Watchdog Urges Mandatory Mortgage Principal Reductions

sigtarp.govThe watchdog that oversees the effectiveness of the government’s bailout programs again urged the U.S. Treasury to make either discretionary or mandatory a program to rescue borrowers from foreclosure through mortgage principal reductions.
Currently, the alternative program is voluntary, leaving the decision up to the mortgage servicer.
The reiterated position by the Special Inspector General for the Troubled Asset Relief Program, TARP, came in a quarterly update released today on bailout efforts. The inspector general, Neil Barofsky, was nominated by President Bush in November 2008, and confirmed by the Senate. 
Barofsky’s report concluded that U.S. taxpayers’ support of the financial system – most of it targeting the housing market through mortgage guarantees– soared $700 billion in the last year to about $3.7 trillion.
The findings by Barofsky, whose position is known as  SIGTARP, also questioned the overall effectiveness of the administration’s mortgage relief effort, Home Affordable Modification Program, which is costing about $50 billion in incentives to lenders.
U.S. Treasury and Housing officials last month issued new directives to HAMP servicers on the Principal Reduction Alternative, or PRA. The program is intended for struggling borrowers whose homes are worth significantly less than the remaining balance on first-lien mortgage loans
However, the decision to provide the write-downs is up to the mortgage servicer, even if HAMP screenings and modification trial results determine that principal reductions would best serve a particular borrower’s needs.
Treasury officials have already passed on reconsidering the voluntary nature of the program, citing concerns that such a move would spark more cases of strategic defaults, or borrowers “walking away” from their mortgages despite the ability to make the monthly payments.
Treasury also feared that servicers would opt out of HAMP entirely to avoid mandatory principal reductions. Officials also expected objections from responsible borrowers who believe their tax dollars are subsidizing principal reductions, even when investors would not otherwise offer the benefit.
“Although each of these issues is important, and, in the final analysis, it is up to Treasury to weigh the competing interests involved, SIGTARP remains concerned that Treasury may be overestimating the problems with a mandatory (principal reduction program) and discounting the problems with a voluntary one,” Barofsky wrote in his report.
Barofsky contends that Treasury already has safeguards in place to prevent or minimize cases of “moral hazard,” or the mind-set that leads to more instances of strategic defaults. HAMP administrators have implemented stringent financial screenings and income verification guidelines.
The Treasury’s argument “presumes that potential strategic defaulters can bypass safeguards and are willing to commit a federal crime by knowingly executing a false hardship affidavit…” Barofsky’s report said.
“To be clear, SIGTARP is not discounting moral hazard risks generally, but merely pointing out, as emphasized in prior quarterly reports, that Treasury has already jumped into the deep end of the moral hazard pool through TARP in general,” the inspector general’s report said. “Any incremental moral hazard implicated by making principal reductions for homeowners mandatory pales in comparison to the moral hazard caused by TARP assistance to Wall Street, particularly when the difference here might be between a successful HAMP and an unsuccessful HAMP.”
See the TARP inspector general’s report.