Policy Focus Needs to Shift on Foreclosures

Last week, the House Financial Services Committee approved legislation that would bring the Home Affordable Modification Program (HAMP) to an end. HAMP aims to reduce the mortgage payments of troubled homeowners by providing incentives for lenders to modify the terms of mortgage loans. As such, it has been a cornerstone of the Obama administration’s effort to address the foreclosure crisis.

The numbers make it clear why the HAMP program is viewed as a disappointment. The original hope had been that the program would help 3 to 4 million homeowners, but, nearly two years into it, there are only 540,000 permanent HAMP modifications. The count seems unlikely to rise much further over time given that the number of new entrants into the program has averaged less than 30,000 in recent months. Furthermore, there is considerable potential for households to default on their modified mortgages given that, once other types of household loans and commitments are taken into account, the typical program participant still faces monthly payment obligations amounting to more than 60 percent of pre-tax income.

That said, it is much harder to make the case that the HAMP program was a mistake. The flip side of the limited take-up is that the expected cost of the program has been small by the standards of other crisis-and recession-related measures. The Congressional Budget Office
that HAMP disbursements will total $12 billion when all is said and done.

Furthermore, it is not clear what better alternatives we have for preventing foreclosures. It has long been recognized that a key limitation of HAMP is that it does little to prevent households from defaulting because they owe more than their homes are worth. The main proposed solution to this “underwater” mortgage problem is forcing or attempting to incentivize lenders to write down the principal value of loans. But, some experts are arguing that the costs per foreclosure prevented under such a scheme could be exorbitant—implying that the idea, at best, raises fairness questions and, at worst, could damage the financial system in a way that would have far-reaching repercussions for the rest of the U.S. economy.

Unfortunately, we need to wrap our minds around the unpleasant reality that millions of currently troubled mortgage borrowers may not be able to stay in their homes over the longer run. These transitions will be costly for the affected households, their communities, and the financial institutions involved. The best way to facilitate the process is not obvious, particularly when there is so little appetite to do more federal spending, but the issue certainly warrants more policy focus.