Obama’s Big Mortgage Bailout Failure

Better take your blood-pressure medication before you read this story.  It could make your blood boil.       

On January 26, 2011 the inspector general monitoring the Federal government’s mortgage bailout program bluntly labeled it “a failure” (Note 1).  The inspector general gave this testimony to the House Committee on Government Oversight and Reform.  He was referring to the Home Affordable Mortgage Modification Program enacted by Congress in March 2009.  HAMP was intended to help financially troubled homeowners avoid default on their home mortgages.  After two years, the bailout program has accomplished little.     

Rewind to February 2009.  Newly elected President Obama unveiled his mortgage rescue plan.  He pledged financial aid to some 9 million distressed homeowners. Obama called upon Congress to appropriate $275 billion in mortgage relief.  The President said (Note 2):      

“This plan will not save every home, but it will give millions of families resigned to financial ruin a chance to rebuild.  It will prevent the worst consequences of this crisis from wreaking even greater havoc on the economy.  And by bringing down the foreclosure rate, it will help to shore up housing prices for everyone.”      

Of the 9 million households expected to benefit from HAMP, the Obama administration estimated that 4-5 million were seriously delinquent and faced imminent foreclosure and eviction.  Obama’s HAMP program proposed to quickly rescue these poor souls with taxpayer money (Note 3).       

ObamaHAMP was thus conceived.  It proposed to pay incentives to mortgage lenders to modify loans of delinquent homeowners.  Loan modifications include reducing the borrower’s interest rate, extending repayment terms or forgiving some of the homeowner’s debt.  The goal was to reduce a delinquent borrower’s monthly payment to avoid default and eviction (Note 3).  The ObamaHAMP program also pays incentives to borrowers to keep them from defaulting (Note 4).       

At the time of its creation, ObamaHAMP was lauded by consumer groups, minority and homeowner advocacy groups, and even the financial industry (Note 2).  They welcomed the government’s taxpayer commitment to rescue financially troubled citizens.  As the US economy continued to falter and homeowners deepened their distress, ObamaHAMP seemed like an appropriate government response.  It was portrayed like the cavalry arriving in the nick of time.       

ObamaHAMP was also criticized for many reasons.  First, it created moral hazard by, in effect, rewarding consumer behavior that was otherwise unacceptable.  This gave rise to a phenomenon called the “strategic default,” where homeowners made a strategic decision to deliberately default on their mortgages in order to get better repayment terms (Note 5).      

   

Second, ObamaHAMP was unpopular with the voters because it was viewed as just another bailout program.  The program did nothing to help the millions of people struggling on the margins of delinquency but managing to avoid default. Also, many of the program’s beneficiaries were people who bought homes they could not afford and took mortgages they could not repay in the first place.  The program essentially helped these people avoid personal responsibility for the consequences of their foolish financial decisions.  This was another aspect of moral hazard.       

Last but not least, critics observed that incentives for financial institutions to modify mortgages were largely insufficient to cover the costs of modification in most cases (Note 6).      

ObamaHAMP has been a failure by any measure.  Of the $29.8 billion earmarked for the mortgage modification program, only $840 million – less than 3% – has been paid-out after two years (Note 7).  Of the approximately 4-5 million homeowners in serious distress – those whose mortgages are nine or more months delinquent or who are already in foreclosure – only 549,000 have received mortgage modifications.  These are the people whose situation was most urgent.  After two years, only 12% of them have gained relief from the program (Note 8).      

It gets worse.  Another 792,000 financially distressed homeowners were accepted into the ObamaHAMP program but were later kicked out.  In these sad cases, the homeowner was either ultimately disqualified, received a modification but defaulted anyway, abandoned their property, or declared bankruptcy (Note 8).      

The government blames the banks.  Critics believe the banks are being too stingy about modifying mortgages.  They say the modifications should be mandatory.  The banks claim that government red tape and bureaucracy makes the program ineffective.  Also, the incentives are too small to offset the modification cost of most mortgages.  The maximum incentive to modify a mortgage is only $4,500 (Notes 2, 3, 6).       

The HAMP program has various eligibility requirements (Note 9).  One requirement is that delinquent borrowers must have monthly housing expenses (mortgage, property taxes, insurance, utilities, and maintenance) that exceed 31% of their gross income.  For eligible borrowers, the standard modification – if they can get one – reduces their monthly mortgage payment to within the 31% ratio.  does nothing to help borrowers who still cannot afford their mortgage at the 31% level.  This obviously does nothing to help the borrower who is delinquent because they have lost their job.       

