What’s more, housing had so quickly turned from tremendous boom to disastrous bust that the mortgage industry was unable to cope. Lenders and loan servicers had never operated in that kind of environment and had no mechanism to respond to the dramatic surge in delinquencies and foreclosures. One senior administration official called the servicing system “dysfunctional” in 2008 and 2009, and an industry representative agreed. “The system was not designed to deal with massive foreclosures,” he said. “It simply was not clear what was the response to take.”
From the start, two principles would drive the housing-policy team’s debate about the form that government intervention would take. First, Geithner and Summers sought to preserve the sanctity of contracts, and that commitment determined the structure of the president’s core housing programs. The government would not force banks to modify loans, and any changes made to mortgage terms would have to work for investors as well as homeowners. Those requirements led to hours of discussion and proposal drafting around the idea of “net present value,” or NPV—a formula used to determine whether modifying or foreclosing on a mortgage would result in higher profitability for investors.
Moral hazard was the other debate driver. Having witnessed Main Street’s reaction to the Wall Street bailout under the Troubled Asset Relief Program, Obama’s team went to great lengths, time and again, to promise Americans that taxpayer money would not be used to help people who had simply purchased too much house. This was assistance built for “responsible” and “deserving” homeowners, the story went. So your neighbor got in over his head? Or a friend bought a house to flip and then couldn’t sell it? Their fault, the White House was saying. “That narrative is one we had to be careful with,” a senior administration official said.
Taken together, contract sanctity and moral hazard set the parameters for the president’s housing policy. And within four weeks of Obama’s swearing-in, his team proclaimed itself ready to unveil the sharply tailored strategy.
ALL CARROT, NO STICK
On Feb. 18, 2009, the administration unrolled its Homeowner Affordability and Stability Plan, an overarching effort that would soon generate programs with similar sounding names, grouped under yet another umbrella initiative called Making Home Affordable. At the core were two efforts, detailed weeks later in March—the Home Affordable Modification Program and the Home Affordable Refinance Program. Under the former, the government would use TARP money to pay mortgage servicers to modify loans held by borrowers who were delinquent or likely to default. Under the latter, homeowners who were “underwater”—meaning that they owed more than their house was worth—but current on their mortgage payments, could refinance into a lower interest rate, but only if their loans were held by Fannie Mae or Freddie Mac. Today, HAMP and HARP remain the main components of Obama’s web of programs meant to repair the housing market.
Other ideas, including a direct government purchase of mortgage loans, had been brought to the table for discussion, and many more would come in the months ahead from Treasury staffers, housing and banking regulators, and outside experts. But when those options forced a fresh look at contract sanctity or moral hazard—in other words, when they raised potential political risks for the White House—the team set them aside.
Two of those sidelined options—a policy known as cramdown and a broad-based reduction of the principal owed on loans—could have been game-changers, according to economists inside and outside the administration. Even high-level policy officials and advisers today readily concede that those options were missed opportunities. That’s especially true of cramdown, a proposal that would allow federal bankruptcy judges to reduce mortgage balances, cut interest rates, and lengthen the terms of loans to help borrowers get out of trouble. “It was a missed opportunity,” Donovan said. “It would have been the right thing to do and it could have helped.” (See “The Fix Was Out.”)
In early 2009, supporters saw cramdown as the stick that would make the industry bite the Home Affordable Modification Program’s carrot. If lenders were uninterested in participating voluntarily in the government’s modification and refinancing initiatives, then federal bankruptcy judges would have the option of modifying and refinancing for them. “HAMP would have worked better with cramdown,” one House Democratic aide said. “But [the administration] didn’t try.” Specifically, Summers and Geithner didn’t try, according to numerous sources who were involved in the discussions. Instead, they sided and with the financial sector, and the administration went quiet as Wall Street pulled out all the stops to kill cramdown in the Senate.