I've been rough on Bank of America (BAC) in recent months over its failure to help struggling homeowners avoid foreclosure. So it's encouraging to see the financial giant saying that it will begin reducing the principal balance on mortgages for eligible borrowers.
Cutting loan balances is perhaps the best way to keep people in their homes, especially those with properties whose value has fallen well below the mortgage amount. More broadly, B of A is the nation's biggest financial institution and by far the largest issuer of mortgages. Its move could spur other lenders to offer similar foreclosure relief.
"It's a step in the right direction," Roberto Quercia, director of the Center for Community Capital at the University of North Carolina in Chapel Hill, told me.
B of A is implementing the program, which will be offered nationwide, under pressure from Massachusetts officials. Another prod -- consumer advocates have filed a class-action lawsuit against the company in Massachusetts district court for allegedly breaching its agreement to modify people's mortgage under the federal Home Affordable Modification Program. B of A faces a similar suit in Washington. Massachusetts residents also have filed complaints against J.P. Morgan Chase (JPM), OneWest Bank and Wells Fargo (WFC) accusing the companies of violating HAMP guidelines.
B of A's principal-reduction program is aimed at both subprime and prime borrowers. For qualified homeowners, the bank will look first to cut up to 30 percent of the mortgage balance; only then it will consider other options to reduce loan payments, such as cutting the interest rate.
Initially, however, the program will cover only two kinds of loans -- pay-option and hybrid ARMs. That's a concern, Quercia said, explaining that to really draw a line against foreclosures B of A needs to expand the initiative to include other types of mortgages. He also noted that the program seeks to rehabilitate underwater loans over a period of five years. That may not do much to help people recover their home equity in the short-term, he said, and people might still be tempted to walk away if they are too far underwater.
For now, B of A expects to be able to offer principal reductions to only 45,000 customers nationwide. That's a significant number, but not relative to the huge number of its customers who face foreclosure. According to the latest federal data, fewer than 21,000 B of A borrowers out of an eligible pool of nearly 1.1 million have had their mortgages permanently modified under HAMP.
As I explored in my recent piece about OneWest (aka IndyMac), such desultory figures aren't solely B of A's fault. HAMP itself is a bust. In a new report, TARP Special Inspector General Neil Barofsky characterized the $75 billion modification program as ineffectual and said it has fallen far short of expectations. He also accused the U.S. Treasury of inflating the number of homeowners who've gotten help by focusing on the number of trial, rather than permanent, loan modifications. Says the report:
"Absent a thorough review of HAMP and its goals, the program risks helping few, and for the rest, merely spreading out the foreclosure crisis over the course of several years, at significant taxpayer expense and even at the expense of those borrowers who continued to struggle to make modified, but still unaffordable, mortgage payments for months more before succumbing to foreclosure anyway."HAMP is riddled with problems, according to Barofsky. These include changing document requirements for borrowers; confusion over how participating lenders calculate whether a mortgage qualifies for relief; inadequate verification of homeowners' income; and poor training for loan servicers in HAMP.
To this I would add an even more important factor: Banks and loan servicers have financial incentives to foreclose on homes rather than to alter mortgages. Concluded Diane Thompson, an attorney with the National Consumer Law Center, in a recent report: "The compensation and constraints imposed on and chosen by servicers generally lead servicers to prefer refinancing, foreclosures and short-term repayment plans to modifcations."
What's the solution? B of A's move will help, as will patching up HAMP by, for instance, clarifying who qualifies for the program. But the best option would be for the Obama administration and Congress to revisit legislation empowering bankruptcy courts to "cram down" mortgages.
That would hurt bank earnings. But companies like B of A are strong enough to take the pain, with analysts predicting a major rebound for the industry. Meanwhile, the foreclosure epidemic continues to rage, which hurts not only individual homeowners but also the economy at large. Time for stronger medicine.
Images from Flickr user Respres and the Office of the Special Inspector General for TARP