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Gaming Uncle Sam’s Mortgage Modification Program

Posted by Larry Doyle on March 31, 2010 11:08 AM |

A new release by the SIGTARP (Office of the Special Inspector General for the Troubled Asset Relief Program) is exceptionally enlightening in detailing how a likely significant percentage of those homeowners who entered the trial mortgage modification process gamed the system.

Once again, major high five to our friends at 12th Street Capital for sharing this report and providing insightful commentary. As 12th Street points out this morning:

With all of the hoopla surrounding the government and Bank of America announcements to push principal forgiveness to the top of the waterfall for mortgage modification triage, it would have been easy to miss the latest report from the SIGTARP (Special Inspector General of TARP). I have attached the report here and would encourage you to print it out and read it.

In spite of the best efforts of the government and mortgage servicer community, I believe some of the challenges that have resulted in lower than expected modification volume could continue (or even get worse) when it comes to gaining critical mass regardless of the type of modification utilized. It would be easy to get bogged down in the report where it disparages the metrics upon which the government measures volume of modifications and success rate versus initial projections, but I would say flip to page 12 of the report and take a look at the stagnating number of trial mods and then on page 13 it talks about conversion to permanent mods, which I believe will become even more challenging.

Verbal financial information was acceptable to start a trial modification, however that meant there was more work to do down the road (sound familiar?) to confirm eligibility for permanent modifications. That additional work has slowed down the process and added work for the servicers. The ability to qualify via ‘stated doc.’ will end on April 15th, which I have to assume means there will be far less trial modifications occurring:

The second issue affecting conversion relates to when payments are due during the trial period. On or prior to April 15, 2010, after the borrower makes the first trial modification payment during the initial month in which the trial modification becomes effective, he or she has the full length of the trial period to satisfy further trial payment requirements. As such, a borrower’s likelihood for default is concealed during the trial period and borrowers may have an incentive to delay entering into permanent modifications. Several of the servicers interviewed reported concerns about homeowners trying to game the system in this fashion. Treasury changed these payment requirements so that after April 15, 2010 a borrower must make monthly payments to be considered current.

I never knew about the payment schedule. I know there are a lot of people who think the principal reduction is a game changer, however I would temper the enthusiasm given the ongoing implementation problems of the government programs and the tightening of guidelines and processes that go into effect on the not so ironic date of April 15th.

For those who may not have fully appreciated the words of wisdom provided by 12th Street, I will reduce it to layman’s terms: under Uncle Sam’s mortgage modification plan, homeowners were not required to provide written documentation of verified income in order to qualify. Additionally, the homeowners were not required to continue making monthly mortgage payments. What happened as a result? Just as night follows day, lots of people clearly misrepresented income levels and did not maintain their monthly payments. They beat Uncle Sam and the taxpayers supporting this program like a drum. The report highlights this reality and other issues with the program starting on the bottom of page 24. The report reads:

All five of the servicers interviewed in connection with this audit have identified problems of one sort or another that they have experienced due to repeated changes in program guidelines. One servicer in particular noted that it changed from offering only fully documented trial modifications to verbal modifications after Treasury threatened to make examples of servicers with low trial modification numbers (note 22 see below). Servicers have reported among other things that:

>>repeated changes to program guidelines have made it difficult for servicers’ operators to keep up with program rules.

>>verbal modifications have allowed borrowers to obtain trial modifications due to misrepresentations, and identifying borrowers who have misrepresented their eligibility is difficult and resource intensive.

>>borrowers might be gaming the system by withholding required documents (and thereby avoiding to have to make payments until the end of the trial period and still avoid foreclosure), and that some borrowers might be withholding documents to avoid disclosing misrepresentations on their original loan applications.

Note 22: Other servicers have noted issues relating to Treasury’s drive in July 2009 to increase the rate of trial modifications. One servicer found the meeting on July 28, 2009 as not helpful and just a forum for Treasury to tout publicly its goal of 500,000 modifications. Another complained that several servicers were made examples of for the sake of providing a certain public perspective about Treasury’s oversight of the program.

Do you get the sense that Treasury was trying to game the system itself in order to present it as a success? I do.

What does this all mean for the future of the principal reduction program? Just as 12th Street highlights, look for a likely decline in the numbers even applying for the program. I would add, however, that we should expect an increase in those who will change behaviors (that is, an increase in mortgage delinquencies) in the hope of becoming eligible for this program. That development would be exceptionally unhealthy for housing and our economy.

In my opinion along with many others, the mortgage modification program has been an abysmal failure in terms of development, management, execution, and results. I would hope I am wrong but I expect no better with the principal reduction program. I see it as merely another wealth redistribution program promoted by the Obama administration.

One last comment. This $75 billion undertaking is not insignificant from a dollars standpoint, but relative to healthcare reform it is a drop in the bucket. You tell me how Uncle Sam is going to manage that.

For the overachievers in the crowd, I am happy to submit the full 60-page report (click on the image to access a pdf document). In addition, if you like what you read at Sense on Cents, please subscribe to all of my work via e-mail, an RSS feed, on Twitter, or Facebook. ~LD

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