Near the end of our foreclosure panel, we finally got into the meat of the situation: what it will take given a government unwilling to do more for struggling borrowers to actually reset the broken housing market. With HAMP’s complete failure – to date only $250 million of the $75 billion promised by the program has even been spent, and leaders are reduced to begging for more modifications – and the inability of bankruptcy judges to force loan modifications out of the servicers using cramdown, really the only prospect left for these homeowners is to default. That’s not the breaking of a contract but the honoring of it. When the homeowner cannot make the payments or decides the investment isn’t worth it, they turn the house back over to the bank. It’s implicit in the contract, and it’s a typical, normal business tactic taken by all kinds of small businesses and corporations over the years.
Just a quick perusal of this CRS report on foreclosure mitigation programs shows them to be completely impotent to stop the problem, which reached record levels in the second quarter of this year. Even the tweaks to HAMP made by Treasury haven’t changed the basic “wish and a hope” structure of the program (not the bolds, which are mine):
Another change to HAMP is that participating servicers will be required to consider reducing principal balances for homeowners who owe at least 115% of the value of their home. Servicers will have to run two net present value tests for these borrowers: the first will be the standard NPV test, and the second will include principal reduction. If the net present value of the modification is higher under the test that includes principal reduction, servicers have the option to reduce principal. However, they are still not required to do so. If the principal is reduced, the amount of the principal reduction will initially be treated as principal forbearance; the forborne amount will then be forgiven in three equal amounts over three years as long as the borrower remains current on his or her mortgage payments. The Administration will also offer incentives to servicers specifically for reducing principal. This change is not yet in effect, but the Administration expects it will be operational within a few months of the date it was announced.
Everyone who has tried to make this voluntary system work must know that they are operating without a hammer, a legitimate incentive (not the relatively weak cash outlay HAMP offers) to the banks, in the form of a stick and not a carrot, to implement the modifications. Cramdown could have been that hammer, but a captured Congress decided against it. So all that’s left as leverage for someone facing foreclosure is the threat to walk away. This is way Fannie and Freddie, along with Congress, are trying to punish strategic defaulters, as they have been termed, by denying them FHA-backed loans (basically all non-jumbo loans) for seven years.
There’s a moral component to this. Basically, people in trouble are being told they’re bad people for considering getting out of their predicament. They’re being compared to welfare queens and demonized in the elite media. As a result you turn houses into debtor’s prisons, a point reiterated by civil rights leader and organizer Gerald Taylor on a separate panel about the financial sector. “They are trying to bully and punish average folk and put them in a modern-day debtor’s prison,” Taylor said. “The banks won’t do it on their own. This change won’t happen unless we create a crisis.”
Not everyone will up and leave their home, nor will they have to. It’s the threat of leaving that will lead to the kind of sensible loan modifications needed to reset the market. Homeowners simply have no other leverage. You can already see Bank of America and others instituting modification programs that are in many ways better than HAMP, and threatening to leave, which would cause major writedowns, had a lot to do with it.
Strategic defaults are supposed to go against the American ideal of fairness. But what is more American than starting over? Elizabeth Warren made the point on the panel that our bankruptcy laws have created the innovative, nimble economy we have, because it allows entrepreneurs to fail without life-threatening economic consequences. Homeowners need this kind of backstop and right now they don’t have it.
The other option is leaving behind a substantial chunk of the middle class, particularly racial minorities and the elderly, people with a lot of equity in their homes. And everyone else, too, because without resetting the housing market, the economic crisis isn’t likely to resolve itself. The choices are clear – wait it out and disrupt the lives of millions permanently, or walk away, and get a new start on life.