Before he took office, President Obama repeatedly promised voters and Democrats in Congress that he’d fight for changes to bankruptcy laws to help homeowners — a tough approach that would force banks to modify mortgages.
“I will change our bankruptcy laws to make it easier for families to stay in their homes,” Obama told supporters at a Colorado rally on Sept. 16, 2008, the same day as the bailout of AIG.
Bankruptcy judges have long been barred from lowering mortgage payments on primary residences, though they could do it with nearly all other types of debt, even mortgages on vacation homes. Obama promised to change that, describing it as exactly “the kind of out-of-touch Washington loophole that makes no sense.”
But when it came time to fight for the measure, he didn’t show up. Some Democrats now say his administration actually undermined it behind the scenes.
“Their behavior did not well serve the country,” said Rep. Zoe Lofgren (D-CA), who led House negotiations to enact the change, known as “cramdown.” It was “extremely disappointing.”
Instead, the administration has relied on a voluntary program with few sticks, that simply offers banks incentives to modify mortgages. Known as Home Affordable Modification Program, or HAMP, the program was modeled after an industry plan. The administration also wrote it carefully to exclude millions of homeowners seen as undeserving.
The administration launched the program with a promise that it would help 3 million to 4 million homeowners avoid foreclosure, but it’s likely to fall far short of that goal. The Congressional Oversight Panel now estimates fewer than 800,000 homeowners will ultimately get lasting mortgage modifications.
Over the past year, ProPublica has been exploring why the program has helped so few homeowners. Last week, we reported how the Treasury Department has allowed banks to break the program’s rules with few ramifications. The series is based on newly released data, lobbying disclosures, and dozens of interviews with insiders, members of Congress and others.
As the foreclosure crisis grew through 2008, the large banks that handle most mortgages were slow to offer modifications to struggling homeowners. Homeowners were left to navigate an onerous process that usually did not actually lower their mortgage payment. More than half of modifications kept the homeowner’s payment the same or actually increased it.
Many in Congress and elsewhere thought that mortgage servicers, the largest of which are the four largest banks, would make modifications only if they were pressured to do so.
Servicers work as intermediaries, handling homeowners’ mortgage payments on behalf of investors who own the loans. Since servicers don’t own the vast majority of the loans they service, they don’t take the loss if a home goes to foreclosure, making them reluctant to make the investments necessary to fulfill their obligations to help homeowners.
To force those servicers to modify mortgages, advocates pushed for a change to bankruptcy law giving judges the power not just to change interest rates but to reduce the overall amount owed on the loan, something servicers are loath to do.
Congressional Democrats had long been pushing a bill to enact cramdown and were encouraged by the fact that Obama had supported it, both in the Senate and on the campaign trail.
They thought cramdowns would serve as a stick, pushing banks to make modifications on their own.
“That was always the thought,” said Rep. Brad Miller (D-NC), “that judicial modifications would make voluntary modifications work. There would be the consequence that if the lenders didn’t [modify the loan], it might be done to them.”
When Obama unveiled his proposal to stem foreclosures a month after taking office, cramdown was a part of the package. But proponents say he’d already damaged cramdown’s chances of becoming law.
In the fall of 2008, Democrats saw a good opportunity to pass cramdown. The $700 billion TARP legislation was being considered, and lawmakers thought that with banks getting bailed out, the bill would be an ideal vehicle for also helping homeowners. But Obama, weeks away from his coming election, opposed that approach and instead pushed for a delay. He promised congressional Democrats that down the line he would “push hard to get cramdown into the law,” recalled Rep. Miller.
Four months later, the stimulus bill presented another potential vehicle for cramdown. But lawmakers say the White House again asked them to hold off, promising to push it later.
An attempt to include cramdown in a continuing resolution got the same response from the president.
“We would propose that this stuff be included and they kept punting,” said former Rep. Jim Marshall, a moderate Democrat from Georgia who had worked to sway other members of the moderate Blue Dog caucus on the issue.
“We got the impression this was an issue [the White House] would not go to the mat for as they did with health care reform,” said Bill Hampel, chief economist for the Credit Union National Association, which opposed cramdown and participated in Senate negotiations on the issue.
Privately, administration officials were ambivalent about the idea. At a Democratic caucus meeting weeks before the House voted on a bill that included cramdown, Treasury Secretary Tim Geithner “was really dismissive as to the utility of it,” said Rep. Lofgren.
Larry Summers, then the president’s chief economic adviser, also expressed doubts in private meetings, she said. “He was not supportive of this.”
The White House and Summers did not respond to requests for comment.
Treasury staffers began conversations with congressional aides by saying the administration supported cramdown and would then “follow up with a whole bunch of reasons” why it wasn’t a good idea, said an aide to a senior Democratic senator.
Homeowners, Treasury staffers argued, would take advantage of bankruptcy to get help they didn’t need. Treasury also stressed the effects of cramdown on the nation’s biggest banks, which were still fragile. The banks’ books could take a beating if too many consumers lured into bankruptcy by cramdown also had their home equity loans and credit card debt written down.
While the Obama administration was silent, the banking industry had long been mobilizing massive opposition to the measure.
"Every now and again an issue comes along that we believe would so fundamentally undermine the nature of the financial system that we have to take major efforts to oppose, and this is one of them," Floyd Stoner, the head lobbyist for the American Bankers Association, told an industry magazine.
