The Obama Administration’s efforts to help homeowners stay in their homes and avoid foreclosure by modifying mortgages have already failed.  One would hope the Administration is smart enough to know that.  Maybe they are just hoping we wouldn’t notice, but we did.

Federal agencies have announced a variety of programs to discourage foreclosures and encourage mortgage modifications.  Some of these programs are for people who are current on their mortgages, some for people who are behind, some for people who have equity, and some for people who have none.  None have these programs has been a success, nor will they be successes in any time frame that is useful to the economy.

Treasury Secretary Geithner promised $75-$100 billion to help homeowners primarily through subsidies to lenders, NOT homeowners, but the reality is most of that money won’t be spent.  After throwing more than $1 trillion at Wall Street, perhaps $10 billion will eventually help homeowners — a 100-to-1 ratio that says loud and clear how disconnected both Republican and Democrat politicians are from the people who employ them.

This is strong language, I know, but I can prove it.  There is a lot of dubious and untested math being thrown about lately in press releases from the FDIC and FHA, but one fact that keeps being trumpeted is that so far 55,000 homeowners have been “helped” with mortgage modification offers (not actual modified mortgages) compared to the four million homeowners that these agencies said are qualified for such help.  That’s about 1.5 percent of the target achieved in the almost four months these modification programs have been enabled.  Having helped only 55,000 out of four million eligible homeowners in four months it will take at least two years (best case scenario) to reach the other 3,945,000. By then nearly all of them will have lost their homes.

About 45 years ago an old professor of mine, Ev Rogers, first noticed that cultural innovations from telephones and indoor plumbing to home computers and, yes, mortgage modifications, are adopted by populations at a rate that inevitably follows an S-shaped curve.  Innovations can’t happen until they are enabled by an invention or, in this case, legislation.  That’s when the clock starts ticking.

It takes awhile for anything to happen at all but eventually there are “pioneers” followed by “early adopters” and finally — if it is ever going to happen — the adoption rate hits an inflection point, a knee, and goes viral with a sudden and enthusiastic geometric growth phase called the “early majority,” which is where we’d get to the first half of those four million at-risk mortgages.  The problem is that we are 120 days into this process, are nowhere even close to an inflection point, and the mortgages in question are already at least 120 days late.

It’s too late.  Even if the inflection point is reached tomorrow, most of those homes are lost.

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Prepare to be robbed, America, because the hedge funds are coming.  The federal plan to rid banks of their so-called “toxic assets” appears to be turning into an opportunity to transfer hundreds of billions of dollars risk-free into the pockets of hedge fund investors armed with sophisticated new software. It is a scam, a con on American taxpayers.

The toxic assets in question are, for the most part, mortgage securities created and sold during the recent housing bubble.  For banks to survive — and we’ve been told over and over again by Republican and Democratic administrations alike that it is absolutely vital that at least the big banks survive — they have to be relieved of these mortgage securities that would appear to have little or no value right now but will perhaps have some value over time.

The way U.S. Treasury Secretary Timothy Geithner proposes this to happen is through a public-private partnership in which hedge funds will buy the bad paper with the government both financing the deal and limiting total hedge fund risk.  This plan was initially intended to be limited to half a dozen huge funds but has recently been expanded following claims of favoritism.  Now a broader spectrum of financial operators will be allowed to rape us.

The mechanism as explained by the government is simple: hedge funds will competitively bid on pools of mortgages.  The funds will put 15 percent down with the rest of the purchase price being financed by the government.  If deals go sour the funds have to absorb as losses only their down payment, with the rest of the loss being picked-up by the Treasury.  If the assets are ultimately sold for a profit, some of that profit will go to the government but most will stay with the hedge fund.  The model as usually described has assets being bought at 60-70 percent of their face value and sold for 80-90 percent as the housing market recovers.

Only that’s not the way it will actually work.

At the heart of this con is a lie and a feint.  The lie is that the buyers have no way of knowing the quality of the assets they are buying.  Throw an average of 10,000 mortgages together in a bond and who can calculate the individual value of all those mortgages or, indeed, the total value of the bond?

