Loan Mods Get Kicked Into The Obama Administration

With trumpets blaring, the government announced Fannie and Freddie's new loan modification program. The message? Let Barack take care of it.

Here are the bones of the plan and skimpy they are:

1. Borrowers must be 90 days past due and owe more than 90% on their mortgage.
2. The loan will be modified by reducing interest or increasing amortization and in some cases by deferring principal payments though the borrower is still responsible for paying all principal.
3. The loans will be modified so that the borrower achieves a 38% debt-to-income ratio.
4. The modifications will be done on a streamlined basis.
5. The plan applies to only Fannie and Freddie mortgages

The plan does not address the issue of borrowers being substantially under water and its terms are unlikely to attract that much attention. The sad truth is that few even with an absurdly high 38% DTI are likely to qualify and someone who qualified by falsifying their income (lots of borrowers here) is not likely to give the government documents to prove their fraudulent acts. Note their is no moratorium on foreclosures either. What it will accomplish is to induce some at the margins to stop paying their mortgages so look for the roll rates to skyrocket.

What's really going on is political theater. The Congress and the Bush administration knew they had to do something but the Republicans aren't about to go on the hook for anything that is going to be controversial and I can't say that I blame them. The ball is being passed to the Democrats and the Obama administration. Senator Schumer gave a hint of the strategy likely to be employed in dealing with the issue.

Sen. Charles Schumer, D-N.Y., said the plan ignores the elephant in the room: Most of the troublesome mortgages are owned by large pools of investors, or have been securitized in a way that makes a modification impossible. "The only viable solution, and it is one we will take up under President-elect Obama, is to modify the bankruptcy code" he said.

To the extent they can, the Democrats are going to try and dump this on the judicial system. That will accomplish two things. One, if the courts are allowed to invalidate billions of dollars worth of contracts investors are going to demand credit card like rates of returns in exchange for purchasing mortgage securities in the future. Two, the court system will break under the weight of the sheer number of petitioners. The problem will literally take years to be sorted out.

The more the political class tries to "fix" this the more they are going to muck it up. Let the system work through it and devise another remedy for those who do lose their houses. Obliterating a functional mortgage market is a ridiculous price to pay.