Mortgage Modifications: What Is the Point?

January 13, 2010 (Housing Market Monitor)

By Dean Baker

Modifications that involve payments to banks are giving money to banks, not homeowners.

It’s been two and a half years since the mortgage crisis became a national issue. In this time, more than 3 million homeowners have lost their homes through foreclosure. The current rate is close to 170,000 a month, near the peak for the crisis.

The various efforts to curtail foreclosures have had relatively little effect thus far on the number of people losing their homes. The first effort was the entirely voluntary “Help for Homeowners” program announced under President Bush. This had virtually no discernible effect on the rate of foreclosures.

The following summer, Congress passed legislation that committed up to $300 billion in loans to support modifications. As of April last year, when President Obama’s Home Affordability Modification Program (HAMP) began to kick in, around 2,000 homeowners had received permanent modifications through the program.

The HAMP program has been somewhat more successful, but it certainly is not helping the vast majority of people facing foreclosure. The latest data show just over 700,000 homeowners entering trial modifications out of more than 4 million delinquent mortgages. Only 32,000 of these trial modifications have been made permanent thus far, and many of these are likely to result in re-defaults. In other words, the modification efforts are badly trailing the pace of delinquency and foreclosure. After two and a half years of modification efforts, there seems little likelihood that this situation will change.

In pushing modifications, many analysts have failed to seriously consider the potential benefits to homeowners compared to alternative mechanisms. The fundamental problem in the vast majority of delinquencies is that homeowners are seriously underwater in their mortgages. In these cases, it is extremely unlikely that homeowners will ever end up with equity, even if they benefit from a successful modification.

During the bubble years, the median period of homeownership was just 5 years. In prior times it was 7 years overall, but less than 5 years for low- and moderate-income families. With house prices likely to fall another 10-15 percent as the remaining air goes out of the bubble, it is improbable that even a homeowner who ends up with zero equity as a result of a principle write-down will have accumulated any equity at the point where they sell their home.

Furthermore, most modifications are likely to still leave homeowners paying more in ownership costs than they would pay to rent a comparable unit. This means that each month, they are effectively throwing away money that they could otherwise spend on their children, on saving, or other uses. It is difficult to see how this excess spending on housing benefits homeowners and their families.

By contrast, if government or GSE funds are used to either pay for a principle write-down or buy mortgages at above market prices, then the banks will be clear beneficiaries. Payments from the government to banks for write-downs on loans where they would have otherwise taken large losses are, in effect, a direct subsidy to banks. The same is true when the government pays an above-market price to purchase a mortgage. With Fannie Mae and Freddie Mac now authorized to draw more than $200 billion each from the Treasury, it appears that a much larger subsidy will be given to the banks through various mortgage programs than through the TARP.

The obvious alternative to mortgage modification programs that benefit banks more than homeowners is legislation that directly benefits homeowners facing foreclosure by giving them the right to stay in their home as renters paying the market rent. Right to rent legislation that allows homeowners to stay in their homes for a substantial period of time (5-10 years) would immediately give homeowners facing foreclosure security in their homes. It would also prevent the blight of vacant foreclosed properties that have devastated many neighborhoods. And it would give banks much more incentive to negotiate modifications, since foreclosure would be a less attractive option.

However, right to rent laws would mean challenging the banks. Even in this crisis there is still very little will in Congress to do anything that might seriously reduce banks’ profitability, so the prospects for right to rent legislation is not good.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.