Obviously, a high percentage of mortgage delinquencies are created by job losses due to depressed economic conditions.   Default and foreclosure are inevitable in these cases unless the homeowner regains employment.  Also inevitable, are the many instances of so-called “sub-prime” mortgages in default because the borrower could not afford to repay in the first place.  Only a radical and prohibitively expensive modification can help these unfortunate people.  In many of these cases, it is less expensive for the lender to foreclose and sell the property at a depressed value than to modify the original mortgage.      

Aggravating this problem is the persistent depression of the housing market.  The housing market collapsed in mid-2008.  Housing prices plummeted nationwide.  The collapse was so severe and prolonged that millions of homeowners now owe more on their mortgages than their homes are worth.  In Nevada, for instance, about 66% of all home mortgages are “under water”.  Other severely “underwater” areas are Arizona at 51%, Florida at 49%, Michigan at 48% and California at 42% (Note 10).  In many cases, this prompts the “strategic default” scenario referenced earlier.       

The most damning criticism of ObamaHAMP is a statistic rarely reported in the news.  More mortgage modifications have been made outside of the HAMP program than within it.  It is rarely mentioned that most lenders had their in-house modification programs long before ObamaHAMP came along.  Mortgage delinquencies and defaults, after all, are not new phenomena.       

Foreclosure is a long, time-consuming, costly and unpleasant process.  Banks, therefore, have developed their own modification programs that have produced significantly better results than ObamaHAMP. This is because more people typically qualify for mortgage modification under in-house bank programs than ObamaHAMP.  For example, distressed homeowners under ObamaHAMP can only have their mortgages reduced according to the 31% rule, mentioned earlier.  Many in-house bank programs are more lenient.      

Numbers tell the true story.  In-house bank programs have modified more than 2 million mortgages since ObamaHAMP was introduced – about four times more than the government program.  One of the largest mortgage originators in the US has also modified the largest number.  86% of its modifications are outside the ObamaHAMP program (Note 11).       

Another revealing statistic is the outcome of modification.  After two years, ObamaHAMP modifications are twice as likely to relapse into default, compared to non-HAMP modification (Note 11).       

Finally, non-HAMP modifications are also substantially less costly than ObamaHAMP counterparts.  The average non-HAMP modification cost only $332 per month.  This compares to an average ObamaHAMP cost of $585 per month (Note 11).        

Why has ObamaHAMP failed so badly?  First, it is poorly structured.  The results speak for themselves.  The program should be scrapped.       

Second, is the persistence of poor economic conditions.  Despite the administration’s cheerleading, the economy remains particularly bad from an employment perspective.  With the “realistic” unemployment rate in the range of 16% nationally, joblessness continues to fuel most of the mortgage delinquency problem (Note 12).  The longer this problem persists, the deeper homeowners fall into financial darkness.      

Thirdly, due to protracted bad economic conditions, the housing market has failed to recover after two years of depressed prices.  This encourages higher default rates.  In many instances borrowers simply abandon their home and walk away from their mortgage.      

All these factors are sadly evident in mortgage delinquency and foreclosure rates.  Since the meltdown of the housing market began in early 2008, delinquency and foreclosure rates have soared.  The HAMP program has done little to reverse crisis conditions in the mortgage market. This map shows the extent of the foreclosure crisis by the end of 2008: 

Mortgage delinquencies improved by about 20% during 2010 but still remain at extremely high levels.  About 8.8% of mortgages are currently delinquent, down from 10.2% a year ago.  However, delinquencies are still well above levels of two years ago.  The previous high for delinquency rates occurred at the end of 1991, during the recession of 1990-1991, when delinquencies hit 3.4%.        

About half of the 20% delinquency improvement is an illusion.  This results merely from a corresponding increase in foreclosures, which extinguish delinquent loans.  The foreclosure rate showed some improvement during 2010 but surged to an unprecedented 4.2% toward the end of the year.  This is more than twice the foreclosure rate of two years ago.   States with the highest foreclosure rates, as of December 2010, are FL at 13.4%; NV at 8.9%; NJ at 6.6%; IL at 5.6%; OH and AZ at 4.7% (Note 13).   (The previous height of foreclosures was at the end of 1992 when the rate was just 0.3%.) 

The following map shows the extent of the mortgage crisis in January 2011.  The foreclosure problem has clearly spread like wildfire, despite ObamaHAMP. 

