Even as the Obama administration's signature foreclosure-prevention
program has foundered, Treasury Department officials have known that a
key driver in keeping people in their homes in the long run is reducing
mortgage principal, senior Treasury advisor Seth Wheeler told the
Huffington Post. Wheeler is one of the architects of the administration's housing plan.
But rather than pressure the mortgage companies to start reducing
the amount mortgage-holders owe, the administration simply sat back and
hoped servicers would do it on their own.
"When the administration came into office last year, from the
get-go, it has certainly been aware of the link between negative equity
and challenges in housing," said Wheeler. "As the administration
initially designed the modification program last year, it was aware of
negative equity, was aware that some servicers were doing principal
But the administration "specifically had designed the program to
allow principal reductions without taking a position of where principal
reductions would be most advantageous," he said.
So for the past year, the administration had a policy of "rather
than us endorsing a uniform approach to principal reductions, let's
give flexibility to servicers and hope that they do it on their own in
the right circumstances," Wheeler said.
Now that the program has been universally panned, the administration
is working on ways to be more assertive on that point, he said.
In the meantime, mortgage delinquency rates and foreclosures have
continued to rise. The number of homeowners "underwater" -- those owing
more on their mortgage than the home is worth -- now stands at roughly
11 million, about a quarter of all mortgage holders, according to real
estate research firm First American CoreLogic. It's expected to increase.
"Negative equity is the single most important driver of defaults," Laurie S. Goodman,
senior managing director at Amherst Securities and a top mortgage bond
analyst, said Tuesday during a panel discussion at the American
Securitization Forum's annual conference.
Wheeler, who was on the panel, listened for an hour as mortgage
experts lambasted the administration's foreclosure-prevention efforts,
saying it's been inadequate; will ultimately be ineffective in its current form; and doesn't address the underlying causes driving foreclosures. In short, as it's currently constructed, it's destined to fail.
"Clearly negative equity creates -- especially for borrowers that
have a financial hardship and have a high LTV [loan-to-value ratio], a
very high LTV -- a complicating factor, and it certainly makes it more
challenging to make a modification work for borrowers," Wheeler told
In an interview, Wheeler said the administration is trying "to understand how to encourage more principal reductions."
Less than 10 percent of permanent modifications under the administration's Home Affordable Modification Program have involved principle reductions.
"I won't take a position on whether there's been too much or too
little, but we are studying if it is being used as effectively as it
should be," Wheeler said. "There could be better outcomes." Referencing
those mortgages that have been sliced and diced and sold to investors,
Wheeler said the administration "is encouraging more principal
reductions in instances where we find that it would maximize recovery
Simply reducing interest rates for five years, which the Obama
administration's program does for homeowners who transition out of
three-month trial periods, is "a purely temporary modification [that]
ultimately doesn't solve the problem," said Micah Green,
a partner at Patton Boggs LLP, a Washington law firm that represents a
mortgage-investor group of asset managers who hold more than $100
billion in residential mortgage-backed securities.
Without principal reductions, "there is a growing realization within
the administration and on Capitol Hill that it's very difficult to
bottom out the housing market," Green said.
"The interests of investors are totally aligned with those of
homeowners," he added. "Investors are willing to put money on the table
and frankly take their losses, which they already have."
Wheeler acknowledged that, from an economic perspective, principal cuts are the way to go.
"Certainly on both second [lien mortgages] and first [lien
mortgages], principal reductions can actually reduce total losses from
an economic perspective [and] from a finance perspective," he said.
The administration is also under pressure because losses on AAA-rated subprime mortgage-backed securities are growing.
These securities were designed so that different classes of
investors got different rates of return depending on the risk they were
willing to take. Those who agreed to take on the first losses, for
example, got higher rates of return.
But increasingly over the past few months, the amount owed to
investors has begun to eclipse the value of the mortgage principal in
the securities, said Alan M. White, a professor at Valparaiso University School of Law and an expert on mortgage-backed securities
and housing issues. Those at the bottom rung -- the ones who agreed to
take first losses -- had already taken their lumps as homeowners fell
behind on payments or defaulted. Now it's investors at the top of the
food chain who are recording losses.
White said that is creating a growing sense of urgency among
investors to do something now to keep homeowners in their homes so they
can keep making their monthly payments, which go to investors.
Despite the fact that many experts -- including some in the
administration -- agree that principal cuts are the best way to resolve
the foreclosure crisis, there are impediments.
Wheeler said issues of fairness are complicating efforts. So is
moral hazard, a theory that posits that when people enjoy the fruits of
their actions without having to suffer any of the consequences they do
it more. It's something Treasury officials have repeated on conference
calls with reporters when discussing the administration's
"Not just in a general sense," Wheeler said. Specifically, he
pointed out, "there are many analysts on Wall Street who say do not
reduce principal because anything you do to encourage borrowers to
behave differently, so as to obtain a certain outcome, that could
actually encourage more delinquencies."
But that's not the real problem, said one mortgage expert. It's politics.
"They've been preoccupied with this whole moral hazard idea. The
administration has been obsessed with it," White said. "It's more of a
political hazard issue."
White argues that the administration is scared of the political
fallout if some homeowners are seen as being bailed out by the
government while their neighbors struggle. After hundreds of billions
of taxpayer dollars were used to bail out banks and the financial
system -- a tab that could reach into the trillions -- moral hazard
should no longer be a concern, White says.
Asked if the housing situation has deteriorated to a point where
moral hazard should no longer be an issue, Goodman of Amherst
Securities said: "I think so."
White points out there are ways to ensure only the most deserving homeowners catch a break. On that point, Wheeler agreed.
As White put it: "They're going to lose the ability to be in denial very soon."