The federal HARP and HAMP programs have failed to prompt mortgage lenders to enter into practicable debt negotiation with enough troubled homeowners, says commentator Philip Holmes of FinancialWire, and lack of lender motivation is the likely reason.

Bank of America recently promised to work with more underwater mortgage borrowers to actually reduce principle, as opposed to merely modifying mortgage terms to lengthen the repayment period or agreeing to reduce penalties. B of A's pledge is voluntary -- probably not much different from an agreement to participate in the Home Affordable Modification Program (HAMP) or Home Affordable Refinance Program (HARP).

According to Holmes, 1,032,837 distressed homeowners sought help through the HAMP program in the third quarter of 2009. The fact that only 31,382 have been offered permanent modifications to their mortgage loans is an indication of how "mortgage servicers and lenders are going out of their way not to participate."

In a more traditional situation, where the issuer of the mortgage or trust deed holds it in its own portfolio, the lender has more to lose in a foreclosure. The lender could incur substantial procedural and selling costs, as well as losing the difference between the current market value of the property and its mortgaged value.

For issuers holding these loans in portfolio, it makes sense to take some losses in order to prevent a foreclosure. On the other hand, holding a seriously delinquent borrower in limbo can have a valuable accounting benefit -- keeping a deal worth $500,000 on the books, as opposed to recording a modification or writing down a loss.

This accounting benefit acts as a perverse incentive against engaging the borrower in debt negotiations -- a powerful enough incentive to counterbalance pro-modification incentives offered by the government. All of the Obama plans require participation by lenders. Borrowers and their attorneys have no direct access to the programs, and no recourse if lenders don't play along.

What incentive could B of A have to reduce mortgage principal for its borrowers and thereby risk enormous potential losses while its competition stands by? This is why Holmes argues that "...the reduction of mortgage principal (called a cram-down when it's done forcibly by a third party authority, like a bankruptcy judge) is a critical element of any real relief effort."

Related Resource

FirstAlert(tm) Daily 4/6: Cram-down? (Philip Holmes, FinancialWire.net, April 6, 2010)