These trends are put into perspective in the following table.  Delinquency and foreclosure rates on residential mortgages are compared to corresponding economic and unemployment data over time (Note 14):     

                                           Mortgage and Economic Data 

Quarter	Mortgage Delinquency Rate	Mortgage Foreclosure Rate	Jobless Rate (U-1)	Jobless Rate (U6)	GDP Growth
4:1991	3.36%	0.22%	7.1%	n/a	+ 1.9%
3:1992	3.02%	0.28%	7.6%	n/a	+ 3.9%
4:2005	2.24%	0.12%	5.0%	8.7%	+ 1.3%
4:2006	1.94%	0.16%	4.4%	8.1%	+ 2.9%
4:2007	3.05%	0.51%	4.8%	8.6%	+ 2.9%
4:2008	6.54%	1.68%	6.9%	12.8%	- 7.0%
1:2009	7.87%	1.81%	8.2%	14.8%	- 5.0%
2:2009	8.70%	2.33%	9.3%	16.2%	- 0.7%
3:2009	9.73%	2.37%	9.7%	16.7%	+ 1.6%
4:2009	10.23%	2.84%	10.0%	17.3%	+ 4.9%
1:2010	10.95%	2.39%	9.7%	16.7%	+ 3.7%
2:2010	11.34%	2.03%	9.6%	16.7%	+ 1.7%
3:2010	10.98%	1.75%	9.6%	16.8%	+ 2.5%
4:2010	8.83%	4.18%	9.6%	16.9%	+ 2.8%

  

The persistence of high unemployment is due to anemic economic growth.  GDP growth averaged 2.8% during 2010.  This growth rate is insufficient to accommodate new workers entering the workforce – 3.5% is necessary.  Thus, economic growth is insufficient to produce anything but marginal improvements in the unemployment rate.  Even worse, the current GDP growth rate of 3.1% is substantially less than the comparable period a year earlier.  This, despite President Obama’s massive economic stimulus spending.     

Even these dismal statistics mask the severity of our problem.  The number of chronically unemployed people (those out of work for one year or more) rose to a post-Depression high in October 2010 – 4.5 million people.  They account for 31% of all unemployed persons.  The number keeps growing.  By the end of 2010 there were 6.3 million discouraged job-seekers who dropped out of the workforce.  This is in addition to 14.8 million unemployed people still looking for work (Note 15).  These developments will continue to weigh-down the mortgage problem and the housing market problem.  There is little relief in sight.     

The number of serious delinquencies – homeowners who are 9 months or more behind on their mortgage payments – rose to its highest level ever in December 2010.  Serious delinquencies represented only 19% of all past-due mortgages at the beginning of 2009.  A year later, by January 2010, serious delinquencies climbed to 36%.  By the end of 2010, this segment grew to a whopping 46% of all delinquent mortgages (Note13).     

Delinquency and foreclosure rates among subprime mortgages (Note 16) since 2008 are 2-3 times above the average for conventional mortgages.  This is not surprising because subprime loans represent the weakest borrowers – those least able to weather harsh economic conditions.  The delinquency rate peaked at 35% in 2010 then eased a bit to 31% by the end of year.  The current delinquency rate, however, is unchanged from where it was two years ago (Note 17).     

Unfortunately, these ill-advised loans boomed from almost nothing in 1990 to $35 billion of new loans in 1994 to $600 billion of new loans in 2006.  By then, subprime mortgages comprised about 20% of all mortgages and a much higher percentage of new mortgages.  The bust was not far behind.      

Option-ARM mortgages (Note 16) also have unusually high delinquency rates.  Past-due borrowers in this group rose from 18% to 22% during 2009 and rose to 24% during 2010.  Not surprisingly, foreclosure rates on ARM loans are currently at all-time highs – an incredible 20%.  This is more than double the rate of two years ago.  The same negative trend exists for subprime foreclosures.  The subprime foreclosure rate has risen from 9% at the beginning of 2009 to 14% currently.      

These sorry statistics clearly define the utter failure of ObamaHAMP.  It has accomplished little.  Yes, some people are helped by the program.  But of these few, many are only temporarily helped.  Nearly one-third of all borrowers receiving ObamaHAMP aid relapse into default (Note 13).  Moreover, the people in biggest trouble with the most urgent situations, have hardly been helped at all.       

