On July 9, 2009, the House Subcommittee on Commercial and Administrative Law held a hearing entitled “Home Foreclosures: Will Voluntary Mortgage Modification Help Families Save Their Homes?” to discuss how to effectively respond to the residential foreclosure crisis. Testifying before the committee were:

  • Alan M. White, Assistant Professor of Law at Valparaiso University School of Law
  • James H. Carr, Chief Operating Officer of the National Community Reinvestment Coalition
  • Mark A. Calabria, Ph.D., Director of Financial Regulation Studies at the Cato Institute
  • Irwin Trauss, Manager, Attorney for the Consumer Housing Unit of Philadelphia Legal Assistance

Central to all of the testimony was a discussion of the Obama Administration’s Home Affordability and Stability Plan, or Making Home Affordable, which is intended to incentivize lenders and borrowers to work together voluntarily to find alternatives to foreclosure such as loan modifications.

Mr. White generally favored loan modifications as a way to address the foreclosure crisis, but testified that the Home Affordability and Stability Plan “will not and cannot achieve the necessary degree of foreclosure prevention and mortgage debt reduction that are the essential prerequisites to an economic recovery.” Among the problems he cited is that the most common voluntary home loan modifications involve adding unpaid interest and fees to the mortgage balance. In addition, he stated that many voluntary modifications merely postpone the underlying problem because they only reduce interest and payments for a three- to five-year period. He suggested that the “simplest way to achieve the deleveraging of American homeowners” is to allow bankruptcy judges to reduce mortgages to the value of the home. (Recent efforts in Congress to make this change to the bankruptcy code have been unsuccessful.)

Mr. Carr focused his testimony on the severity of the foreclosure crisis and its disparate impact on minorities, citing the higher levels of unemployment among minorities than non-minorities. While supportive of the Making Home Affordable initiative, Mr. Carr said that the program’s performance thus far “remains far from meeting the foreclosure prevention needs demanded by the magnitude of the crisis.” To remedy the inadequacies of Making Home Affordable, Mr. Carr proposed a more robust foreclosure mitigation program, focusing recovery dollars on the communities most negatively impacted by the crises, and enacting strong consumer protections against deceptive and reckless lending practices. (A variety of federal regulatory actions already are underway to enhance consumer protection; the Obama administration’s recently proposed Consumer Financial Protection Act would require additional protections.)

Mr. Calabria, testifying on his own behalf, challenged the predominant belief that the current wave of foreclosures is the result of predatory lending practices and adjustable rate mortgages, which lead to large payment shocks when the rate changes. Instead, he suggested that “a negative equity position on the part of the homeowner coupled with a life event that results in a substantial shock to [the homeowner’s] income, most often a job loss or reduction in earnings” have driven mortgage defaults. (The Obama administration’s Housing Affordability Refinancing Program expands the re-financing of performing loans insured by Fannie Mae or Freddie Mac to cover “negative equity” with a loan-to-value ratio of up to 125%.) He argued that there is little evidence that high transaction costs or a misalignment of incentives is causing lenders to make foreclosures that are not in their economic interest. He stated, “Since lenders have no way to separate troubled borrowers from those gaming the system, some positive level of negative value foreclosures will be profit-maximizing in the aggregate.” He also stated that allowing bankruptcy judges to reduce mortgages to the value of the home would not be effective and doing so would send a signal that a private agreement is subject to being rewritten. He urged Congress to look for voluntary solutions such as encouraging bank regulators to give lenders more flexibility to lease foreclosed homes to the current residents.

Mr. Trauss described his perspective as that “of someone who day in and day out represents homeowners attempting to stay in their homes.” He acknowledged that Making Homes Affordable has made a significant difference in a small percentage of cases, but it alone is not enough. It has not made servicers more willing to enter into modifications that meaningfully reduce monthly payments. He remarked that, in his experience, lenders reject homeowners for consideration for loan modifications for reasons not related to the eligibility requirements. Moreover, he explained that there is little guidance with respect to the application procedure and some servicers do not inform rejected applicants that they have been turned down. He concluded that the only way to make a meaningful difference is to provide the homeowner “with leverage over the servicer, such as the threat of a bankruptcy judge imposing a modification.”