When the Obama Administration’s plan to mitigate foreclosures came out, it was clear that it would be insufficient to deal with the particular challenges faced in California.  Initially, the plan would only modify loans where the amount owed was 105% of the home’s true value.  Given that home prices have collapsed here, this would have helped almost nobody in California.  State lawmakers, in particular the Democratic point person on mortgages and foreclosures Asm. Ted Lieu, went to Washington to lobby for changes.  And today, faced with a sluggish mortgage rescue program attracting few lenders or homeowners, the Administration expanded the plan.

The Obama administration said Tuesday it is expanding its foreclosure prevention program to cover second mortgages and to direct more troubled borrowers to the Hope for Homeowners program.

Under the administration’s new program, the interest rate on second mortgages will be reduced to 1% on loans where payments cover interest and principal and to 2% for interest-only loans. The government will subsidize the rate reduction, with the money going to the mortgage investor […]

Also Tuesday, the administration said it is now requiring servicers to offer troubled borrowers access to Hope for Homeowners as a modification option if they qualify.

Expanding Hope for Homeowners would address one of the major holes in the original Obama foreclosure prevention plan. It helps homeowners whose homes are now worth far less than their mortgages.

Servicers had balked at participating in the Hope program because it required they reduce the mortgage principal balance to 90% of a home’s current value.

Hope for Homeowners, which began in October, is being revamped in Congress. Servicers would have to reduce the principal to 93% of the home’s value. The change would also reduce the program’s high fees, which turned off many troubled borrowers.

Loan servicers get a fair bit of cash incentives for participating in the program, which I don’t totally support, but if we have to bribe lenders in order to keep people in their homes, that makes more sense than spending the same amount of money on the fallout from a foreclosure.  And lenders do take a haircut in the Hope for Homeowners program, the first loss to my knowledge that lenders have been forced to take.

Asm. Lieu responded with this release (flip it):

“I am very pleased the Obama Administration today acted on the concerns raised by states such as California and took two steps to expand refinance and foreclosure assistance to distressed homeowners.

First, the Administration announced it would incorporate the Federal Housing Administration’s (FHA) Hope for Homeowners program into the existing Making Home Affordable Program.  This is significant because currently, the Making Home Affordable Program has a 105% underwater refinancing cap, which shuts out many Californian homeowners.  The Hope for Homeowners program does not have that limitation; instead, the Hope for Homeowners program states that lenders will take a loss on the difference between the existing loan amount and the new refinanced loan, which is set at 96.5% of the appraised loan value.      

For example, under the existing Making Home Affordable program, a homeowner whose home is valued at $100,000 but owes $120,000 on the existing loan balance would not qualify for refinancing under the program because the loan is 120% underwater.  However, under the Hope for Homeowners program, the homeowner could qualify and the new refinanced loan would be $96,500.  The lender would take the loss of $23,500.  The Obama Administration would increase the number of lenders participating in the Hope for Homeowners program by offering financial incentives to the lenders.

Second, the Administration announced steps to address the second lien problem.  Many distressed mortgages have two liens and often the second lien holder does not want to modify the loan.  The Obama Administration will provide financial incentives to allow the second lien to be reduced or extinguished.

These two critical actions will expand assistance to distressed homeowners in states such as California, where many loans are more than 105% underwater or have second liens.”

This is decent news.  Unfortunately, the tool that homeowners really need to stave off foreclosure, the ability for bankruptcy judges to cram down the principal of a loan on a primary residence, appears poised for what amounts to defeat in the Senate, a testament to the continued power of the nation’s biggest banks.

In order to garner the support of conservative Democrats and a few Republicans, the proposal has been watered down. The bankruptcy legislation will still allow homeowners to renegotiate mortgages in bankruptcy – the so-called cram down provision – but only under strict conditions. The banking industry has lobbied fiercely against cram down, but Durbin said on the Senate floor Monday night that the compromise was supported by Citigroup, which has been at the negotiating table.

“In the past, some of my colleagues understood the need for action but have been uncomfortable with the original language. Let me be clear: this amendment is different,” said Durbin. “The amendment I’m going to offer will make a modest change in the bankruptcy code with a lot of conditions. It won’t apply across the board. This amendment limits assistance in bankruptcy to situations where lenders are so intransigent that they are unwilling to cooperate with the foreclosure prevention efforts already underway – Obama’s homeowner assistance and stability plan and the Congressionally-created HOPE For Homeowners, which this bill will greatly improve.” […]

Meanwhile, the banking lobbyists are furiously lobbying against it and Durbin acknowledges it will be difficult to “muster the votes, although I know it will be hard.”

It is “hard to imagine that today the mortgage bankers would have clout in this chamber but they do,” said Durbin. “They have a lot of friends still here. They’re still big players on the American political scene and they have said to their friends, stay away from this legislation.”

We will be in a better position with foreclosures by the end of the week than we were at the beginning, but not where we need to be.