Home Owners’ Loan Corporation (HOLC). Many readers will recall that the government established the HOLC in 1933 to refinance the loans of distressed borrowers to help avert foreclosures. The HOLC came to own nearly one fifth of the home loans in America but was ultimately able to sell off the loans and any underlying properties acquired via foreclosure—and even turned a small profit—when the market stabilized. In the present case, though this solution does not appear politically palatable, there is good reason to believe that an entity that could afford to hold these loans for long enough could recoup a significant portion of its investment (or even a profit) when the housing market recovers. Moreover, the government is probably the entity best equipped to cut through the red tape surrounding workouts and mediate between the various players involved in the securitizations containing most of the loans at issue. By utilizing its powers under the Takings Clause and paying just compensation to injured investors or lenders, the government could compel loan modifications that it determines will serve the public interest.
Otherwise, the only solution that makes sense at this point is to tilt the cost-benefit analysis being performed by banks by hitting them where it hurts–in the pocketbook. Washington has tried the carrot, now maybe it’s time to try the stick. Instead of giving servicers cash incentives to modify, try fining them when they don’t. The Treasury is already fining servicers for not reporting final disposition of their trial modifications, but again this strategy seems to be aimed at encouraging better behavior by publicizing intransigence. While I’m a big fan of this sort of reflexive incentive system where companies depend on repeat patronage by customers, servicers do not face the same fears of public scorn because borrowers cannot choose who is servicing their loan. And in this financial climate, it is wishful thinking to believe that those seeking a loan will shun the Big Four banks because of their abysmal record in performing loan modifications. Instead, the decision of who to go to for a mortgage is likely driven by who will approve the borrower for a loan at the best rate.
Though legislators and Wikipedia may pay lip service to the many programs Congress has rolled out to encourage modifications, there is precious little evidence that these programs are actually working. It has been nearly a year since the bailouts and other responses to this financial crisis began; it is high time that Washington abandon its gentle prodding and take a more direct approach to reducing foreclosures.