Why Aren't Loan Modifications Working Better?

CNN Money wrote an article detailing that 3 out of 4 modified loan modifications are expected to default within the next 12 months.

The theory of loan modifications was flawed to begin with.  It seemed popular to blame unscrupulous loan originators, greedy Realtors, or ignorant home owners getting houses they couldn't afford.  If these reasons were the true problems for defaults, then adjusting the loans should fix those problems.  Our government (both the Bush and Obama Administration) set aside hundreds of billions of dollars to assist banks to restructure these loans.

While some people did buy homes they had no business purchasing, many of the homeowners in distress find themselves in a much different financial predicament now than on the day they signed the paperwork.   Most of the people applying for a loan modification were not able to afford to keep their house for one of two reasons:  1) significant reduction of income or 2) significant increases in expenses.

Significant reduction in income can be blamed on high levels of unemployment.  1 out of 5 Americans who want to work are not able to find a job.  There is a direct correlation between unemployment and foreclosures.  Saving someone $200 a month on their mortgage with a loan modification doesn't help if this homeowner has no savings or income coming in.

Significant increases in expenses can be blamed on debt.  "Many of these borrowers still have very heavy levels of other debt," said Diane Pendley, managing director of Fitch Ratings, a credit rating service in NY.  "Auto loans, credit cards and other expenses are adding up."  As income goes down, reliance on credit goes up and puts people in a bigger hole.  Ms. Pendley continues "...(most loan modified home owners) have 64% of their monthly pretax income spent before they even buy a quart of milk. If even a small emergency arises -- an unexpected car repair, a medical bill or a loss of overtime income -- they're in trouble."

To make matters worse, most home values are decreasing.  In past generations, if times were tough and you needed to sell your house, you may have been able to do so and even make a profit.  Now, times are dire.  In Phoenix, California, Nevada and Florida, for example, a house that was once worth $300k may only be worth $150k now.  What is a homeowner to do when they can't sell or keep a house?

Obviously a loan modification is NOT the answer.

The solution of giving money to banks to reduce monthly mortgages for people with no incoming coming in or who are drowning in debt is akin to putting a band aid on a tourniquet.   I am not surprised at the default rate.  In fact my guess is the 25% of loan modifications that haven't redefaulted have been houses purchased by investors subject-to the existing financing remaining in place.

The cure to the ills of this economy is found in job creation in the private sector.  Until we create more jobs,  loan modifications will continue to fail, foreclosures will continue to rise, and more of our fellow Americans will continue to suffer.  The billions (if not a trillion) given to banks to motivate them lend money would be much wiser spent as incentives to businesses to hire employees.