Yves Smith: Should We Hope US "Making Homes Affordable Program" Doesn't Work?

Yves Smith at NakedCapitalism.com is one of my favourite bloggers, often covering issues I do not have capacity myself ...


Today Yves has an opinion about the US Treasury' s "Making Home Affordable Program". Read the full post here, but I excerpt here the key message:

In other words, if the program succeeds, we may not be so happy with where we wind up in a few years.

But I have my doubts that it will work. First, despite the bribes to servicers, I don't see strong reasons for them to play ball. These mods will be costly, I am not certain the comp is adequate, and mortgage securities holders may sue.

Second, the redefault rate on mortgage mods that do not have significant principal reduction in the first six months now is high. The New York Times reports that payment reductions are expected to be "hundreds of dollars" a month. Is that really going to make a difference with most borrowers, particularly since the interest portion is tax deductible and these mortgages are recent (ie, the interest component is a high proportion of the total payment).

Third, the program qualifies people based on mortgage payments relative to total income. Some consumers are so up to their eyeballs in debt that a mortgage mod is merely rearranging the deck chairs on the Titanic. So in this version of the program, borrowers with high levels of overall debt (55%= to income) get debt counseling! Let me tell you, someone in that fix is probably beyond hope. In the old days of easier credit, someone paying 29% on credit cards could get a somewhat less punitive rate via debt consolidation. I doubt there is much of that sort of credit on offer right now.

Fourth, second mortgage holders don't have reason to play ball. From the guidelines:
While eligible loan modifications will not require any participation by second lien holders, the program will include additional incentives to extinguish second liens on loans modified under the program, in order to reduce the overall indebtedness of the borrower and improve loan performance. Servicers will be eligible to receive compensation when they contact second lien holders and extinguish valid junior liens (according to a schedule to be specified by the Treasury Department, depending in part on combined loan to value). Servicers will be reimbursed for the release according to the specified schedule, and will also receive an extra $250 for obtaining a release of a valid second lien.

Fifth, these mods are voluntary. There is enough pressure being applied to banks now on government life support that they will be expected to make a good show of it, but the government has designed the template, and it is not obvious how much latitude banks have in participant selection (and whether they have the skills to make informed choices even if they were motivated to). However, there is limited protection against "mods for the sake of mods". The servicer gets no incentive payment if the borrower defaults within three months.

The possible real effect of the program may be revealed here:
Servicers will receive incentives to take alternatives to foreclosures, like short sales or taking of deeds in lieu of foreclosure. For those borrowers unable to maintain homeownership, even under the affordable terms offered, the plan will provide incentives to encourage families and servicers to avoid the costly foreclosure process and minimize the damage that foreclosure imposes on financial institutions, borrowers and communities alike. Servicers will be eligible for a payment of $500 and can make reimbursable payments up to $1000 to extinguish other liens, and borrowers are eligible for a payment of $1500 in relocation expenses in order to effectuate short sales and deeds-in-lieu of foreclosure.

Dean Baker has a point on media reporting here!