The hedge funds can.

It isn’t that hard to do, really, and is getting easier by the day.

The feint is that the hedge funds are going to try to buy only the most valuable assets — ones that aren’t toxic at all.  Everyone knows such assets are in there - good mortgages hidden among the bad.  Indeed most mortgages AREN’T bad, but everyone pretends there is no way to find find just the good ones.

The assets up for auction are mainly bonds called Collateralized Mortgage Obligations or CMOs.  These are created by pulling together a huge pile of mortgages about $100 million high and chopping that debt into various classes of principle, interest and risk amounting typically to 4-5 different types of bonds sold to institutional investors.  CMOs are derivative securities, many of which are protected by Credit Default Swaps (CDS’s), another class of derivative securities sold usually to insurance companies like AIG.  The $184 billion-and-growing given to AIG to keep it afloat was to cover bad bets on CDS’s, remember, because the CMOs were going down in price, homeowners were defaulting in high numbers and still are.

One thing important to remember about CMOs is that, as the banks continually explain, they are so complex and so dispersed that there is no way to put them back together again prior to maturity.  Can’t be done.

And since politicians are particularly stupid when it comes to math (being only able to understand negative numbers, it seems), they buy this argument, which is supported to some extent by experts at the Treasury and the Federal Reserve whom I think, frankly, identify maybe a little too closely with the bankers.

The fact is that Wall Street has all the time had the ability to put those CMOs back together again, just like Dorothy was able to return to Kansas.  Computers are very good at keeping track of deals like CMOs and they have to because – contrary to what the bankers and brokers tell us — CMO’s are put back together all the time. This happens every time a mortgage is retired either through the sale of a house or a refinancing.

CMO’s were invented in 1973.  That date stems from the arrival of several market conditions, one of which was having the available technology to both create CMO’s — to tear apart and securitize the mortgage pools — AND TO KEEP TRACK OF ALL THE DISPERSED BITS FOR REPAYMENT.  If we could do it in 1973 we can do it EASILY today and the fact that we are continually told it is difficult or impossible might represent ignorance, institutional inertia, or someone not really wanting to try, but I think they’re just lying.

Think about it: you’ve sold your house, the mortgage is gone (repaid), so the CMO, which is where the mortgage debt obligation actually lies, has to have been repaid, too — every little bitty piece of it, held in different proportions by at least four different bondholders. And as long as there have been CMOs it has been thus.

The funny part is that what is supposed to be impossible happens so easily and so often.  A typical CMO deal involves about 10,000 mortgages, the bank knows the shelf life of those loans is three years, which means they get paid off or adjusted after the first year at about 5,000 loans-per-year or around 15 loans-per-day. So the CMO that was so dense as to be indecipherable is actually deciphered 15 times per day after the first year.

It takes time and effort on the part of mortgage servicers to figure out CMO’s and it costs them money, too.  That’s one reason why they want a pre-payment penalty if you pay off your mortgage in the first year.

Here’s what the hedge funds are going to TRY to do.  Despite their claims that CMOs are indecipherable they are going to try to buy just the good mortgages from inside the 10,000 in a given CMO.  I can’t wait to hear how they explain this one.  It’s a gutsy move and might not succeed, but if it does — and the hedge funds basically have nothing to risk by trying — it will create the greatest transfer of wealth from the middle class to the rich in American history.

Don’t be surprised, then, if Secretary Geithner, in his next explanation of how these sales are going to take place, doesn’t put a little English on his pitch and allow that CMOs are going to be somehow “restructured” then sold.  “Restructuring” means the good mortgages will be plucked out and sold to the hedge funds and the bad mortgages will be left behind to be disposed-of at taxpayer expense by another entity called a Bad Bank.

The way the hedge funds are able to tell which mortgages are the good ones is through the use of compliance software from companies like Questsoft Inc. of Laguna Hills, CA.  Questsoft and its competitors make software normally intended for lenders to use before making a loan to verify information provided by the borrower.  Using public and private databases such software can effectively fact-check a mortgage application in seconds, fighting mortgage fraud.  But according to Questsoft CEO Leonard Ryan, sitting next to me last month on a panel about mortgage technology, many of his new customers aren’t lenders at all but “hedge funds trying to pick and choose the assets they buy under TARP.”

