Today, the FDIC unexpectedly released a loss sharing proposal to promote affordable loans modifications. This follows a statement by Treasury Secretary Paulson on Wednesday that the Bush Administration was considering the FDIC’s proposal, but that the FDIC’s loss sharing guarantee was essentially “direct spending” and not the type of investment “intended to promote financial stability, protect the taxpayer, and be recovered under the TARP legislation.” Absent Treasury's agreement to use existing TARP funding, the FDIC plan will likely need enabling legislation and appropriation of either new funding or diversion of existing funding from the TARP authorization.

The FDIC's announcement follows Tuesday’s announcement by HOPE NOW, Treasury and the Federal Housing Finance Administration of the Streamlined Mortgage Modification Plan (SMP). The FDIC’s proposal is modeled after its IndyMac Mortgage Loan Modification Program, but by including a loss sharing guarantee on redefaults of modified mortgages, it is “designed to promote wider adoption of such a systematic loan modification program.” Unlike the SMP, it is meant specifically for non-GSE mortgage loans, i.e., various kinds of variable rate and option payment loans. The FDIC program is essentially a credit enhancement for loans that a lender elects to modify. Borrower eligibility is limited to borrowers who have missed at least two consecutive payments on a non-conforming loan, and payments are to be adjusted to no more than 31% of a borrower’s income. (The SMP, by contrast, would modify payments to 38% of income.)

The FDIC believes that the loss sharing guarantee provides the “necessary incentive to modify mortgages on a significant scale.” The loss share percentage would be progressively reduced for certain “underwater” mortgages. The guarantee would not take effect until the borrower has made six payments on the modified loan and would last only for the first eight years of the modification. Under the plan, servicers would receive $1,000 to cover expenses for each loan modified under the plan. It is proposed that the FDIC serve as contractor for Treasury.