The New New Foreclosure Plan

The Obama administration rolled out yet another initiative to stem the foreclosure tide even as evidence mounts that the earlier plans are having a marginal effect.

I haven’t seen any details on the new plan but the reports are that it focuses on encouraging short sales. Without any details, I have no idea what they mean by encouraging but I suspect you can substitute taxpayer assistance for encouragement and be pretty close to what’s going on.

I’ll have some thoughts on short sales in a moment but first let’s take a quick look at the success or lack thereof of the current programs.

We all know by now that the original Hope for Homeowners has been a dismal failure. I don’t think “dismal failure” properly describes a program that produced 50 modifications, 49 of which are being investigated for fraud. The more recent Obama plans are off to a slow start as well.

The NYT noted yesterday that after two months 55,000 homeowners have received help under the new program. To put that into perspective, in April there were 342,000 foreclosure filings. The comparison is a bit unfair as many lenders and servicers are just getting their programs ramped up but it demonstrates how far the program has yet to go to make a meaningful impact.

Mark Zandi, the chief economist of Moddys, estimates that the program may eventually end up helping 1.5 million to 2 million homeowners. Not an insignificant number but currently 15.4 million homeowners are underwater on their mortgages. Since negative equity is one of the prime causes of default, you can see how intractable the problem has become. A modification may cure immediate cash flow issues for the homeowner but if he remains underwater, the prospects for redefault are significantly higher.

The Obama plan is also handicapped by — big surprise here — bureaucracy. Homeowners can’t decipher the rules and when they do try and obtain help are met with a confusing maze of procedures and often just bad information.

Back to the new initiative. Some sketchy information on CNBC indicates that it’s not much more than throwing some more billions at servicers to get them to do short sales or do deeds in lieu. They’re also going to throw more incentives their way in order to incent them to do more mods in areas that continue to see declining home prices.

This goes directly back to the problem I mentioned above. The servicers are reluctant to do mods in these areas because they know that they’re likely to fail due to the negative equity position of the borrower. So the government throws more money their way to compensate them for losses on failed mods.

There are all sorts of problems with short sales which explain why they haven’t worked to date and are unlikely to be of much help with the problem now. For instance, mortgage insurance is cancelled if a lender agrees to a short sale, so in those cases in which a lender has an insured mortgage a short sale could result in a larger absolute loss than a foreclosure even though the house may be sold in a short sale for more than would be realized through foreclosure and resale. Additionally, in this market they aren’t likely to garner a much higher sales price than they would in a foreclosure sale. They make sense when there’s not much foreclosure inventory, not when there’s a lot.

The Obama plans may have some impact on the margin but the ultimate solution to this problem is going to be the same as the solution to any other asset bubble. Prices are going to have to reach a clearing level and the excess inventory absorbed over time. The world will begin to properly spin on its axis again but it won’t be due to the intervention of the government.

More: here (MarketWatch on the new plan).

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