Are mortgage modifications really the key?

Not to beat a dead horse, but it is worth revisiting the Making Home Affordable initiative because the foreclosure problem just isn't going to go away. I want to point out two things: one that is missing and another that isn't working anywhere close to expectations.

Unlike 2007 and 2008, the primary catalyst for foreclosures is now job losses. This will continue to be the case through 2009, and, in my estimation, 2010 as well. One aspect of Making Home Affordable that is sorely missing is what I would term a "national forbearance program for the unemployed." You don't need me to tell you that unemployment is at a 26-year high with the number of unemployed having doubled since the onset of the recession in December 2007 to 14.7 million. Even scarier is that one-in-three, or 4.4 million, have been unemployed longer than six months.

So we can see that foreclosures aren't going to come to a screeching halt as long as we're seeing numbers like this. Which is why I feel that a formal "forbearance program for the unemployed" is a glaring omission from the plan and something sorely needed. Some may say that if homeowners had an adequate emergency savings fund to begin with that a job loss wouldn't lead to foreclosure. While I am a huge proponent of emergency savings, with 4.4 million people unemployed longer than six months, there are plenty of homeowners that DID have an adequate savings cushion only to completely blow through it during an extended period of joblessness.

So what would my so far mythical "forbearance program" entail? Only homeowners that could show they were current on their mortgage payments up until the point of a job loss would be eligible. These people are not deadbeats. They deserve the benefit of the doubt. And what I would like to see is a plan that relieves them of making mortgage payments during a period of joblessness. (And OK, maybe you limit it to a one-year time frame. I'm not going to quibble too much about the details at this point when we don't even have the current framework in place). Only once they return to full-time work would they be required to make mortgage payments. And if they go back to work at a reduced pay rate, they could be fast-tracked toward a potential loan modification at that point to bring the payments (but not the total debt owed) in line with their new income.

In addition, the current modification plan uses what is known as a net present value test to determine whether a modification makes sense. (This test assesses which of two courses has a higher current value and is done by discounting future payments back to a value today.) The net present value test is certainly applicable to a "forbearance program for the unemployed" and is one that eligible borrowers would likely pass with flying colors. After all, someone that has made payments on time every month while employed has demonstrated a willingness to make payments as long as they are capable. Forbearing mortgage payments at the onset of unemployment and resuming six or nine months hence would carry a higher net present value than the permanently reduced payments of a mortgage modification.

Again, I'd rather not quibble over the exact details and shades of gray of who is or isn't eligible. Rather, my goal is to point out a gaping hole that, if addressed, could slow foreclosures and avoid those that are preventable.

But instead, I continue to see a focus on mortgage modifications. Just recently, Treasury Secretary Timothy Geithner and HUD Secretary Shaun Donovan penned a letter to large mortgage servicers urging them to staff up and accelerate the pace of mortgage modifications. I'm not sure that cures our current ills. The Making Home Affordable Modification Plan is geared toward reducing mortgage payments as a percentage of household income, with the goal of preventing foreclosures by reducing mortgage payments to 31 percent of household income. For a variety of reasons, I am not a huge fan of the plan but there are some laudable elements.

However, with unemployment as the primary determinant of foreclosure, this does not work to fix the current problem. What's 31 percent of zero?

Some lenders have taken a step in this direction by reducing mortgage payments to $500 for those that are unemployed. This is nice, but without a job, making even reduced mortgage payments isn't feasible. There are priorities for the first $500 coming through the door that outrank the mortgage payment, such as putting food on the table, keeping the water and the lights on, and putting enough gas in the car to get to job interviews.

Now to my second point. The focus, or "push" if you will, on mortgage modifications is more unsettling if those same lenders and loan servicers forsake the mortgage refinancing side of the Making Home Affordable equation.

Clearly, the Making Home Affordable Refinancing program is not working anywhere close to expectations. Click here for Holden Lewis's fine explanation of the various impediments.

But make no mistake. The refinancing side of Making Home Affordable, or MHA, is critically important to avoiding a redux of 2007 and 2008. I'll go so far as to say that the MHA refinancing plan is far more important than the modification plan, even if the fruits of the MHA refi plan will not be truly evident until 2011 or 2012.

Here is what I mean: Folks, we've seen this movie before. Short-term interest rates are as low as they can go. Eventually -- whether led by inflation or an economic rebound -- the Fed will need to begin raising short-term interest rates. (This may be 18 to 24 months away, but we need to be thinking about it now). The one-year Treasury yield is currently 0.5 percent. It's not a stretch to see that eventually going back to 3 percent or 4 percent, and perhaps occurring rapidly when it does. When short-term interest rates move higher, that will spell higher monthly payments for millions of homeowners that have any type of adjustable rate mortgage. If they're stuck in an adjustable rate loan and are unable to sell because of being upside-down, look out! We don't want to go back to 2007 and 2008 just at the time when the economy is getting its feet back and the worst of the housing debacle would be behind us.

Fortunately, this is a bullet that can be dodged. But to do so means the MHA refi plan has to work, it has to work well, and it has to be expanded. Let me explain.

The MHA refi plan offers the possibility of refinancing millions of homeowners that are not currently in any financial distress into the permanent payment affordability of a fixed rate loan. These are homeowners that are in many cases, victims of nothing other than bad timing. Perhaps they bought a home in 2005 or 2006 only to see the value since plummet and not only wipe out whatever down payment they had but leave them upside down by a significant margin. Or maybe they bought a starter home in 2004 intending to move on by 2010 or 2011, and they took a 7/1 ARM. Now that their timetable has changed and the starter home is taking on a more permanent feel, they need a loan better suited to their extended time frame. In either instance, facilitating a refinance into today's low fixed rates avoids the possibility of future payment shock and keeps the homeowner in a home that they've demonstrated is affordable for their budget. (This is even a better option than the permanent mulligan of a taxpayer-funded mortgage modification for those that got upside down by using the home as an ATM.)

Sadly, there isn't much evidence that the focus of regulators, lenders and the administration is being placed on doing these refinancings. Instead, the focus seems to be kicking the can down the road through mortgage modifications that may or may not be necessary or effective.

Think about how many adjustable rate loans will reset between 2010-2012 and then add to that any adjustable rate loans currently outstanding that are experiencing payment decreases now only to be whiplashed upward in a higher rate environment. To make MHA refinancing viable and effective on the scale that it needs to be will require not only the focus of lenders and regulators but also the politicians. They can start by toning down the mortgage modification rhetoric and lifting the refinancing eligibility cap even further, from 125 percent to 150 percent or even 175 percent. This is money that is already on the books, owned or guaranteed by Fannie Mae and Freddie Mac. Refinancing and assuring stability in the payments involves no extra money being doled out, increases the likelihood that the borrower will remain current and avoids having to clean up another mess in a few years.

If you've read this far, you deserve to be heard. I welcome your thoughts.