Govt’s Loan Mod Program Crippled by Lax Oversight and Deference to Banks

Posted on Jan 27, 2011

By Paul Kiel and Olga Pierce, ProPublica

With millions of homeowners still struggling to stay in their homes, the Obama administration’s $75 billion foreclosure prevention program has been weakened, perhaps fatally, by lax oversight and a posture of cooperation—rather than enforcement—with the nation’s biggest banks. Those banks, Bank of America, Wells Fargo, JPMorgan Chase, and Citibank, service the majority of mortgages.

Despite a dismal showing for the program, rising complaints from homeowners, and repeated threats from officials, the government has levied no penalties against even the most error-prone banks and mortgage servicers. In fact, despite issuing public warnings for more than a year about imposing penalties, the Treasury Department told ProPublica this week they don’t even have the power to punish servicers for wrongfully denying help to homeowners. Instead of toughening the program, Treasury has actually loosened it in the face of industry lobbying.

Over the past year, ProPublica has been exploring why the government’s program has helped so few homeowners. Over the coming weeks, we will be detailing how the administration quietly retreated from a plan to get tough on banks, why the mortgage servicing industry lacks incentives to invest in helping homeowners, how the industry succeeded in thwarting oversight, and what reforms could lead to more help for homeowners.

The stories are based on newly disclosed data, lobbying disclosures, dozens of interviews with insiders, members of Congress, and others. Today’s story looks at the timidity of Treasury’s oversight, a conclusion echoed in a government report Wednesday.

“At some point, Treasury needs to ask itself what value there is in a program under which not only participation, but also compliance with the rules, is voluntary,” says the new report, from the special inspector general for the TARP. “Treasury needs to recognize the failings of [the program] and be willing to risk offending servicers. And if getting tough means risking servicer flight, so be it; the results could hardly be much worse.”

The administration launched the program nearly two years ago, in early 2009, promising it would help three million to four million troubled American borrowers rework the terms of their mortgages. Amid widespread reports that servicers have been wrongly rejecting homeowners, losing paperwork, and otherwise breaking the program’s rules, it appears the program will fall far short. The Congressional Oversight Panel now estimates fewer than 800,000 homeowners will ultimately get lasting mortgage modifications.

An early problem for the program was that banks and other mortgage servicing companies were quickly letting homeowners into the program on a trial basis, but failing to make decisions regarding hundreds of thousands of homeowners while multiple government deadlines passed.

To push banks to solve the problem, senior Treasury official Michael Barr, who has since left the department, warned in a November 2009 conference call with journalists that if the banks didn't clear their backlogs, the firms would "suffer consequences." Treasury issued a press release the same day saying banks could face “monetary penalties and sanctions.”

It turns out Treasury had already taken most penalties off the table.

The program rests on contracts that Treasury drafted and banks signed onto. To participate in the program and receive potentially billions in government incentives, banks and mortgage servicers agreed to offer homeowners modifications under guidelines subsequently drawn up by the government. In exchange, they would receive $1,000 for a completed modification and up to $4,000 if the loan continued to perform.

The contracts say Treasury can withhold or claw back incentive payments to servicers when they violate the contract. Members of Congress and homeowner advocates have long pushed Treasury to issue such penalties. There have also been calls within Treasury itself.

Around the same time that Barr and other officials were making public threats, Treasury staffers were looking at reports showing that some banks were modifying virtually no loans. Frustrated, they called at an internal meeting for withholding payments to the worst offenders or imposing fines, according to a person familiar with those discussions. But the staffers were walked back by Treasury lawyers, who said the government was only party to a commercial contract with servicers and not acting as their regulator.

Despite Treasury officials appearing before Congress and elsewhere warning of potential penalties, the department told ProPublica after months of questioning that its hands are tied. Treasury now says it has a very narrow authority to withhold incentives under the contracts. Only in cases where the servicer incorrectly granted a modification and claimed a payment can Treasury withhold or claw back a payment as a punishment.

That interpretation of the contracts means that if a homeowner was wrongfully denied help through the program, there is no possible financial penalty.

“There is no provision in the contract that permits Treasury to assess punitive fines or penalties for a servicer's failure to modify a loan, for an improper modification of a loan, or for failure to adhere to any other program requirements,” said a Treasury spokeswoman.

Experts say Treasury is handcuffing itself. Alan White, a law professor at Valparaiso University, called Treasury’s interpretation of its own contracts “extremely crabbed.” Treasury does have the power to punish servicers for broad violations by withholding incentive payments, he said, and it could also sue servicers for not fulfilling the contract.

Additionally, Treasury has the power to change the contracts, said Julia Gordon from the Center for Responsible Lending. (The Sandler Foundation is a major funder of both the Center and ProPublica, which operate independently of each other.)

The reason Treasury hasn’t changed them, Gordon said, is that Treasury is afraid servicers would drop out of the voluntary program, known as the Home Affordable Modification Program (HAMP), in the face of real penalties.

"If servicers don't get paid for future modification activity, there is a risk that they will be less inclined to continue completing HAMP modifications or to follow HAMP guidelines to evaluate homeowners for all loss mitigation options before referring them to foreclosure," said a Treasury spokeswoman.

Instead of getting tough with servicers, Treasury says they work with banks to make sure problems are fixed.

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