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.

In some respects the battle over the May 19 propositions is overblown. It’s important to kill the spending cap in Prop 1A, and Props 1C-1E represent some dangerous one-time budget solutions that will probably cause more problems than they solve.

But none of these propositions will change the fact that on May 20, California will again be facing a multibillion dollar budget shortfall. And in turn that raises the specter of default. California cannot go “bankrupt”, but we can find ourselves without enough money to pay those we owe. The state flirted with that possibility in February, and although John Chiang is confident that we will have enough money to last through the summer, the ongoing collapse of the global economy and its kneecapping of our state’s revenue have already caused our bond ratings to sink to the lowest in the nation.

We’re only able to keep the lights on through continued borrowing, and that has been helped by federal hints and proposals to guarantee some or all of our debt. But that may not be enough to resolve growing concerns among bond buyers about California debt, and as a result a high-stakes standoff appears to be developing, as Felix Salmon explains:

The more interesting response was, basically, “my moral hazard trumps your moral hazard”. In other words, it’s true that because California has insured itself against default, there’s moral hazard there: whenever anybody is insured against anything, the likelihood of that thing happening goes up. But at the same time, there’s a bigger moral hazard at play: the federal government will never let California default, it’s too big to fail. And so when push comes to shove, California will get a federal bailout before it defaults on its bondholders.

I suspect, however, that the moral hazard seniority works the other way around: the fact that California’s bondholders are insured means that it’s not too big to fail, and that in fact a payment default by the state would have very little in the way of in-state systemic consequences. (I have no idea what it might do to the monolines, but if they can’t cope with a single credit defaulting, they really shouldn’t be in the business they’re in.) The federal government might step in to mediate the negotiations between the monolines and the state, but it’s not even obvious why it would want to do that.

The basic issue here is what exactly would happen if California defaulted – who blinks first, who has to accept getting less than they are owed. As I see it the possible outcomes look like this, in order of increasing regressivity:

1. Federal government steps in to provide operating capital to California in order to both pay what the bondholders are owed and prevent the state from having to make crippling cuts. This is essentially what has been done with the big banks, and a solid argument could be made for doing it with CA – if we have to close schools or hospitals, the economic downturn WILL become a Depression.
2. Federal government makes the bondholders whole but demands California implement crippling budget cuts in order to repay the feds for the cost of helping insure the bondholders. This could be ameliorated with some form of cramming down the bondholders, but folks like you and I would get crammed down even more.
3. The feds take the Gerald Ford route and tell California “drop dead” – CA under law cannot fail to pay the bondholders, so we’re on our own. We could try and negotiate with them, or pay outright. This basically turns California into a Latin American IMF client, having to cramdown working people so the bondholders get paid.

It’s worth noting just how important that last point is. As David Harvey explained in A Brief History of Neoliberalism, the 1975 New York City default was a major turning point in economic history. Ford’s Nixonian advisers argued that NYC shouldn’t be bailed out in order to hit liberals and unions. As a result NYC had to negotiate with the bondholders and was forced to make massive spending cuts, reversing 40 years of policy of increasing services to help working people in the city.

Once the NYC strategy was rolled out and shown to be a success, it became the seed of the IMF’s “Washington Consensus” moves in the 1980s and 1990s to impose right-wing economics on nations that needed their aid. NYC was thus one of the earliest victims of the shock doctrine – California may well be next.

Someone is going to have to pay more to solve this mess. The question before Californians is whether the low- and middle-income will be the ones to pay, as we have been in the recent budget deals, as we have been in Asia and Africa and Latin America – or whether the federal government will do the right thing and protect our public services and those who depend on them.

Which is why the Zombie Death Cult is so insistent on forcing the state to go over a cliff. They’re salivating at the chance to shock doctrine this state, always have been.