Since the introduction of the Obama HAMP program, Banks and loan servicers have modified loans primarily by reducing interest rates or extending the term of the mortgage. These methods may temporarily help borrowers struggling to make payments without requiring lenders to lower the principal owed. By avoiding principal reduction, the bank's don't have to recognize immediate losses on their books, profits are improved, book value assets remain inflated and stock prices can continue to climb.  Its smoke and mirrors accounting that ignores the true financial health of the banks and allows for fat bonuses for executives and improved value for the shareholder.  Based on 2nd quarter 2009 data, the government claims that in a small but growing number of cases, banks are going further and writing off some of the loan altogether.

The Obama administration, has made saving homeowners from foreclosure a cornerstone of its economic-rescue strategy. The Obama plan aimed at helping as many as nine million households struggling with mortgage debt through loan modifications or refinancings. The plans include financial incentives for mortgage-servicing firms that modify loans.  Unfortunately, the bankruptcy loan modification provision, which would have given judges the power to reduce principal on residences, died in the U.S. Senate a few months ago. 

The lobbying strength of the mortgage industry prevented passage of this much needed change in the law. Currently, judges can reduce principal loan balances on all over encumbered assets in bankruptcy, EXCEPT primary residences, thanks to a 1977 amendment pushed through by the mortgage industry.  The BK court system and procedures are already in place to handle judicial loan modification.  It turns out that, even in a crisis, the receipt of campaign contributions remains a powerful incentive for our representatives.  Broke people can't afford lobbyists.  Homeowners in financial distress cannot match the historically documented campaign contributions offered to many of our public representatives by the mortgage industry.

Ironically, banks may now have more flexibility to modify loans because of their success in stabilizing their balance sheets and, in some cases, raising fresh capital. A look at the stock market reveals that banks are doing fairly well.  Billion dollar executive bonuses are flowing again as a result of the infusion of billions of tax payer welfare subsidies.  Banks can afford "to take the pain up front," said Kevin Fitzsimmons an analyst at Sandler O'Neill & Partners LP in New York. "If they want a legitimate chance of salvaging something out of the loans, they are better off taking the loss now."  But will they...really?

The portion of loan modifications in the second quarter that involved reducing the principal jumped to 10% from 3.1% in the first quarter, according to the report released Wednesday by the Office of the Comptroller of the Currency, or OCC, which regulates national banks.  Big deal!  Consider that last year, banks were very rarely giving any loan modifications.  From this bankruptcy attorney's perspective, the loan mod industry didn't exist until less than 2 years ago.  Before 2008, it was known as the subprime mortgage industry.  With all due respect, the tripling of the number of principle reductions, in contrast to the government hype, indicates a failing economic-rescue strategy.  The fox is still watching the chickens and California law dogs have been muzzled by SB94.  Without BK reform or a private cause of action against loan servicers for lack of compliance with HAMP guidelines, we will not soon solve the growing problem facing home owners in financial distress.  

Look at the actual numbers:  The government plan targets 9 million homeowners in financial distress.  Realistically that number should be doubled as it fails to account for the borrowers who are current on loan payments, but who are considering walking away from properties that hundreds of thousands of dollars underwater, especially in the case of high debt Califonia.  The OCC report tallied 439,574 agreements offered to help troubled borrowers, including loan modifications and other repayment plans, in the second quarter. That was up only 75% from a year earlier when loan mods were rarely offered, just impossible repayment plans. But of this year's Q2 total, only 142,362 of the agreements were classified as loan modifications.  Consider that these HAMP loan mods are themselves time bombs akin to variable rate mortgages.  Based on today's rates, a HAMP loan mod can add up to 3.5% to the interest rate from year 6 to 10.   

Notwithstanding the problems borrowers may face down the road, these loan mods are often insufficient to help borrowers today.  Of loans modified in this year's first quarter, 28% were in default again within three months, the OCC said. Among those modified in last year's second quarter, 56% were in default again a year later.  More and more California borrowers are asking the question:  Even with a 5 year break in interest rate and payment, do I really want to own a home that is worth half of what I owe?  Even for current borrowers, the answer is increasingly, No way!  Many banks are ok with this, BankOne West gets a subsidy from the government to ofset its losses on foreclosed homes in addtion to an insurance pay out.  Foreclosures can be money makers for banks and servicers.

The real numbers on principal reduction are dismal.  Of the 142,362 loan mods executed, only 10% of those involved reducing the principal.  Think about it:  out of perhaps 18 million homeowners in financial distress, less than 15,000 principal reductions were offered lat quarter?  But there is another twist:  From an anecdotal standpoint, having touched about 200 loan mods in the last year, we have seen ONE principal reduction offered on a first mortgage.  The loan was serviced by Wachovia.  In contrast, we have seen about 20 principal reductions offered on second mortgages.  The sampling of my cases supports the notion that the vast majority, perhaps 95%, of the 15,000 principal reduction loan modifications are on second mortgages.

Why does this matter?  Understand that a second mortgage that is completely underwater gets nothing after a foreclosure, and maybe a few cents on the dollar on a short sale.  Furthermore, an underwater junior lien can be VOIDED and stripped off title in a Chapter 13 bankruptcy even under existing law.  Reducing principal on second mortgages barely helps the borrower and the bank's cooperation isn't need anyway.  If 95% of the 15,000 loan mods are merely second mortgage principal reductions, where is the real incremental value to the borrower?  Does this mean that less then 800 principal reduction loan mods were offered on first mortgages in the second quarter of 2009?  It seems so. 

The data represented in the government report is truly a drop in the bucket compared to the 18 million homeowners potentially in financial distress.  In my opinion, banks will never offer first mortgage principal reductions in such a significant number so as to stop the coming wave of property foreclosures.  Asset managers and real estate agents are lining up for the coming gravy train, too.  Banks must be forced to do so by changing the bankruptcy law back so as to allow judicial loan modification.  This will keep families and communities intact. 

Unfortunately, there is too much money to be made by lenders in coming wave of foreclosures  Offering principal reduction and recognizing the true losses that have occurred in the value of the collateral would kill current bank profits and eliminate billion dollar executive bonuses.  People need real help, I'm starting to wonder who our federal govermnent truly represents?

 

COMMENTARY ADDED, SOURCE:  http://online.wsj.com/article/SB125431960273352535.html