Federal programs promising to help hundreds of thousands of struggling homeowners avoid foreclosure are falling painfully short of their goals. Policy makers, as a result, are tweaking existing initiatives and considering new ones as pressure builds for more aggressive – and more effective – strategies to forestall a foreclosure tide that threatens to further damage an already battered economy.
Against that backdrop, support is building for a loan modification program developed by the Federal Deposit Insurance Corporation (FDIC) that permits wholesale, large-scale loan modifications.
Diverging publicly from Bush Administration policy, FDIC Chairman Sheila Bair has been actively promoting this initiative, which would tap some of the remaining funding in TARP for loan modifications, despite the reluctance of Treasury Secretary Henry Paulson to use the bail-out funds for that purpose. Based on a strategy the FDIC has used with some success at Indy-Mac – the giant thrift that failed earlier this year – the program creates a system for modifying loans en masse (hence the name, “mod-in-a-box”) rather than individually, permitting the large-scale modifications that Bair and others contend are needed to address the problem.
Under the plan, the FDIC would share with lenders up to 50 percent of the losses on modified loans on a sliding scale based on the loan-to-value ratio. Between 101 percent and 150 percent, the FDIC share would decline to 20 percent, phasing out completely for loans above the 150 percent mark. The program would be available only for loans secured by primary residences and would allow loan-to-income ratio of up to 38 percent. Lenders would have to offer modified loans reducing the borrower’s monthly payment by at least 10 percent. The loss-sharing feature would apply only if borrowers make at least 6 payments after the modification.
Bair has estimated that the “systematic and sustainable” approach the FDIC is proposing would successfully restructure half of the 4.4 million loans currently in default or expected to default by year-end, covering an estimated $444 billion in loans at a cost to the government of $24.4 billion.
The FDIC plan has been attracting broad support across the political spectrum, from, among others, Federal Reserve Chairman Ben Bernanke, who said it offers “a very promising approach” and Sen. Arlen Specter (R-PA), ranking member on the Senate Judiciary Committee, who said the plan “deserves close consideration.”
In recent Congressional testimony, Paulson indicated that he has not closed the door on using TARP funds for loan modifications, but he has not expressed much enthusiasm for crossing that threshold. The FDIC’s modification strategy is “an important program,” Paulson said, but it is “a subsidy or spending program,” inconsistent with what he insists is the “investment” purpose of TARP.
MORE HOPE FOR HOMEOWNERS?
The foreclosure assistance program Congress authorized in the housing rescue package enacted in July has fallen short of the optimistic predictions for it – to say the least. As of a few weeks ago, the Federal Housing Administration (FHA) had received only 111 applications for the program, which agency officials had projected, would help as many as 400,000 borrowers over the next two years. “The response has not kept up with the need,” Steve Preston, secretary of the Department of Housing and Urban Development (HUD), acknowledged recently in a speech to the National Press Club. “Many Americans who should be getting help are not getting [that assistance],” he noted.
The program allows the FHA to refinance loans for troubled borrowers, but requires participating lenders to write-down the loan to 90 percent of the property’s current value – a haircut few lenders have been willing to accept. To make the program more palatable to borrowers and lenders, HUD has revised the rules so that lenders can approve loans of up to 96.5 percent of the property’s current value. The agency has also relaxed some of the underwriting requirements, allowing loan terms of up to 40 years (beyond the FHA’s standard 30-year maximum), and including borrowers with loan-to-income ratios of up to 31 percent. Borrowers with higher ratios are eligible for the program, but they must have at least 10 percent equity in their homes. The revised rules also offer lenders holding second liens (home equity loans or second mortgages) a share of any potential appreciation in the property when it is sold, and offer servicers an “immediate payment” (the amount of which isn’t specified) in exchange for approving the refinancing.
Critics doubt the revised rules will do much to increase the program’s appeal to borrowers (who don’t like the shared appreciation feature) or lenders, who aren’t required to participate. Uncertainty is another major problem, as Administration officials continue to revise existing assistance programs and ponder new ones, noted Jaret Seiberg, an analyst at the Stanford Group Co. “Until the industry has a better sense of all the options that are going to become available in the coming weeks or months,” Seiberg told American Banker, “it’s unlikely to lead to a surge in FHA rescue refinancings.”
As lawmakers and lenders explore strategies for increasing the number of loan modifications and improving their success rates, attention is focusing increasingly on the extent to which investors who own many of the loans are impeding restructuring efforts. While there is general agreement that servicers have some discretion to restructure loans, in order to protect the interests of investors, there is wide disagreement about just how much discretion servicers have. One case in point: Investors are reportedly challenging the expansive initiative Bank of America has unveiled to modify loans originated by Countrywide Mortgage – the failed company B of A acquired earlier this year.
