Wells Fargo & Co (WFC), Bank of America Corp (BAC): New Homeowner Bailouts Again Send the Wrong Message

Page 2 of 2

To its credit, FHFA specifically addresses the moral hazard involved in the Streamlined Modification Initiative. The agency notes that “because many borrowers who miss one or two payments have a temporary hardship and often reinstate their mortgage to current status, it is most effective to target borrowers who are at least 90 days delinquent.” Moreover, in its efforts to curb abuse of the program, the FHFA notes that Federal National Mortgage Association (OTCBB:FNMA) and Federal Home Loan Mortgage Corp (OTCBB:FMCC), which the FHFA oversees, have “existing proprietary screening measures to prevent strategic defaulters from taking advantage of a Streamlined Modification.”

Still, the danger with this program is the same as with past attempts to help potential victims of foreclosure: It’s hard to help deserving homeowners while avoiding giving unneeded help to those who are simply trying to game the system. In particular, principal reduction introduces a whole new element to moral hazard, as the government has to consider the costs that Federal National Mortgage Association (OTCBB:FNMA) and Federal Home Loan Mortgage Corp (OTCBB:FMCC) have to bear under total-default scenarios compared to the more limited costs of principal reduction. According to projections by the Congressional Budget Office (link opens PDF file), extending principal forgiveness under another program, the Home Affordable Modification Program, could result in net decreases in the budget deficit of between $2.2 billion and $2.8 billion. Yet the CBO analysis acknowledges that strategic defaults would lead to cost reductions that would be “less than costs would fall if borrowers whose modifications were costly could be excluded.” Moreover, because HAMP involved having to document financial hardship, the potential for gamesmanship in the Streamlined Modification Initiative is arguably more substantial.

Is there no solution?
In the end, any government program will struggle to identify those who most need help. Rather than focusing on decisions within homeowners’ control, such as becoming late on payments, programs should choose objective criteria that limit manipulation and truly find those in need.

The article New Homeowner Bailouts Again Send the Wrong Message originally appeared on Fool.com.

Fool contributor Dan Caplinger owns warrants on Bank of America and Wells Fargo. The Motley Fool has no position in any of the stocks mentioned.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Page 2 of 2