U.S. Mortgage Modification Program Doing More Harm Than Good?

The New York Times (2 January) has an excellent and unusually balanced article on the status of the federal mortgage modification program. It turns out many economists and real-estate experts think the program is doing more harm than good. It’s confusing, encouraging people to stay in homes they can’t afford, and extending the time its taking for banks to get their balance sheets in order. According to the Times:

“Since President Obama announced the program in February, it has lowered mortgage payments on a trial basis for hundreds of thousands of people but has largely failed to provide permanent relief. Critics increasingly argue that the program, Making Home Affordable, has raised false hopes among people who simply cannot afford their homes.

“As a result, desperate homeowners have sent payments to banks in often-futile efforts to keep their homes, which some see as wasting dollars they could have saved in preparation for moving to cheaper rental residences. Some borrowers have seen their credit tarnished while falsely assuming that loan modifications involved no negative reports to credit agencies.

Some experts argue the program has impeded economic recovery by delaying a wrenching yet cleansing process through which borrowers give up unaffordable homes and banks fully reckon with their disastrous bets on real estate, enabling money to flow more freely through the financial system.

“The choice we appear to be making is trying to modify our way out of this, which has the effect of lengthening the crisis,” said Kevin Katari, managing member of Watershed Asset Management, a San Francisco-based hedge fund. “We have simply slowed the foreclosure pipeline, with people staying in houses they are ultimately not going to be able to afford anyway.”

Of course, not everyone agrees. chief economist Mark Zandi believes pulling back on the program would lead us into another recession. Zandi wants a new program to target the homeowners already in foreclosure. In addition:

“Mr. Zandi proposes that the Treasury Department push banks to write down some loan balances by reimbursing the companies for their losses. He pointedly rejects the notion that government ought to get out of the way and let foreclosures work their way through the market, saying that course risks a surge of foreclosures and declining house prices that could pull the economy back into recession.

“We want to overwhelm this problem,” he said. “If we do go back into recession, it will be very difficult to get out.”

Under the current program, the government provides cash incentives to mortgage companies that lower monthly payments for borrowers facing hardships. The Treasury Department set a goal of three to four million permanent loan modifications by 2012.”

I think Zandi is incorrect. I don’t think the housing sector is the primary threat to the recovery. Housing led us into the current recession, but, in my view, this was primarily because it was a financial services and liquidity problem. In an economy driven by finance, the lack of transparency in investment and financial packages–mortgage backed secuirities in particular–precipitated a financial and liquidity crisis. This won’t straighten out until the financial services industry gets squared away on both the value of the the assets they hold (which is a market-determined value) and stabilize their balance sheets (which is tied to the former).

A far bigger threat to recovery is the continued uncertainty injected by an unfocused, tactically driven federal spending policy with no real strategic purpose or value. Federal spending has been almost completely demand driven and, as such, ineffective as a mechanism for bringing the economy out of recession. What little good federal spending has done has focused almost completely on income maintenance (including the so-called shovel-ready infrastructure projects). What the economy needs now is meaningful investment by the private sector in products and services that have long-term value added.