Software from vendors like Questsoft can find “all the needles in all the haystacks,” according to Ryan, allowing prospective purchasers to have the complete picture of what they’ll be buying that is supposed to be impossible to draw.

We could all complain about this, of course, and Secretary Geithner might back down and not allow CMO restructuring after all.  That would make things a little better, but not a lot. because it would only turn the hedge funds from pickers-and-choosers into the mortgage equivalent of blackjack card counters.  Using the same software they can get a picture of the total value of a CMO — the aggregate value and risk in those 10,000 mortgages — and easily figure out which CMO issues are more valuable than the others.  The hedge funds will know then which bonds to bid on and exactly how much to bid.

Knowing exactly how much to bid on which baskets of securities among thousands means the hedge funds will have almost no risk at all despite the fact that the government is “protecting” them from, well, nothing.

It’s heads they win, tails we lose.

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Federal Deposit Insurance Corp. Chairman Sheila Bair said banks involved in the U.S. Public-Private Investment Program won’t bid on their own assets to clean-up their balance sheets, which would effectively be an accounting dodge.

“There should be no confusion: Banks will not be able to bid on their own assets,” Bair said today at a Washington news conference.

The FDIC is helping the Treasury Department set up and run the PPIP, which will use $75 billion to $100 billion of Troubled Asset Relief Program funds to entice private investors to buy as much as $1 trillion in distressed mortgage-backed securities and other assets.

Banking groups and the Clearing House Association LLC, a group of 10 lenders including JPMorgan Chase & Co. and Bank of America Corp., are pressing the FDIC to let them use the program to buy their own troubled assets, the Wall Street Journal reported today.

Meanwhile, it seems that enthusiasm may be waning entirely for the proposed PPIP sales, which may be called-off altogether for lack of seller interest. Pressure for the banks to sell the assets has evaporated with changes in the mark-to-market accounting rules and the demonstrated ability of big banks lately to raise capital in the private markets.

It remains to be seen how much interest the fund managers who have applied to take part in the scheme actually bring to the program. While the government subsidies are attractive, fund managers may be leery of making too big a profit in a government program, or being involved at all.

“A significant and growing obstacle to private participation in government bailout plans is that many investors are wary of political backlash and the imposition of additional restrictive conditions post-investment,” wrote accounting firm PriceWaterhouseCoopers in an analysis published this week.

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Sales of existing homes in the U.S. rose in April as foreclosure auctions and cheaper prices spurred bargain hunters, butt those who think this signals a market bottom would be wise to also notice that inventories of unsold homes have gone up, portending more price drops to come.

Sales were still down 3.5 percent compared with a year earlier.

Purchases increased 2.9 percent to an annual rate of 4.68 million from 4.55 million in March according to the National Association of Realtors. The median price was down 15 percent from a year earlier, the second-biggest drop on record.

The average price of a U.S. home fell 7.1 percent in the first quarter, slower than the fourth quarter’s 8.3 percent drop that was the largest on record, the Federal Housing Finance Agency said in Washington.

A pick-up in sales may eventually help trim the glut of unsold homes and eventually stem the slump in property values. But the number of houses on the market climbed 8.8 percent to 3.97 million in April. At the current sales pace, it would take 10.2 months to sell those homes, up from 9.6 months in March.

Distressed properties accounted for 45 percent of all existing-home sales, but this was down a bit from March, the NAR report showed. First-time buyers accounted for about 40 percent of April sales, also down from March.

Foreclosure filings in the U.S. rose to a record in April for the second consecutive month, Realtytrac Inc., a seller of foreclosure data, said May 13, as the jobless rate climbed to its highest in more than a quarter century. Foreclosure filings jumped 32 percent from a year earlier, the group said.

Recent increases in mortgage rates have hurt owners looking to lower monthly payments. Mortgage applications declined 14 percent last week, led by a plunge in refinancing, a report today from the Mortgage Bankers Association also showed. Still, the group’s purchase measure rose 1 percent, indicating rates are still low enough to spur sales.

