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Tuesday, October 13, 2009

The Mortgage Rescue Plan and the Lessons for Health Care Reform

CNBC has a long and detailed article about the current state of the President's mortgage rescue plan.

Eight months later, the plan is plagued by delays, red tape and, some critics say, a reluctance by banks to do their part. Just 17 percent of eligible borrowers have had their loans modified and monthly payments cut. Hardly any have been given a cut in the amount they owe on homes which are now worth less.

That means many successful applicants are left with loans that they still will not be able to afford in the long run. So instead of resolving the housing crisis that pushed the U.S. economy into recession, America may be prolonging it and, in the process, stunting the global recovery.

Think of the President's mortgage rescue plan as a mini version of the president's health care plan. This certainly wasn't debated as furiously as health care, but most of the same types of promises about health care were made about this plan.

When it was announced in February, the president said that up to 7 million RESPONSIBLE homeowners would have their mortgages renegotiated and save themselves from foreclosure. Furthermore, President Obama said that homeowners not in need of help would be helped because this plan would stabilize real estate values. Meanwhile, foreclosures continue to rise to record levels. This plan has actually helped a fraction of the people it was supposed to. On top of all of this, the actual process of modifying a loan has turned into a bureaucratic nightmare. Modifications often take up to six months.

The most frightful part is that the final verdict still hasn't been analyzed. In 2008, when loan modifications were done without a government program backing them, about half of loans modified wound up going back into default. Numbers for the initial batch of modifications have yet to be analyzed. If this crop's numbers are anywhere near those in 2008, then this plan will truly be a total disaster.

That would mean that not only very few be helped, a bureaucratic nightmare be created, but on top of it all the plan wouldn't work.

All of this was perfectly predictable. Prior to 2008, loan modifications were done a handful of times. Banks rarely publicized them and only did them in rare cases when the situation really did warrant it. With rising defaults and mortgages difficult to get, mortgage professionals discovered this tool. Loan modifications rose exponentially. Of course, loan modifications were never supposed to be an industry. They were always supposed to be something done on occasion. Banks had the capability to handle a loan modification here and there. They didn't have the capability to handle them on a mass scale. Then, the president wants to do up to 7 million loan modifications.

They don't just get done. There's paperwork that needs to be processed. There's numbers that need to be analyzed. There's more paperwork that needs to be created. This is an entirely new bank bureaucracy. Is it any wonder that this is a bureaucratic nightmare. The president created a new bank service without accounting for how a bureaucracy would deal with the service.

Worse than that, loan modifications work in the opposite way of the way a loan should work. Whereas in a loan, a borrower would want all their credit profiles maximized: income, assets, credit. In a loan modification, the exact opposite must be true. The whole thing is premised on the idea that you can't afford your current situation. So, all the same principles must be minimized. Let's just look at one story the article highlighted.

In March, Latta heard about Obama's Home Affordable Modification Program, or HAMP, that allows mortgage payments to be reduced to 31 percent of a homeowner's income. The plan was launched as a central plank of Washington's efforts to stem foreclosures.

Latta applied for a loan modification but was rejected. His bank said his income from selling pumpkins and firewood — a net of $906 in 2008 — was too high.

"Frankly, I'm disappointed," Latta said. "I thought I would qualify as I am at high risk of default."

Mr. Latta was denied a modification specifically because he got a second job to help him pay his bills. I don't need to state the obvious and tell people just how corrosive a policy is if it denies people a loan product because they got a second job. Let's apply this concept to health care reform. By mandating that everyone that wants coverage will get coverage, the current health care reform program encourages people not to get insurance when they're healthy but when they get sick. Of course, the point of insurance is to protect against the unexpected not the expected. Current health care reform encourages the exact opposite of what we want to encourage much like this loan modification plan.

It's hard to put into words just how much of a disaster this policy has been and there's no end in sight. The failure of the president's loan modification program has mostly been reported in business journals. Most people know that foreclosures are at near all time highs and that's an inherent failure of the plan. It's a lot less reported just how much of a bureaucratic nightmare it's been and Mr. Matta's case, one of millions, rarely gets any exposure.

The same people that brought you this program want to totally transform health care. Make no mistake, the transformation is no less monumental than this program. This program revolutionized an industry, loan modifications. It did everything in the exact opposite manner of what was promised. Imagine health care reform with everything working the opposite of what was promised: higher costs, less access, less choice, add to the deficits, etc. and you have the outcome that this program had. The same foolish arguments now being made about health care were made in defense of this plan. That failed MISERABLY and so to will health care reform if it is enacted.

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