This is a miracle. The Treasury Department has said for two years that they were very limited in how they could sanction mortgage servicers for violations of HAMP guidelines. Critics would reply that, well, Treasury is paying the servicers for successful loan modifications, and they could simply withhold or even claw back the payments. At this point, Treasury would hem and haw.

Well, guess what. More than two years later, Treasury has done some rudimentary assessments of servicer conduct, and they found enough violations and bad behavior that they actually announced they would withhold the incentive payments.

Three of the nation’s largest mortgage servicers will no longer receive payments tied to their participation in the Obama administration’s main foreclosure prevention initiative until they improve their performance in that program, a senior administration official said Wednesday.

Bank of America, J.P. Morgan Chase and Wells Fargo need to make “substantial improvements” to collect fees through the Making Home Affordable Program, which helps struggling borrowers by lowering their monthly mortgage payments.

The companies failed to meet basic program requirements, such as properly contacting borrowers, the official said. The details are scheduled to be released Thursday in a report that will assess the performance of the 10 largest participating servicers [...]

The three targeted servicers — which received $24 million in payments last month — will not receive payments for permanent modifications reported from June onward until they address their weaknesses.

That’s one way to keep the country under the debt limit; stop paying fraudulent companies for conduct that violates their contact with the government!

I have the performance report on the servicers right here. As you can see, based on the data in here, as well as this preliminary review of how HAMP is working in Massachusetts, BofA, JPM and Wells are simply violating the program guidelines. The number of days it takes them to get to a decision on a trial modification is well above the national average. The number of resubmissions, or additional times these servicers ask borrowers to resubmit personal income statements or other documents, is well above the national average. The time from trial to permanent modification is above the national average. The wait times for customer service are elevated.

Interestingly, Treasury actually named four servicers who needed “substantial” improvement, but only sanctioned three with the withholding of incentive payments. The other is Ocwen. You may recall that they just bought Litton Loans, the servicing unit of Goldman Sachs. Perhaps that was a factor; Treasury says that “Ocwen’s compliance results for the first quarter 2011 were substantially and negatively affected by its acquisition of a large servicing portfolio during the compliance testing period.” Litton Loans, incidentally, is one of the servicers named as needing “moderate” improvement.

In a statement, Tim Massad, who is overseeing HAMP at Treasury, said, “While we continue to get tens of thousands of new homeowners into mortgage modifications each month, we need servicers to step up their performance to meet the needs of those still struggling. These assessments set a new benchmark by providing an unprecedented level of disclosure around servicer performance and will serve to keep the pressure on servicers to more effectively assist struggling families.”

A few things here. One, it took over two years for Treasury, after several denials that there was any problem with the servicers at all, and multiple excuses for why they couldn’t do anything about it, to withhold the incentive payments. I suppose it’s good news that Treasury succumbed to insistent pressure from consumer and housing advocates who maintained that the servicers were breaking the contract and needed to be held accountable. But Treasury could have gone further and clawed back ALL incentive payments paid to these servicers because of their broken promises. After all, noncompliance should void the contract entirely.

There’s also a sense that it’s far too late for this newfound stringency to have much of an effect. Borrowers have given up on HAMP. There were only 29,000 new trial modifications in April, which is actually close to the six-month average. There are millions of borrowers in trouble; 22% of all properties are in negative equity, or “underwater” on their home. HAMP is a non-program at this point, and it’s mainly because of word of mouth; borrowers have been so damaged by the program that they’re wary of getting involved with it, and counselors are wary of steering borrowers into it. This is why HAMP will miss its targets for permanent modifications by a wide margin, and why just $1.85 billion out of $50 billion allocated has been spent.

These steps, like withholding incentive payments, and mandating a single point of contact, and introducing the net present value calculator, are all things Treasury should have done IMMEDIATELY when they saw the servicers abusing the program. That would have not only forced compliance, but alleviated the suffering of hundreds of thousands if not millions of borrowers. It took too long to get to this point, and by now HAMP has outlived its usefulness.

UPDATE: Wells Fargo is “formally disputing” the withholding of payments and may sue the Treasury Department. Apparently the phrase “breach of contact” isn’t a big one over at Weels.