Lower mortgage costs are also helping to make buying more affordable. Rates on 30-year fixed loans fell to 4.78 percent in April, the lowest level since Freddie Mac began keeping records in 1972. Federal Reserve purchases of mortgage securities have contributed to bringing down rates, economists said.

“The housing market is beginning to stabilize,” Fed Chairman Ben S. Bernanke said in congressional testimony on May 5. “We continue to expect economic activity to bottom out, then to turn up later this year.”

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At the end of last week, as predicted here, President Obama signed new legislation changing some rules for loan servicers and making it easier for home owners to modify their existing mortgages.  This is good news for the servicers, because they now can modify mortgages without fear of being sued by mortgage security investors for having done so.  On the other hand it doesn’t mean there will inevitably be a wave of modifications because there remains an unholy alliance between the servicers who are, after all, also the largest banks and have a long and cozy relationship with mortgage security investors since those banks originally sold a good percentage of the very securities that are now at risk of plummeting even more in value.

So while mortgage modifications will increase, don’t expect them to do so to any dramatic scale.  The Obama Administration projected up to four million out of a total 51 million mortgages might be modified in 2009.  Now one million looks more likely and even that estimate might be high.

In the meantime mortgage interest rates are stagnant or slowly rising, average home sale prices are down again, even more than predicted, as a rash of foreclosures and short sales wracks the market.  Oddly this might actually be good news in the longer run because it means excess housing inventories are also being eliminated at a faster than expected rate.  Lucky us.

The short story is, then, that we haven’t yet hit bottom for the housing market and the plans to help homeowners that have been put in place so far are helping less — and slower — than the folks in Washington hoped.

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President Obama yesterday signed two measures that provide incentives for lenders and loan servicers to make troubled mortgages more affordable. The legislation also streamlines Hope for Homeowners, a government program to refinance “underwater” loans that so far has helped few distressed borrowers.

Obama said the bills also require banks to honor existing leases on foreclosed properties, and provide $2.2 billion to help homeless families. In addition, the measures give federal investigators more tools to crack down on mortgage and commodity fraud.

The bills did not include a provision endorsed by Obama that would have allowed bankruptcy judges to modify the terms of troubled home mortgages. That measure died in the Senate under fierce opposition from the financial industry.

“I believe we’re moving in the right direction, but I want to remind everybody that it took many years and many failures to get us here, and it’s going to take some time to get us out,” Obama said. “The stock market will rise and fall. The job market has taken a beating and won’t be back immediately. The housing market still has a long way to go. But I’m confident we will get there.”

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A federal board charged with sanctioning mortgage lenders who violate Federal Housing Administration policies is ineffective and slow, according to an inspector general’s report scheduled for release today. The report responds to concerns raised by Sen. Charles E. Grassley (R-Iowa), who questioned the FHA’s ability to police fraudulent lenders approved to do business with the agency.

Grassley’s concern was that some lenders may be using the same abusive tactics that contributed to the collapse of the subprime market and that the FHA may not have the resources or policies to stop them and protect itself against losses. The agency insures lenders against defaults.

The report by the Housing and Urban Development inspector general focused on the Mortgagee Review Board, created in 1989 to sanction problem lenders. It found that the board has ruled on only 94 cases since the beginning of October even though 12,641 lenders do business with the agency, raising questions about whether the system is set up to catch abuses. The board rules only on cases referred to it by HUD offices.

The board “will remain marginal as an effective sanctioning body unless its enforcement actions include a much larger caseload,” the report said.

Yesterday, after HUD received the report, the department announced that the board had recently taken action against more than 120 additional lenders: 102 had their FHA approval withdrawn, five agreed to make payments to the FHA totaling more than $500,000, and 24 were assessed fines or administrative costs totaling more than $1.2 million.

The inspector general’s report also concluded that the board’s sanctions have not been aggressive enough to deter bad behavior. The harshest penalties were rarely applied.

Since October, the board has placed three lenders on probation, temporarily suspended two others and barred four from working with the FHA.

