I know we’ve been talking about the tax rate like it’s the only thing that affects the economy, but the truth is that housing has led every recovery in the last 50 years, and there’s absolutely no sign that the market will pick up or that we’ve even begun to arrest the foreclosure problem. The Congressional Oversight Panel’s latest report on HAMP is depressing in this regard.

HAMP is basically flailing. The report claims that 700,000 families will ultimately be helped by TARP, but that’s undercut by a 21% first-year redefault rate for the program. HAMP allows the lender to basically set the terms of the deal, and as a result the “permanent” modifications are generally 5-year payment reduction programs that reduce the interest rate slightly. Almost never do the banks engage in the kind of principal reductions that would give the borrower a fighting chance to stay in the home over the long-term. This would still be a good deal for the mortgage holder, since the other option would be a foreclosure sale at a much lower price.

But as we’ve discussed, the loan servicers managing the modifications have substantial incentives to foreclose instead of modify. They simply make more money off of a foreclosed borrower than they do with the puny incentive payments handed out by the Treasury Department for modification. This simple truth means that the design of the system is flawed. Over the next several months, we’re likely to see more borrowers drop out of the system, even out of permanent modifications, than borrowers who get approved for one (borrowers, owing to word of mouth I suspect, have stopped even trying for a HAMP modification). And it’s only going to get worse at the end because, instead of reducing principal, HAMP modifications typically have balloon payments and multi-point interest rate increases on the back end. Even if struggling borrowers make it through the five-year period, they’re going to be in basically the same position on the other side, absent a change in their financial situation. Adam Levitin believes that by the end, only 100,000 or so borrowers will save their homes through HAMP.

That’s a stunning failure in the face of a foreclosure crisis with millions of homes entering the default stage over the next year or two. And I’m not even getting into the clear failures of HAMP in wrecking credit scores, turning good borrowers into foreclosure victims, preying on borrowers with hidden fees and demand letters, etc. Treasury could at least stop this rampant abuse of their program, but to date they have not sanctioned any servicer for misdeeds with HAMP. They’re afraid the servicer would drop out of the program, and so this fear of the banks has stifled any regulation or oversight. Levitin argues that Treasury needs to shut down the program, and since they statutorily cannot restructure it in a major way (the deadline was October 3), I have to agree:

Is HAMP a worthwhile program?

It’s hard to say that it is. HAMP will help some homeowners keep their homes and avoid foreclosure. That’s always a good thing, even if it helps only say 100k homeowners in the end, instead of 4M. And HAMP has had some benefits in terms of creating standards for non-HAMP modifications. But some of the homeowners who keep their homes with a HAMP modification might have been able to keep those homes without HAMP through a proprietary modification that wasn’t subsidized with taxpayer dollars.

Ultimately, the message to take away from HAMP is that the Obama administration just isn’t serious about helping homeowners. The plight of distressed homeowners’ is subsidiary to protecting the banks from having to take serious write-downs. There’s plenty to say about the politics of that decision, but from an economics perspective, I just think it’s short-sighted. The economy will not see a robust recovery until there is serious consumer deleveraging and a stabilization of the housing market. Those two problems go hand in hand, given that mortgage debt is the biggest chunk of consumer leverage. And there really isn’t any way to deleverage consumers without there being losses for the financial sector.

Levitin points to a figure in the report showing the percentage of Tier 1 capital the big banks have tied up in second liens. It’s incredible, (BoA: 83%; JPM: 78%; Citi: 41%; Wells: 116%) and it suggests that if the banks did anything serious about the housing problem, they would be insolvent. This is reflected in the blocking of modifications on first mortgages where one of the banks has an interest in the second lien. So we’re just going to muddle through, and HAMP will just remain an extend and pretend scheme that has real consequences for borrowers.

Given that HAMP is predicted to only pay out $4 billion in incentive payments – out of a $75 billion commitment between Treasury and the GSEs – the only thing it bought is time for the banks. But that won’t even work out for them. The market is losing steam, prices continue to drop, and the servicer strategy of foreclosing on everybody will soon meet the limits of success.

More from Yves Smith.

…Yes, Treasury could simply shift the money allocated for to other programs, and actually they’ve done that in part. But recall that Treasury refuses to allow the Hardest Hit Fund grants to go to legal services for foreclosure victims in the states, something in dire need so borrowers have adequate representation. They’re trying at every turn to make these programs ineffective.