Treasury's Mortgage Modification: Empty Threats?
The news coming out of the U.S. Treasury Dept. seemed like red meat for angry homeowners: The feds are going to get tough with mortgage servicers. Officials said the banks were moving too slowly in making lasting changes to the loans of struggling homeowners. Loan servicers that don't deliver, warned Michael Barr, Treasury's assistant secretary for financial institutions, "are going to suffer the consequences." But what exactly are those "consequences?" Barr wouldn't go into detail with reporters on Monday. The terms laid out in Treasury's contracts with the banks may not leave the government much room to maneuver. The program in question is the core of Treasury's homeowner-assistance program. which pays $1,000 to servicers—and more to borrowers and investors in various circumstances—in return for reducing interest rates or extending loan terms when economically sensible. The problem is that the program has proven something of a disappointment to almost everyone but bankers and Treasury officials. The message on Monday was mixed, emphasizing primarily the need to make permanent the modifications in as many as possible of the 375,000 mortgages that have been in a trial stage of lowered rates or extended loan terms. In all, some 650,000 loans have received payment reductions averaging $576 a month, but not all have been in trial long enough to become permanent. Moreover, a lot of borrowers have been hung up over paperwork—20% haven't submitted any, Treasury says, and 37% have submitted only partial documents. Banks say they're doing all they can. Housing advocates say the paperwork is confusing and lenders seem to be dragging their feet. Meantime, foreclosures are mounting: One in seven mortgages is late or in foreclosure, by some counts. High unemployment means the figure is likely to worsen before it improves. Treasury's programs are voluntaryIn his comments to reporters, Barr walked a fine line between chastising borrowers ("in our judgment, servicers to date have not done a good enough job of bringing people a permanent modification solution") and making it clear that the Administration feels its program is working ("we're exactly on the target for trial modifications that we set out for you all in February"). The solution? Against a background of potential penalties, "SWAT teams" of regulators will look over the shoulders of big servicers and banks will be required to send daily status updates to the government. In the end, the government may not have much leverage. Treasury relies heavily on voluntary agreements and cash incentives to get servicers to help homeowners, both with primary home loans and with an as-yet incomplete program to tackle the second mortgages and home-equity lines that complicate many mortgage modifications. But servicers can opt to drop out of most of the Treasury programs. Ultimately, servicers may conclude that the Treasury needs them more than they need the government. Both the Bush and Obama administrations encountered great consternation whenever there was talk of meddling directly with existing mortgage contracts, particularly about the expense of buying up loans and modifying them en masse, as was done in the Great Depression. As a result, the emphasis has been on voluntary programs, on cajoling and jawboning banks and investors to go along. The government can wave the stick of contractual penalties Barr threatened. How stiff are they? The biggest is that the government can reduce the annual $1,000-per-mortgage payments that servicers earn for modifying loans. In some circumstances, it can also try to claw back payments the servicers have already received. That generally applies only to payments directly related to a servicer's "materially insufficient" performance or further failure to abide by Treasury's rules. (Fraud or other "grossly negligent, willful, or intentional or reckless" acts might let the government claw back additional sums.) Uncle Sam's other options amount to moral suasion and administrative pressure: The government can impose more oversight, require additional paperwork, and in extreme cases, cut servicers out of the program altogether. more transparency and accountabilityOne problem is that any servicers that failed to modify enough loans won't have much money on the table in the first place, so there would be little for Treasury to try to recoup. If servicers get peeved, they can simply walk away. Disputes over the contracts ultimately land in federal court, which would likely tie up final determination for months or years. The options available to the agency are technically carried out through Fannie Mae (FNM) and Freddie Mac (FRE), its contractors. A Treasury Dept. spokeswoman says, as Barr did on Monday, that Treasury is currently concentrating on increasing transparency and accountability for servicers. "We're confident that they will have a significant effect," she says, adding: "Ultimately, if servicers do not comply with the program, we will pursue any and all punitive measures." Beyond the formal contracts, Uncle Sam may have some leverage. Many big banks are still beholden to the government by virtue of the preferred-share purchases made during the initial rounds of the federal bailout, which could give the feds unofficial pressure points to gain further mortgage modifications. Moral suasion, too, may prove more effective than critics fear. Talking with reporters on Monday, Barr said some banks had stepped up mortgage-modification activities after their lagging performance was publicized. The latest data on modifications, which may give an indication of whether that tactic is working, is due out next week.