The Home Affordable Modification Program (HAMP) launched by President Obama in early 2009 to stave off foreclosures, despite its good intentions, has fallen short of its original goal.
The program, which aimed to keep homeowners in their homes by offering incentives to banks that modified mortgages, promised $1,000 to lenders for every loan they modified, as well as annual $1,000 “success payments” for every homeowner that managed to stay on top of their payments over the course of three years.
A new study released by Amit Seru at Stanford Graduate School of Business, found that HAMP did in fact result in 1 million additional permanent loan modifications and prevented approximately 600,000 foreclosures.
The results, though seemingly encouraging, fell short of the millions of foreclosures that had been expected to be stalled.
The program’s objective was to correct what is seen as a “market failure” given that foreclosures are not considered a win for the real estate industry. Foreclosures have far-reaching implications, including lowering the value of neighboring homes and costing banks thousands in lost revenue.
The Amit Seru study found that the program proved underwhelming due to the inability of many big banks and mortgage-servicing companies to keep up with the task at hand, thereby limiting their ability to take full advantage of the program.
The study analyzed data from 60% of all outstanding mortgages at the time of the market collapse.
The program incentivized 1 million loan modifications, reducing homeowners’ monthly payments by approximately 25%, or $400 a month. Those who benefitted from modifications were on average 12% less likely to go into foreclosure.
According to experts, HAMP also managed to stabilize housing prices, especially in areas where banks were actively exploiting the federal incentives to negotiate loan modifications. In those regions, home prices recovered at a faster rate than average and homeowners were able to keep up with other outstanding debt, such as credit cards and home equity loans.
Part of the problem with the program’s lack of overwhelming success was lack of foresight.
“The moral of the story is that policymakers have to think about the nature and organization of the intermediaries,” Seru says. “Policymakers who want to encourage more renegotiation have to take into account that some banks just don’t have the organizational design conducive for such activity.”
Despite the government’s failure to prepare banks for launch of the program, the numbers show that there was tremendous disparity in how mortgage lenders responded to the program. Some banks sought four times as many loan modifications as others although there was no perceivable difference in the mortgage loan portfolios.
If these banks had kept up with their competitors, the study shows that the number of permanent loan modifications would have reached 1.7 million, or 70% higher than it actually was. It also found that these institutions generally have a history of being less inclined to offer loan modifications, which seems to be the result of their organizational infrastructure, which provides fewer professionals staff for loan servicing and has a deficient call center capacity.
One solution, the researchers found, would be to make it easier for unprepared organizations to handover their mortgage loans to those with greater capacity. This transfer is common in the commercial real estate market, which is known to automatically assign non-performing loans to other servicers that are prepared to deal with loan modifications.
Another issue the study explored was how the program impacted homeowners. For many, it provided a short-term solution to a long-term problem.
According to Diana Farrell, head of the Chase Institute and a former Obama Administration official, “So much of the work that we’ve done looking at individuals and families say that so many of the problems have to do with short-term liquidity, not long-term solvency.”
“You can get in an enormous amount of trouble for what is a short-term cash flow issue. The first front line of defense we want to help families build more liquid financial buffer. That’s the first line of defense. Equity in the house doesn’t help you much.”
In fact, a comparison of 2,000 homeowners who had their principal reduced by an average of 32% — or $112,000 — and a group of 7,000 who had no principal reduction found that both groups had remarkably similar rates of default two years later.
The study recommends the implementation of “policies that help borrowers establish and maintain a suitable cash buffer than can be drawn down in the event of an income shock or an expense spike could be an effective tool to prevent mortgage default.”
The researchers discovered that larger payment reductions resulted in lower default rates, revealing that a 10% reduction in mortgage payments reduced default rates 22% over the two years after the modification. If mortgage payments could have been reduced another 10%, the researchers uncovered, an additional 169,000 homeowners would not have fallen behind on their payments.
A recent report from JP Morgan Chase backs up the study’s findings.
“For modification programs intended to reduce defaults, the payment reduction should not be limited to an amount that reaches a pre-determined affordability target, without regard to the amount of payment reduction delivered,” the reports says.
“A one-size-fits-all affordability target did not prove effective in this context, as illustrated by our comparison of default rates for borrowers on either side of the HAMP 31 percent mortgage PTI cut off. Furthermore, we have shown that default was correlated with negative income shocks regardless of the borrower’s mortgage PTI, and income shocks are hard to account for when setting a one-time affordability target,” it adds.