Ironically, many troubled homeowners would have been better off without ObamaHAMP.  This is because the mortgage company giants, Fannie and Freddie, announced a self-imposed moratorium on foreclosures in November 2008.  They lifted the moratorium on March 31, 2009 after ObamaHAMP was passed.  This was because ObamaHAMP was supposed to fix the foreclosure problem.  In reality, ObamaHAMP only made matters worse (Note 18)     

ObamaHAMP is one more example of government’s limitation and incompetance.  It is time to put ObamaHAMP out of its misery.  Let us save the $29 billion not yet spent and reduce the deficit instead.  With the current fiscal year’s deficit projected to be a whopping $1.5 trillion, we need to quickly find these worthless and marginal boondoggles and permanently end them – and their bureaucracies.      

Meanwhile, what about all the financially strapped homeowners?  Throwing money at them will not solve the problem.  Too many are too deep in trouble and the cost to bail them out is prohibitive.  Also, there is the question of moral hazard.  The unemployed need a job not a bailout.  The best solution is to get the economy moving again.  The housing market and the mortgage market will not recover until the economy recovers.  We need to double the current rate of economic growth.  Yet this is not likely to happen with a divided Congress and a tax-and-spend President.  Meanwhile, time is running out.     

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1       Neil Barofsky made this statement in testimony given to the House Committee on Oversight and Government Reform, headed by Republican Darrell Issa.  USA Today, “Inspector General:  Mortgage Modification Program A Failure,” by Gregory Korte, January 27, 2011.      

2       Obama announced his $275 billion HAMP program one day after he announced his $787 billion economic stimulus plan.  New York Times, “$275 Billion Plan Seeks to Address Housing Crisis,” by Sheryl Stolberg and Edmund Andrews, February 18, 2009.  The Wall Street Journal, “Housing Bailout at $275 Billion,” by Laura Meckler, February 19, 2009.     

3       Bloomberg, “Obama Pledges $275 Billion to Stem US Foreclosures,” by Alison Vekshin, February 18, 2009; also New York Times, supra.      

4       Paying someone a cash incentive to avoid default on their home mortgage is like paying someone an incentive to keep their hand out of the fire.  Why would any reasonable, responsible person need a cash incentive to avoid harming themselves or their family?  ObamaHAMP calls this an “incentive” because it sounds good.  In reality, it is a gift from taxpayers not an incentive.  See Notes 5, 6.       

5       Business Insider, “How to Strategically Default on Your Mortgage and Make Life Miserable for Your Bank,” by Lawrence Delevingne, October 17, 2010.  This article takes the reader through a step-by-step process to analyze whether it is in their own financial best interest to intentionally default on their mortgage – even though they are able to repay.  Strategic default is perfectly alright if you believe in moral equivalency.  After all, if the bank can make a “strategic foreclosure” decision, based on whether it is in their best financial interest to modify your mortgage or force you into foreclosure or bankruptcy, then surely the borrower can play the same game.  The difference is that the borrower agreed to the terms of their mortgage loan.  They promised to respect these terms, do their best to honor them, and to repay the debt.       

It is not clear who originated the concept of “strategic default.”  Surely it is an ancient concept.  Perhaps the earliest reference, in the context of the mortgage meltdown of  2008, was CBS News, 60 Minutes, “Walking Away from Mortgages:  A Million Have Walked Away; Trend Could Undermine the Fragile Economic Recovery” on May 9, 2009.          

6       The incentives are only $1,000 to $1,500 per modified mortgage plus up to an additional $3,000 per mortgage that does not relapse into delinquency within three years of modification. HAMP also pays a bonus to homeowners of modified mortgages of up to $5,000 over five years if they do not relapse into delinquency during this time.  Complete details about the HAMP program can be obtained from the Federal Home Loan Mortgage Corporation, Bulletin 2010-17, “Single-Family Seller/Servicer Guide,” July 28, 2009.       

7       President Obama requested $275 billion and Congress appropriated $230 billion.  $200 billion of this amount was earmarked to bailout the government-sponsored mortgage giants, FannieMae (Federal National Mortgage Association) and FreddieMac (Federal Home Loan Bank Corporation).  $30 billion was earmarked  for mortgage modifications.      

$160 billion of the Fannie-Freddie bailout has already been spent.  The money was used to keep the two mortgage companies afloat, after suffering substantial losses in their  subprime and option-ARM mortgage portfolios.  Fannie and Freddie have both recently indicated they need more bailout money.  They will most likely consume much more than the $200 billion already committed.       

Why did so may people get in trouble with their mortgages?  Why do Fannie and Freddie need so much taxpayer bailout money?  Read “The Bailout of Fannie and Freddie,” posted on this website.      

