BLOG VIEW: Working Out The Kinks

As the automobile industry continues to look for cover under a tarp and Henry Paulson continues to shift gears on TARP, the role of the government in preventing foreclosures remains a highly contentious issue. Barney Frank, chairman of the House Committee on Financial Services, went on the offense against Paulson early this week, demanding that funds from the now seemingly directionless $700 billion bailout be channeled more directly toward aiding homeowners.

The Treasury's main man, so far, has strongly resisted this call (and, similarly, Detroit's pleas for assistance). You see, Paulson wants to invest, not spend.

While the debate about how to allocate the bailout package has received much attention (and deservedly so), two important news items may have flown beneath the radar. The Federal Deposit Insurance Corp. has proposed to the government a mass loan modification program modeled after the one in use at IndyMac Federal Bank (but featuring an even lower debt-to-income ratio of 31%). And HOPE for Homeowners (H4H) has been modified, because apparently – despite all the ballyhoo surrounding its Oct. 1 implementation – no one in the industry really found it all that attractive in the first place.

In testifying before the House Committee on Tuesday, FDIC chairwoman Sheila Bair explained that under her proposal, the government would share the risk of borrower re-default. This loss-sharing component, which is supposed to act as an incentive for investors, would be made available only after a borrower has made six payments under the new loan terms. She stressed that proposal guidelines ensure investor-friendly modifications (which is important, as Bank of America found out the hard way).

"If, as under the model applied at IndyMac Federal, the modification provides an improved net present value for security holders as a whole in the securitization compared to foreclosure, the modification is permitted under [servicing] agreements as well as applicable tax and accounting standards," she told the committee. By providing a "clear benefit from the modifications," servicers will also be protected from litigation, she added.

Paulson was correct in saying the U.S. rescue plan is not a panacea. Bair's plan may not be a panacea for the housing crisis, but it sure sounds like a decent starting point.

As for H4H � less than two months into its existence, the program has undergone significant changes. Some participating loans are now allowed to carry a 96.5% loan-to-value ratio (it was formerly 90%), holders of subordinate liens will receive up-front payments instead of possible payments at the time of collateral liquidation, and lenders will be able to extend the loan life from 30 years to 40 years. These changes shouldn't come as any surprise, as the number of borrowers who have signed up for H4H has been nothing short of a tremendous disappointment.

The lack of participation, however, probably can't be attributed to a lack of consumer interest. When FHA Commissioner Brian Montgomery spoke at the MBA's Annual Conference in October, he said traffic to HUD's Web site had doubled since the program's debut, and the agency was receiving no fewer than 1,000 calls a day. Clearly, the resources and/or motivation from lenders was the missing piece.

We'll see if the increased LTV does, in fact, get more mortgagees on board, and if the up-front payments to second-lien holders move any from off the sidelines. It's too bad these rules weren't incorporated into the program's original draft – perhaps more borrowers would be en route to sustainable mortgages – but better late than never.

CORRECTION: This blog was edited on 11/25 to replace ‘loan-to-value’ with ‘debt-to-income’ in the third paragraph.


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