The housing market has been on an upswing these past few years, but the mortgage bailout is far from a distant memory. Anyone doubting as much should pore through the most recent quarterly report from the Special Inspector General for the Troubled Asset Relief Program, or SIGTARP (see pdf). That audit, among other things, concluded that nearly 800,000 homeowners enrolled in the Home Affordable Modification Program (HAMP) face higher monthly mortgage payments once their current subsidy runs out. The five-year-old HAMP was designed to prevent foreclosures at a time when home prices were sinking and unemployment was rising. Yet defaults, the precursor to foreclosures, have occurred at high rates anyway. SIGTARP Inspector General Christy Romero admits that if interest rates continue to rise, the problem may get far more pronounced.
National Legal and Policy Center several times (such as here and here) has taken a critical look at the HAMP program. Back in early 2009 the new Obama administration, in the face of an accelerating nationwide mortgage meltdown, sought to minimize foreclosures and enable troubled borrowers to stay in their homes. The previous fall, during the Bush administration, Congress passed the Troubled Asset Relief Program, or TARP, to provide badly undercapitalized banks and other financial intermediaries with a $700 billion emergency loan pool. A number of federal officials, especially FDIC Chairwoman Sheila Bair, believed that helping homeowners in over their heads in mortgage debt was defensible and necessary. If banks could receive emergency funds to cover poor lending practices, they reasoned, so could homeowners to whom they made loans. Soon enough, in March 2009, the White House unveiled an initiative, Home Affordable Modification Program, to combat residential foreclosures and their negative effects on surrounding neighborhoods. The program, to be run by the Treasury Department, went into effect the next month.
The creators of HAMP intended to give homeowners with outstanding first mortgages originated prior to 2009, and delinquent for more than 30 days, an opportunity to refinance on highly favorable terms. The outstanding balance on a mortgage had to conform to the Fannie Mae/Freddie Mac loan limit of $729,750. If accepted into the program, a borrower would go through a trial and a permanent phase. The trial phase, lasting 90 days, would require the homeowner to make three timely payments. After clearing this hurdle, the homeowner would move on to the permanent phase, which could last up to five years. During this period, the monthly mortgage payment – which includes principal, interest, property taxes, property insurance and homeowner association dues – would be set at no higher than 31 percent of pretax household income. Administration officials envisioned interest rate reductions as the most common form of loan modification. Other potential forms of aid included term extensions, principal forbearance and principal forgiveness. As an incentive, homeowners who made timely payments would be eligible for a $1,000 reduction in principal for each year they remained in the program. And mortgage servicers and investors would receive bonus payments from the government for signing up borrowers and collecting payments.
Obama administration officials saw HAMP as a winner. As many as 3 to 4 million at-risk homeowners could avoid the pain of losing their homes to foreclosure. Banks would be spared of the time and expense of acquiring, managing and selling off large inventories of surplus properties. And neighborhoods with high concentrations of such properties would be stabilized. HAMP could draw upon up to $75 billion. Of that sum, as much as $50 billion could come from TARP and $25 billion could come from secondary mortgage lenders Fannie Mae and Freddie Mac, each under federal conservatorship since September 2008. Millions of homeowners since late 2007 either had lost, or were at a high risk of losing, their homes through foreclosure. A loan modification program seemed worth the effort. A lot could go right and little could go wrong – so it seemed.
The evidence, however, suggests that quite a bit has gone wrong, or at the least, hasn’t gone as right as expected. Evidence comes from a series of mandatory quarterly evaluations conducted by the program’s Special Inspector General, or SIGTARP. The conclusion of these weighty reports, insofar as they pertain to HAMP, is that the program has fallen well short of its goals. This allows for the fact that HAMP has drawn upon only about a fourth to a third of its potential $75 billion funding pool. SIGTARP audits repeatedly have indicated high rates of HAMP cancellations. The default rate for participants in the 90-day trial phase, for example, has been close to 40 percent, a staggering figure by any yardstick. Indeed, as of March 31, 2013, about half of the more than 2 million total HAMP modifications had resulted in cancellation. Around 775,000 of these cancellations occurred during the trial phase and the remainder occurred in the permanent phase. There was little getting around it: Large numbers of program participants had been unqualified to take out a mortgage on any terms.
