U.S. effort to help with mortgages falling short

It is called the "principal reduction initiative," an effort to forestall foreclosure by reducing the mortgage balance on houses that aren't worth as much as is owed.

The intent was to keep people in their houses, something that the government, with its emphasis on voluntary lender and servicer participation in its Home Affordable Modification Program (HAMP) or Home Affordable Refinancing Program (HARP), has been unable to do on the scale originally anticipated.

The HAMP plan was expected to ultimately help between two million and three million homeowners avert foreclosure through loan modification, and the HARP plan was expected to spur four million to five million refinancings by homeowners with little or negative equity.

Instead, the programs together will likely help just an estimated one million homeowners.

Although the number of borrowers who owe more than the value of their houses is falling, it is the result of "foreclosures of severely negative equity properties rather than an increase in home values," according to CoreLogic, the Santa Ana, Calif., company that tracks the data.

Nationally, 10.8 million, or 22.5 percent, of residential properties with mortgages had negative equity, CoreLogic reported Monday. In metropolitan Philadelphia, the figure was 7.3 percent, or 66,282 properties.

The hardest-hit state, Nevada, had 67 percent of its properties underwater.

The principal reduction initiative requires servicers to consider mortgages eligible for HAMP that have what is described as "mark-to-market loan-to-value ratio" of 115 percent or more.

Mark-to-market refers to the value of an asset or liability based on its current market price. The figure of 115 percent means that if the house were sold at current market value, the borrower would still owe the lender more.

If the current value for a property with a loan being modified under the program is more than the balance owed, servicers are encouraged to offer the borrower a chance to reduce the principal as well as the opportunity to refinance the mortgage at a lower rate.

To accommodate lenders, the Federal Housing Administration launched what it called a "Short Refi" program to place underwater borrowers in new government-insured mortgages if the lender or investor writes off the unpaid principal balance of the original first mortgage by at least 10 percent.

The Treasury Department set aside $14 billion for the short-refinance program.

The principal reduction initiative doesn't apply to the majority of conventional loans held by Fannie Mae or Freddie Mac. Yet the government is reportedly pressuring Fannie and Freddie to participate, which could cost the two enterprises $134 billion in new losses.

"I think the administration's efforts to pressure Fannie and Freddie to do more write-downs is to both address the near-term default risks, but more importantly to address the longer-term economic downsides to having 14 million underwater homeowners - my estimate [of the number]," said Mark Zandi, chief economist at Moody's Analytics in West Chester.

Zandi and other economists believe that it will take an additional six to 12 months for home prices to stabilize, with further declines pushing more loans underwater.

"The studies I have seen indicate borrowers re-default at much lower rates if the loan principal is lowered, that is, if part of the loan is forgiven," said economist Patrick Newport, of IHS Global Insight in Lexington, Mass.

"Until recently, banks have been restructuring loans by extending the length of the loan, or lowering the interest rate temporarily, and, at the same time, adding penalties for late payment," he said.

"The redefault rate on these loans is, I believe, over 50 percent," Newport said.

The real solution might be for Fannie and Freddie to allow borrowers in trouble to refinance at the lowest rates instead of allowing only borrowers with credit scores of 720 or above to do so.

If more mortgages were refinanced, fewer borrowers would default, homeowners would have more money in their checkbooks, and the fragile economic recovery would receive a quick, sizable cash infusion, Zandi said.

"Policy-makers don't need to introduce any other significant policy efforts," Zandi said. "It is more important for policy-makers to work on making what policies are in place such as the loan mod efforts to work better."