What the Government Could Still Do to Help Housing

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A worker tends to the yard around a foreclosed home in Miami, Fla.

Earlier this month, President Obama announced tweaks to the Home Affordable Refinance Program (or HARP), which was designed to help homeowners refinance underwater homes but so far had helped only 838,000 of the 5 million homeowners at whom it was aimed.

Under the revisions, borrowers can have one missed payment within the last year and still qualify (but none in the past six months); the 25% cap on “negative equity” is gone (until now, upside-down mortgages could be refinanced only up to 125% of the home’s current value); and the program will be extended through the end of 2013.

Unfortunately, all this amounted to mere tinkering and had little chance of lifting the housing debt burden that’s weighing down our economy. As TIME’s own Massimo Calabresi noted when the revisions were first revealed: “Obama’s new plan addresses only the size of interest payments on mortgages, not the problem of the underlying principal debt, which exceeds the value of one quarter of American homeowners’ houses.”

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The federal government has much less power to force principal reductions than many lay people think. Fannie, Freddie and FHA are responsible for over 90% of home loans being originated today, but the federal government directly controls only 20% of existing mortgages. Most of the rest are owned by investors. And though the Obama administration might have been able to force banks to agree to principal reductions at the height of the financial crisis — in exchange for federal bailout money — that opportunity is obviously long gone.

But the federal government still has some leverage at its disposal: the “robo-signing” settlements.

Last fall, almost every major mortgage lender/servicer was caught or confessed to signing thousands of mortgage affidavits without having read them while trying to process real estate foreclosures, committing the ostensible federal and state crimes of perjury and fraud on a massive scale. In the months since, the Department of Justice and all 50 states’ attorneys general have been working to investigate these crimes and negotiate a settlement with the banks. This settlement will presumably allow the banks to avoid criminal prosecution in exchange for paying a fine that goes to help distressed homeowners and agreeing to some sort of foreclosure prevention programs.

Over the year-long investigation, iterations of the proposed settlement have been criticized by different parties for different reasons. An initial, partial version of the proposed settlement was shouted down by mostly Republican state attorneys general, who said the code of conduct included was too strict and borderline legislative in nature. The next couple of versions proposed to deploy some portion of the penalty funds to principal reductions, but certain key insiders felt the scale of the penalty was inadequate.

In fact, several of the states with the most to gain or lose in the settlement, including California and New York, have opted out of the proposed settlements, saying that they can more aggressively leverage the threat of criminal prosecution on their own. Their primary goal appears to be exacting more dollars for principal reductions. (For their part, the banks have declared they are not willing to settle the case without California’s participation.) The federal DOJ, meanwhile, has at least as much leverage in the robo-signing matter as California.

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But it will require a lot of political will to pressure banks into a sweeping program of principal reductions using the robo-signing settlement. Many in the industry argue, along with several Republican state attorneys general, that such an agreement would promote so-called strategic defaults. (That is, some homeowners who can pay their mortgage might decide to stop in order to convince their bank to modify their loan.) To that, one answer is that strategic default is already fast growing more common and even socially acceptible, and holding the line on principal reductions isn’t helping.

Another is that several successful programs have shown that principal reduction could in fact decrease default rates. Felix Salmon mentions a couple of them here. In addition, West Palm Beach, Florida-based Ocwen Financial Servicing runs its own loan modification program, which resets homeowners’ mortgage balances at 5% below the current appraised value. That program has a re-default rate under 3%, compared with the 40% to 50% redefault rate of industry-wide loan modifications.

The robo-signing settlement is being negotiated this week — though the outlook for a quick settlement looks bleak. But when a settlement does finally emerge, I for one hope broad-scale principal reductions are part of the deal.

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