The latest SIGTARP report, released on January 29, likewise reveals some disturbing tendencies. Of the nearly 2.1 million total HAMP trial modifications conducted during calendar years 2009-13, around 780,000, or 37 percent, of borrowers had dropped out or were removed. Of the 1.28 million trial loans converted to permanent status as of December 31, 2013, nearly 360,000, or 28 percent, had re-defaulted. And of the more than 900,000 remaining permanent loans, 894,410 were active and 23,790 were paid off. As five-year terms expire, sizable numbers of the active borrowers also may default because of interest rates resetting at higher market rates. Under program rules, after a borrower completes the “permanent” phase, that person’s mortgage interest rate rises each year by up to a full percentage point until reaching the prevailing rate on a 30-year fixed-rate mortgage at the time the loan was modified.
The TARP Inspector’s General’s Office, after analyzing Treasury Department data and taking into account likely interest rate increases, projected the overall HAMP median monthly mortgage payment to rise by about $200. However, increases would be significantly less for recent modifications. Whereas the projected rises for permanent modifications initiated during 2009, 2010 and 2011, respectively, are $242, $235 and $216, the increases during 2012 and 2013 (as of November 30) are only $139 and $146. This is encouraging news, but it isn’t cause for relaxation. SIGTARP concludes that between now and 2021, 782,748 HAMP homeowners, or 87.5 percent of the 894,302 current participants, can expect to pay more.
There are some good reasons why HAMP homeowners are facing higher monthly payments. First, around 85 percent of the existing HAMP loans were modified during the 2009-11 period. Thus, the years of higher average increases carry more weight. Second, a large number of participants live in states where house prices are high. In expensive California, which has heavy concentrations of HAMP participation, the projected monthly increase is about $300. Third, interest rates already have begun to rise. Freddie Mac announced last Thursday that a 30-year, fixed-rate mortgage averaged 4.40 percent during the prior week. That’s up by about a full percentage point from a year earlier. Fourth, about 95 percent of HAMP modifications have involved interest rate reductions, if not other forms of assistance as well. Rate increases will affect most borrowers.
Treasury Department officials are divided as to the long-run impact on default and foreclosure rates. Timothy Bowler, the department’s acting assistant secretary for financial stability (i.e., TARP chief) and an alumnus of Goldman Sachs, explains the situation this way: “Right now, we’re not seeing a lot of data saying that people whose loans have reset are more likely to default after having been current for five years. This is an issue we are monitoring closely, and we are determined to stay ahead of the curve.” SIGTARP Inspector General Christy Romero is a good deal more apprehensive. “We’re already seeing alarming re-default rates and are really worried that this could lead to more,” she said. “It will be a real challenge for people to pay the higher amounts.”
But will it? Currently, the median mortgage payment for borrowers in the Home Affordable Modification Program is $773 a month. SIGTARP has calculated that after factoring in all rate hikes, the figure will rise to $989 a month. That’s not a piddling increase, but it’s not unmanageable for those with steady jobs. And what mortgage lender these days will loan large amounts of money to people who don’t have a steady job? Yet there is a larger issue here: Our nation is in the process of socializing of the costs of poor lending decisions. We are turning homeownership for marginally qualified borrowers into an income-maintenance program. HAMP tacitly encourages homeowners as a whole to continue with behavior that led to the program’s creation in the first place. After all, with a bailout program in place, its continuation is politically feasible. And despite its focus on homeowners, the program in practice has been a subsidy for the financial industry as well. Payments to mortgages servicers and investors already have cost taxpayers more than $5 billion.
The unspoken assumption in all this is that homes should never be lost to foreclosure. This is a highly questionable assumption. While lenders and servicers should be punished for engaging in acts of willful abuse or deception, foreclosure remains a necessary feature of functioning housing markets. It is a painful personal experience, and one with dangerous effects on surrounding areas when carried to an extreme. Yet it does return housing to the market and make lenders as whole as possible. By aligning housing supply and demand, it indirectly lowers the cost of housing generally and enables lenders to boost their lending to qualified borrowers. In this light, the decline in the nation’s homeownership rate since the Great Financial Collapse of 2008 from 69 percent to 65 percent should be seen as a good thing. That decline of four percentage points comprises borrowers who, for whatever reason, were in way over their heads. The rate eventually will go up as the supply of vacant for-sale dwelling units returns to its natural level.
The political pressure to extend HAMP indefinitely is real. And it has been realized already. Last May 30, Treasury Secretary Jack Lew announced a two-year extension of the program beyond its scheduled December 31, 2013 expiration date for new applicants; the original expiration date, in fact, was December 31, 2012. Even if the program winds up as a model of efficiency, HAMP unwittingly encourages the sorts of risky lending that led to the mortgage crisis in the first place. HAMP is a costly way to sustain homeownership, yet because it is a response to populist sentiment, the political downside of continuing it is rather minimal. Few things these days are quite as permanent as a temporary mortgage subsidy.