8       Fox Business News, “The Willis Report,” February 6, 2011 airing 17:10 EST.      

9       Any borrower whose mortgage originated before January 1, 2009 and who is 60 days or more delinquent is eligible for the HAMP program.  Mortgage banks and loan servicers were required to solicit eligible homeowners for enrollment.  To be eligible, the mortgage has to be on the borrower’s primary residence and the property must be occupied not vacant.  To get a modification, the borrower must prove their case for financial hardship.  ObamaHAMP mortgage modifications are subsidized by taxpayers.  However, a primary weakness of the program limits modifications to a minimum of 31% of the borrower’s monthly income.  This excludes the vast majority of distressed homeowners, especially the unemployed.  Complete details about the HAMP program can be obtained from the Federal Home Loan Mortgage Corporation, Bulletin 2010-17, “Single-Family Seller/Servicer Guide,” July 28, 2009.       

10     The Manhattan Institute, City Journal, Volume 20, Number 2, “The Menace of Strategic Default,”  by Luigi Zingales, Spring 2010.      

11     The Wall Street Journal, “Banks Boost Home-Loan Relief:  Direct Talks With Borrowers Get More Results than Government Mortgage Modification,” by Robbie Whelan and Anthony Klan, February 1, 2011.  The financial institution referenced here is Well Fargo Bank.      

12     Officially, the economy has been in recovery mode since the first quarter of 2009.  Even so, the primary unemployment rate, computed by the Department of Labor as U3, has remained persistently above 9% during all of the so-called recovery period.  This figure substantially understates the unemployment problem because it does not count the large number of people who are under-employed, such as people working part-time because they can’t find full-time work, nor does it count people who have stopped looking for work out of despair.  These conditions are taken into account by the Department of Labor’s U6 figure.  However, U6 gets very little public emphasis.  See “Mortgage and Economic Statistics”, above.  Unemployment rates are from the Bureau of Labor Statistics online CES database, Tables A3 and D1 at empsit.t15 and empsit.cpsseed1.  Figures are final revisions and adjusted for seasonal variation.      

13     Lender Processing Services Applied Analytics, LPS Mortgage Monitor, January 2011, published monthly.  Current data is for month-end December 2010.      

14     Residential mortgages include single, duplex and four-family residences and condominiums, including home equity loans.  Farm property is excluded.  All data are adjusted for seasonal variations.  Source:  The Federal Reserve Board of Governors, Financial Bulletin, published monthly and quarterly, Washington DC.       

GDP is the final revised figure, adjusted for inflation except 4Q2010, which is the first revision.  4Q2010 GDP was revised downward from 3.1% to 2.8% by the Department of Commerce on February 25, 2011.  Source:  Department of Commerce, Bureau of Economic Analysis, published quarterly.       

Unemployment data are from the Department of Labor, Bureau of Labor Statistics, reported monthly.  See Note 12.      

15     The previous record occurred in 1983 when about 1.5 million people were chronically unemployed.  Department of Labor, Bureau of Labor Statistics, Issues in Labor Statistics, “Ranks of those Unemployed for a Year or More Up Sharply,” Number 10-10, October 2010.  Also Bureau of Labor Statistics, empsit.cpsseed1, supra.      

Despite the severity of our current situation, it is nothing like the Great Depression.  U6 peaked at about 40% during 1933.  At the start of World War II, when the Depression officially ended, U6 was still about 21%, the best it ever attained during Roosevelt’s New Deal.  “Historical Unemployment in Relation to Today,” Figure F, by N. Andrews at http://www.scribd.com/doc/13282170.       

16     Subprime mortgages are made to people with bad credit, inadequate credit, no down payment, inadequate cash reserves, unverified income, and so forth.  Ordinarily, they would not qualify for a mortgage loan.  Option-ARM (Automatic Rate-adjusted Mortgage) loans begin with unusually low interest rates that balloon to very high rates toward the end of the loan, if market rates rise.  (They did.)  ARMs are often interest-only loans without principal repayment to minimize the monthly payment amount.  Why would anyone make such loans?  Why did so many of them go bad?  How did this affect the financial panic of 2008-2009?  How did this relate to all the bank bailouts that followed?  Read “The Bailout of Fannie and Freddie” posted on this website.      

17     All references to subprime and ARM mortgage loan delinquency rates, foreclosure rates and origination volumes are from Lender Processing Services, supra.      

18     Washington Independent, “Fannie and Freddie Quietly Lift Ban on Foreclosures,” by Mary Kane, April 2, 2009.