Testifying recently at a hearing before the House Financial Services Committee, Michael Gross, a Bank of America executive, acknowledged that the institution is encountering some obstacles to its efforts to modify the Countrywide loans. Some servicing contracts, he noted, “may prevent us from doing modifications that would benefit borrowers and investors.” In some contracts, Gross said, “loan modifications are expressly disallowed.”
Democrats and Republicans alike are beginning to talk about the need to address that obstacle. One potentially significant proposal that hasn’t yet gotten much attention comes from Sen. Arlen Specter (R-PA), the ranking Republican on the Senate Banking Committee. Specter has proposed legislation establishing a “Foreclosure Evaluation Office” within the Treasury Department, charged with “coordinating and assisting” federal, state, and local foreclosure prevention efforts.
One provision of Specter’s bill would require loan servicers and attorneys representing investors who are planning to challenge loan modification initiatives, “to conduct a careful inquiry into the factual and legal bases of their claims.” That review should consider, among other factors, the wording of the financial industry bail-out legislation (TARP), which specifies that, unless servicing contracts provide otherwise, services owe a duty “to the entire pool [of investors] and not to any individual groups or tranches…”
Specter’s bill would also require investor attorneys planning modification challenges to obtain an opinion from the new Foreclosure Evaluation Office, certifying that the loan modifications at issue were “unreasonable” or contrary to Internal Revenue Service rules. This opinion, which Specter described as “admissible but not conclusive,” would not give servicers complete immunity from investor law suits, “but it should result in more uniformity, guidance and clarity regarding applicable legal standards and best practices…taking into account the public interest and current threats to our economy posed by barriers to modification,” Specter said in a statement accompanying his proposed legislation.
If the limited protection and guidance provided by this measure aren’t sufficient to overcome modification barriers, Specter said, Congress may have to consider additional measures to provide “sufficient safeguards” for servicers.
Question: Aside from having failed this year, what do Countrywide Financial, Washington Mutual and IndyMac Corp. have in common? Answer: All were regulated by the Office of Thrift Supervision (OTS), and their failures – caused by hyperactivity in the subprime mortgage market – illustrate that the OTS “was not an effective regulator,” a recent article in the Washington Post contends.
The headline – “Banking regulator played advocate over enforcer,” illustrates the primary complaint – the agency was more interested in supporting the thrifts’ growth strategies, and not nearly interested enough in reigning in their excesses. The regulatory shortcomings evolved over several years, the article says, “a product of the regulator's overly close identification with its banks, which it referred to as "customers," and of the agency managers' appetite for deregulation, new lending products and expanded homeownership sometimes at the expense of traditional oversight.” The article quotes, among others, Jim Leach, a former Republican Congressman who headed the House Banking Committee, before it became the Financial Services Committee. Leach supported efforts to ease some regulatory restrictions, but the OTS, he said, went way too far. “What you had here is a regulatory motif that was too accommodating to private-sector interests," he told the Post. And the result, he said, “is chaos for the industry, their customers and the national interest."
The line of industries seeking a piece of the ever-expanding federal bail-out pie continues to grow. The latest group to join that queue is the nation’s homebuilders, who argue that their industry is as essential to the economy as the financial services sector, which has thus far received all of the aid. The National Association of Home Builders is urging Congress to approve “Fix Housing First,” a $250 billion program offering home buyers a tax credit equal to 10 percent of the home’s value. The credit, capped at $22,000, would replace the $7,500 credit included in the economic stimulus bill Congress approved earlier this year, ineffective, builders say, because it was too small and had to be repaid over 15 years.
The incentive package the builders are promoting would also provide government subsidies reducing the 30-year fixed mortgage rate to 3 percent for loans originated during the first six months of next year and to 4 percent for loans during the second half of the year.
Builders argue that these measures would jump-start the stalled housing market — an essential first step, they say, to stabilizing the financial system and buoying the economy. “"The basic asset that is underlying all the financial problems that we're experiencing is highly unstable, and it's causing an ongoing hemorrhaging in the financial system," David Ledford, a housing policy analyst for the NAHB, told the Washington Post. "It's starting to snowball," he added.
But critics contend that the subsidies the NAHB is promoting would artificially inflate home prices and encourage new construction, extending the supply-demand imbalance instead of permitting the necessary market correction. "The government does not have the tools to rewrite the laws of supply and demand Harvard University economist Edward Glaeser told the Post. "By artificially increasing prices,” he warned, “we are encouraging more building."
Other analysts suggest that the larger credit isn’t likely to be much more effective than the smaller one, because market dynamics have changed. Concern that home prices would continue to fall may have been a major obstacle for buyers last year, but the larger problems now, Jared Bernstein, an economist with the Economic Policy Institute, says, are job losses and falling incomes. "You can offer people all sorts of credits,” he told the Post, “but if they don't have a job or income I don't know that they're going to take the bait."