ANALYSIS: Some servicers are dragging their feet on loan modification

Homeowners across the country facing foreclosure are still having a difficult time getting help with their mortgages despite the Obama administration's efforts to reduce home foreclosures through its Home Affordable Modification Program (HAMP).

That’s why representatives from the nation’s top mortgage servicing companies will be called to the carpet later today by senior officials from the departments of the Treasury, Housing, and Urban Development to defend their performance record under the HAMP program.

The invitation to the meeting, described by The New York Times as an ultimatum, was sent as a joint letter signed by Treasury Secretary Timothy Geithner and HUD Secretary Shaun Donovan expressing not-so-veiled frustration with servicers' lack of effective mortgage modification action to date.

Nor are Geithner and Donovan the only ones who are disappointed. At a recent Senate Banking Committee hearing, the frustration was bipartisan.

As of mid-July, there were 160,000 trial mortgage modifications made by servicing companies, with another 165,000 offers outstanding.

This number pales in comparison to the more than 1.5 million properties that received a default or foreclosure notice in the first half of the year. Foreclosure activity in the second quarter reached new highs even as the program was under way.

Unfortunately, while embattled homeowners did respond—MakingHomeAffordable.gov has had 27 million page views—servicers promised to participate but seemingly failed to deliver.

That leaves the Obama administration with two options. The first is to improve mortgage modification outcomes under HAMP. And the second is to lay the groundwork for additional policies to prevent unnecessary foreclosures.

In order to improve HAMP outcomes, we need to understand why modifications aren’t happening at the rate we would like. Unfortunately, the lack of transparency in the program makes it difficult to determine where the points of failure lie.

A Government Accountability Office report released last week, for example, found “The lack of adequate documentation and specification of the assumptions makes it difficult to assess the reliability of Treasury’s estimates and, going forward, may hinder efforts to evaluate how well the program is meeting its objectives.”

HAMP calculates whether a modification is more valuable to the mortgage holder than going through foreclosure.

But the formula is not publicly available, which limits everyone’s ability to determine and debate whether certain choices and assumptions built into the model are appropriate. That's like trying to diagnose why a car won’t start without looking under the hood.

There is a growing chorus of consumer advocates, academics, and investors who want HAMP to promote principal reductions over interest rate cuts.

The monthly payment on a mortgage can be lowered to 31 percent of income by reducing principal just the same as by reducing the interest rate.

Since negative equity in the property is highly correlated with default, principal reductions should reduce default risk on the modified mortgages and make modification the preferred alternative to foreclosure. 

In trying to understand why more modifications aren’t happening, many roads lead back to the mortgage servicing companies. Banks have increased staff levels in their servicing departments, but servicer capacity and training seem to be the biggest roadblocks to success.

Next week the first of monthly scheduled reports from Treasury will break out modification activity by servicer and will allow us to determine whether there are flaws in the program itself—if servicers across the board have low rates of modification—or whether individual servicers are lagging behind.

Unfortunately, enforcement is another area where expectations for HAMP are falling short.

Treasury recently announced it is working with Freddie Mac to develop a “second look” program to make sure that borrowers are not wrongly (or wrongfully) turned down for a modification.

 Early indications are that the second look at rejected applications is flagging far too many cases where a modification should have been offered.

Even so, the program lacks a formal appeals process. Borrowers who get rejected from the program often get no explanation of why they were turned down, which is itself a potential violation of the Fair Credit Reporting Act.

There is no opportunity to challenge any of the servicer’s assumptions, such as the value of the property or the accuracy of the homeowner’s credit score, both of which have tremendous bearing on the outcome of the net present value test.

The Center for American Progress strongly believes that requiring mediation prior to foreclosure for all loans serviced by HAMP participants will improve program outcomes.

Improving HAMP processes may only get us so far, however. If some loan servicers truly lag far behind their peers, then it will be necessary to act more aggressively.

While participation in HAMP is voluntary, and changes to the terms of the contract allow servicers to opt out of the program, Treasury still has the upper hand in most cases. The largest servicers are all recipients of the $700 billion Troubled Asset Relief Program, and many of them are looking to pay back the TARP funds to get out from under the government’s thumb.

In addition to paying back the TARP money with interest, there are also outstanding warrants whose value is open to negotiation. Treasury can use those negotiations over the value of the warrants as an opportunity to improve HAMP.

One idea: allow Treasury to buy out (at a discount) the servicing rights of underperforming servicers or even acquire them outright in exchange for some of the outstanding warrants. Treasury could then resell those rights to the servicers who do a better job.

Bankruptcy reform is not the only avenue for congressional action. As of the end of last year, half of all seriously delinquent mortgages were in privately issued mortgage-backed securities, despite being only 15 percent of the outstanding mortgages.

By way of comparison, Fannie Mae and Freddie Mac had a combined 56-percent market share but only 20 percent of the delinquencies.

Mortgage-backed securities are issued by special trusts known as Real Estate Mortgage Investment Conduits, or REMICS, which have no tax liabilities.

Congress could change the tax code to eliminate that valuable benefit for any REMIC holding more than a certain percentage of defaulted mortgages. This would provide a strong incentive to either modify mortgages or allow borrowers to refinance into Hope for Homeowners, a program designed to allow underwater borrowers to refinance into Federal Home Administration mortgages based on the current value of the property.

Economists and policymakers alike have recognized that solving the housing crisis is the key to economic recovery, and HAMP lies at the center of those efforts.

Andrew Jakabovics is the Associate Director for Housing and Economics at American Progress.