Why Has The Obama Loan Modification Initiative Been Unsuccessful?

The President's loan modification plan is a good faith attempt at keeping people in their homes, but there are a few economical and operational components missing.  First, and foremost, no borrower wants to pay on a mortgage that is so far under water that they will be unable to come up for air in the next 20 years. You could give stressed homeowners a 1% interest rate with a 40 year term and most would still walk away from their homes if they owe more than the home is worth.  Put simply, President Obama's 105% refinance/loan modification program does not address this problem. A big hurdle when you consider some home values have experienced over 30% value reductions in the past two years.

Making matters worse, people are able to walk away from their homes at almost no cost to them (state specific). Many borrowers are in such serious need of restructuring their debts that they have already decided the cheapest/least stressful way to escape their debt responsibility is to just walk away from it. Maybe if the market had depreciated 5% or 10%, then perhaps the program may have been a little more efficient.

When addressing a problem, we always want to present a solution.  One possible solution that has not been widely discussed, or analyzed for financial feasibility is the idea of modifying loans with an annual principal reduction. This would give borrowers the opportunity to catch on their mortgage in five or ten years. From a banking perspective, an annual principal reduction schedule would mitigate massive principal write-downs, thereby giving banks more loan loss reserves and keeping performing assets on their books, all while reducing the operating capital needed to service delinquent borrowers.  But the big question in the annual principal write-down modification (APWD) process still lingers:  Who qualifies?  Servicers have reasonably efficient loss mitigation servicing platforms, so if someone deserves a short sale, maybe they should be eligible for APWD.

Priority of Mortgage Rescue - Traditionally, banks have been unwilling to offer financial aid to borrowers that had yet to exhibit financial distress. Exceptions were made when borrowers encountered legitimate and temporary hardships. However, when exceptions become rules, and bad behavior/bad luck gets rewarded, borrowers are far more likely to start behaving badly - and ignoring the moral hazard. Take a borrower that has a good job with consistent income, is committed to their credit obligations, and is not in a negative equity situation. If that same borrower saw or believed that financial subsidies were being doled out to borrowers like him that were delinquent or out of work - you can be assured that the borrower's moral hazard limits will be tested and credit obligations possibly ignored.

A time for change- The people of the United States elected President Obama because of his promise of change.  President Obama and his team are trying but unfortunately he cannot speak for everyone.  For "change" to happen, everyone needs to change.  Everyone needs to give a little to a common good.  The government calls this tax.  The bank servicers call this loss mitigation.  The homeowner calls this doing what is right (not ignoring moral hazard).  Not everyone wants to pitch in and some don't have a choice.  The banks want to modify loans and promote homeownership, but the borrower doesn't want to be in debt for the rest of their life.  The bank creates an affordable monthly housing payment (Government's new HAM program), and the homeowner is now affordably managing debt for the rest of their lives. The borrower wants to do what's right, but what's the definition of right?  If the homeowner were to make $50,000 on their home, would they split the earnings with the bank who gave them the loan or opportunity to own a home in the first place?  Doubtful.  Now that the house is underwater $50,000, the borrower wants the bank to take the whole loss; that is not what's doing what is right?  Some people are willing to sign reduced promissory notes, some have negotiated new second mortgages to provide some cash in return for erasing debts, and others have all together stopped caring.  The banks cannot come after everyone who defaults on their promise to repay a debt because of the argument that some borrowers didn't know better, or they were taken advantage of (some really were).  For the banks that do come after the borrower for a large debt, this often results in the borrower filing for bankruptcy which isn't good for anyone including the economy as a whole.

Either an annual principal reduction loan modification program needs to be implemented, or banks need to implement a more efficient short sale process with a more creative approach to recovering the amount charged off from the homeowner; rather than filing for deficiencies or large promissory notes.

Change is an action, not an election speech. One change to a complex problem just makes the problem change colors, but the problem remains.  Change needs to happen as a whole.  The borrowers, banks, and government are all operating on their own beliefs and systems, and are not working together and sacrificing as a whole.  There are many different changes we can implement on the government side, the bank side, and the borrower side, but I think President Obama needs to implement creativity and accountability if he plans to "change" our economic times.