Why efforts to stem foreclosures are failing

As the numbers of foreclosures continue to mount, the Obama administration called loan servicers to a meeting today in Washington to figure out what can be done to save the mortgage-rescue plan. Only 200,000 people have been helped since the plan -- which was supposed to help 4 to 5 million -- was announced. To understand the gravity of the matter and the magnitude of the failure, consider that during the first six months of 2009 alone, 1.5 million people received foreclosure notices.

That certainly appears to be failure by any measure. A big stumbling block was that the program was announced before the rules were in place. Many banks are just now starting their efforts under the Obama plan.

Bank of America (BAC) just began implementation of the plan in July for all at-risk borrowers, according to today's Wall Street Journal. A spokesman for the bank said it has been putting borrowers on a plan that allows them to make a partial mortgage payment for several months. Those who prove they can pay are then considered for loan modification.

Wells Fargo (WFC) didn't start to offer borrowers loan modifications under the Obama plan until June. The bank was waiting for final federal guidelines on key issues, such as how to determine whether a loan modification is preferable to foreclosure.

Even a study done by the Federal Reserve Bank of Boston showed that in many cases foreclosures are not in the lender's best interest. Essentially, there are three groups of distressed borrowers, but loan modification only makes economical sense for the bank only with one of them.

The group for which modification makes sense are distressed borrowers who can't sustain payments without modification but will be able to pay with new, more modest terms. The second group are distressed borrowers who will likely fall behind again after getting their loan modified, just delaying foreclosure. A delayed foreclosure means more losses for the bank because the house probably is not being taken care of and house prices continue to drop.

Finally, the third group of distressed borrowers are those who will self-cure after two to three months. That means they will find a way to start paying their mortgage again. Lenders have little financial incentive to help people until they are at least three months behind on their mortgages. That's why so many people are being told to stop paying in order to get a loan modification. But that goes against the aim of the Obama rescue program.

Adding to these complications are the growing number of unemployed. Existing loan modification programs don't help the jobless because they don't have the income to sustain even reduced monthly payments. For example, according to CNNMoney, Morris Davis, an assistant professor at the Wisconsin School of Business, estimates that with 10 percent unemployment there could be 1.9 million borrowers facing foreclosure.

Several options are being considered to help people who have lost their jobs. One involves grants and another involves low-cost loans for people who have reasonable prospects for reemployment. The programs are being proposed to be run by state housing agencies, who are in the best position to determine eligibility. The hope is that this will take some pressure off lenders who are already overwhelmed by requests for loan modifications. But the proposal is likely to be met with great resistance. Congress is not in the mood to commit any more money than the billions already allocated for the housing crisis.

If the loan modification program is not working and the major driving force behind the growing number of homeowners facing foreclosure is job loss, then maybe it's time to shift money planned for modification into a program to help the jobless to temporarily stay in their homes. Whatever is finally decided, the key to stabilization of the housing market is to stem foreclosures.

Unless the Obama administration figures out some combination of programs that will meet the goal of preventing more foreclosures, there is little hope that housing prices will stabilize. That means even more homeowners will find themselves underwater and more will be tempted to walk away from huge loses. If banks don't want to help, it's time to spend bailout money to help Main Street rather than Wall Street.

Lita Epstein has written more than 25 books incluidng the Complete Idiot's Guide to Improving Your Credit Score and The 250 Questions You Should Ask to Avoid Foreclosure.

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