The carrot didn't work, so the Treasury is going to try its luck with the stick. Up to now, mortgage lenders and servicers had been encouraged to modify the mortgages of troubled homeowners through government incentives that they could collect along the way. That hasn't been working very well, as the number of modifications actually completed to prevent foreclosures has been far below Washington's expectations. So the Treasury is trying something new: fining the servicers that fail to permanently modify as many mortgages as the government thinks they should be.

As part of its new initiative to hold servicers accountable, the Treasury will require servicers to provide more detailed daily reports on their modification progress. Additionally, the press release says:

Servicers failing to meet performance obligations under the Servicer Participation Agreement will be subject to consequences which could include monetary penalties and sanctions.



An article in the New York Times today provides a bit more insight to the Treasury's new approach to servicers it feels aren't making enough modifications permanent:

If they fail to [make modifications permanent], the department said it would use "any and all authority" to impose fees and other sanctions. It will also publicly list the worst offenders and withhold cash incentives until reductions in mortgage payments are made permanent. In addition, the Treasury Department will appoint staff to monitor the progress of home lenders on a daily basis.



The way I understand it, a mortgage modification first goes through a trial phase. Presumably, if that trial phase goes well, then the modification should become permanent. Not enough servicers are taking that final step, but still collecting the government incentives provided for modifications. As a result, some homeowners are becoming trapped in the trial period where the servicer does not make the modification permanent, despite having received government money for taking the first step. The fear, of course, is that the servicers will ultimately decide not to make the modifications permanent, and foreclosures will result.

If these "monetary consequences" only consist of taking away those incentives provided, then I'm completely on board with the idea. If a servicer is getting money from the government, then it should follow through with the modifications. It sounds like servicers are trying to ultimately weasel out of making modifications permanent, but collecting money from the government anyway.

If the monetary consequences are fines that go over and above those government incentives provided, then that's a lot more controversial. If servicers are performing a calculation to determine whether it makes sense from a profit standpoint to modify a loan, then the prospect of a fine will add an additional variable to the equation. That will result in some more modifications, but probably not a huge number, unless these fines are quite large. For many borrowers, servicers must believe that foreclosure will be more profitable than modification.

The Times also mentions the idea of shaming these servicers. I doubt that will do much good. Congress and the Obama administration have already made many of those firms look pretty bad. I think few people are under the naïve impression that most of these servicers are in it for the good of the borrowers. The Treasury declaring publically that these servicers are allowing more foreclosures to try to make the highest profit possible should not surprise anyone.

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