In some cases, the penalties were crafted in a way that enabled lenders to dodge public disclosure rules.

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According to Shaun Donovan, secretary of the U.S. Department of Housing and Urban Development, the Federal Housing Administration will shortly allow its lenders to let first-time homebuyers use the recently enacted $8,000 tax credit as a down payment.

This represents an about-face from last fall’s decision under President George W. Bush to cut off down-payment assistance because those loans tended to default more than ones where the buyer put money into the deal.

More buyers are using FHA loans as lending has tightened for conventional loans, so the impact could be wide. FHA requires a down payment of 3.5 percent.

FHA-insured loans make up more than 17 percent, according to its most recent market share report.

It could take up to two months for the down-payment assistance plan to be available. It would work by giving buyers short-term bridge loans, effectively fronting the tax credit at the closing table, Donovan said.

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If you have a mortgage, whether it is current, under water, delinquent, or almost paid off, you are probably hearing every day from companies promising to help you get a mortgage modification that will save you money.

Don’t do it.

There are two Federal loan modification programs — one for homeowners who are current on their mortgage payments and another homeowners who are delinquent.  Neither program charges — OR EVEN ALLOWS — a fee for the modification.

Private mortgage modifications from most lenders don’t involve a fee, either.

Maybe a fee would be justified if the companies offering to help could guarantee you faster service, but they can’t.  All they are doing is helping you fill out paperwork you can download from government web sites.  In most cases they aren’t even helping you fill out the forms and are simply helping the government to distribute them — for a fee.

If you try for a mortgage modification, make sure it actually lowers your monthly payment.  Often it won’t.  And if it won’t (and assuming you are current on your payments) then don’t take the modification, which some lenders are using as a way to actually make MORE money from you, not less.

Remember that the government incentives to lenders and loan servicers to do these modifications aren’t very large — generally $1,000-$1,500 per year.  That’s not enough, in itself, for motivate a lender to cut your $250,000 mortgage principle in half.  So don’t expect it.  The incentives are aimed primarily at loan servicers and may well double their annual take on a given home loan, but only if you continue to pay.  In this way the programs drive a wedge between lenders and servicers, which is odd because they are often one in the same.

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Banks don’t like home foreclosures.  Though losing your house is the inevitable result of failing to pay your mortgage that doesn’t mean bankers look on foreclosures as a way to make money.  Just the opposite; they lose money on almost every one.  There are legal costs, administrative costs, the loss of revenue (you’ve stopped paying, remember?), and because the eventual resale is rushed and distressed, the bank often sells for less money overall.  Add to this the fact that homes sit empty for months while the system churns away and there are issues of wear-and-tear or even vandalism.  Banks HATE foreclosures.

So there is a real incentive for lenders to work with homeowners to keep them in their homes through mortgage modifications.  Even though a modified mortgage costs lenders money through reduced payments, the cost is nearly always less than it would be if the property was foreclosed.  It’s simple math: if your lender loses less through modification, then they won’t foreclose.  Or that’s the way it is supposed to be.  Unfortunately there are way more foreclosures than ought logically to happen under these rules.

This happens for two reasons.  Foreclosure is an EXTERNAL process handled mainly by outside lawyers working for the bank and there is always another lawyer.  So foreclosure is a process that SCALES — it can grow or shrink as needed.  Mortgage modification, on the other hand, is an INTERNAL process handled by the lender and there isn’t a lender in America who was prepared for an 8.1 percent default rate.  Many foreclosures are happening simply because the banks don’t have the trained manpower to do anything else.  That’s crazy.

But there is also a reason built into bank accounting rules why we have so many foreclosures and so few mortgage modifications.  If a lender modifies your mortgage the new reality of that arrangement is supposed to be reflected in the bank’s financial statements IMMEDIATELY, while the even greater hit to the bank’s books of a foreclosure only has to be reported EVENTUALLY and often hits a year or more after the event.  Bankers prefer some flexibility in giving bad news so even though foreclosures are worse for everyone in absolute terms, the lender will often opt for a foreclosure anyway.

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