With big banks hugely unpopular, the key opponents of cramdown were the nation’s community bankers, who argued that the law would force them to raise mortgage rates to cover the potential losses. Democratic leaders offered to exempt the politically popular smaller banks from the cramdown law, but no deal was reached.
“When you’re dealing with something like the bankruptcy issue, where all lenders stand pretty much in the same shoes, it shouldn’t be a surprise when the smaller and larger banks find common cause,” said Steve Verdier, a lobbyist for the Independent Community Bankers Association.
The lobbying by the community banks and credit unions proved fatal to the measure, lawmakers say. “The community banks went bonkers on this issue,” said former Sen. Chris Dodd (D-CT). With their opposition, he said, “you don’t win much.”
“It was a pitched battle to get it out of the House,” said Rep. Miller, with “all the effort coming from the Democratic leadership, not the Obama administration.”
The measure faced stark conservative opposition. It was opposed by Republicans in Congress and earlier by the Bush administration, who argued that government interference to change mortgage contracts would reduce the security of all kinds of future contracts.
“It undermines the foundation of the capitalist economy,” said Phillip Swagel, a Bush Treasury official. “What separates us from [Russian Prime Minister Vladimir] Putin is not retroactively changing contracts.”
After narrowly passing the House, cramdown was defeated when 12 Democrats joined Republicans to vote against it.
Many Democrats in Congress said they saw this as the death knell for the modification program, which would now have to rely on the cooperation of banks and other mortgage servicers to help homeowners.
“I never thought that it would work on a voluntary basis,” said Rep. Lofgren.
At the time that the new administration was frustrating proponents of cramdown, the administration was putting its energies into creating a voluntary program, turning to a plan already endorsed by the banking industry. Crafted in late 2008, the industry plan gave banks almost complete freedom in deciding which mortgages to modify and how.
The proposal was drafted by the Hope Now Alliance, a group billed as a broad coalition of the players affected by the mortgage crisis, including consumer groups, housing counselors, and banks. In fact, the Hope Now Alliance was headquartered in the offices of the Financial Services Roundtable, a powerful banking industry trade group. Hope Now’s lobbying disclosures were filed jointly with the Roundtable, and they show efforts to defeat cramdown and other mortgage bills supported by consumer groups.
The Hope Now plan aimed to boost the number of modifications by streamlining the process for calculating the new homeowner payments. In practice, because it was voluntary, it permitted servicers to continue offering few or unaffordable modifications.
The plan was replaced by the administration’s program after just a few months, but it proved influential. “The groundwork was already laid,” said Christine Eldarrat, an executive adviser at the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac. “Servicers were onboard, and we knew their feelings about certain guidelines.”
As an official Treasury Department account of its housing programs later put it, “The Obama Administration recognized the momentum in the private sector reflected in Hope Now’s efforts and sought to build upon it.” It makes no mention of cramdown as being needed to compel compliance.
Ultimately, HAMP kept the streamlined evaluation process of the Hope Now plan but made changes that would, in theory, push servicers to make more affordable modifications. If servicers chose to participate, they would receive incentive payments, up to $4,000, for each modification, and the private investors and lenders who owned the loans would also receive subsidies. In exchange, servicers would agree to follow rules for handling homeowner applications and make deeper cuts in mortgage payments. Servicers who chose not to participate could handle delinquent homeowners however they chose.
The program had to be voluntary, Treasury officials say, because the bailout bill did not contain the authority to compel banks to modify loans or follow any rules. A mandatory program requires congressional approval. The prospects for that were, and remain, dim, said Dodd. “Not even close.”
“The ideal would have been both [cramdown and HAMP],” said Rep. Barney Frank (D-MA), then the chairman of the House Financial Services Committee. But given the political constraints, HAMP on its own was “better than nothing.”
“We designed elegant programs that seemed to get all the incentives right to solve the problem,” said Karen Dynan, a former senior economist at the Federal Reserve. “What we learned is that the world is a really complicated place.”
The program was further limited by the administration’s concerns about using taxpayer dollars to help the wrong homeowners. The now-famous “rant” by a CNBC reporter, which fueled the creation of the Tea Party movement, was prompted by the idea that homeowners who had borrowed too much money might get help.
Candidate Obama had portrayed homeowners in a sympathetic light. But the president struck a cautious note when he unveiled the plan in February 2009. The program will “not rescue the unscrupulous or irresponsible by throwing good taxpayer money after bad loans,” said Obama. “It will not reward folks who bought homes they knew from the beginning they would never be able to afford.”
While the government had been relatively undiscriminating in its bank bailout, it would carefully vet homeowners seeking help. HAMP was written to exclude homeowners seen as undeserving, limiting the program’s reach to between 3 million and 4 million homes.
In order to prove their income was neither too high nor too low for the program, homeowners were asked to send in more documents than servicers had required previously, further taxing servicers’ limited capacity. As a result, some servicers say eligible homeowners have been kept out. According to one industry estimate, as many as 30 percent more homeowners would have received modifications without the additional demands for documentation.
A lot of the program is focused on “weeding out bad apples,” said Steven Horne, former Director of Servicing Risk Strategy at Fannie Mae. “Ninety percent is not focused on keeping more borrowers in their homes.”