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According to the Times, this federal bailout was intended to save 4 million homes from foreclosure, yet there are only approximately 650,000 homes in the program to date. A previous report showed that ONLY 2,000 of the then 500,000 in process had their loan modifications made permanent.

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The government incentive for this was $1,000 at the time the terms were renegotiated, plus another $1,000 per year for up to 3 years. I’m guessing they believed that after 3 years home prices would go back up and homeowners would then be able to sell or refinance. Of course, $1,000 payment from the government is hardly a meaningful incentive to forgo many thousands of dollars of interest. These renegotiations often took the form of deferred interest payments. That is, adding the interest onto the principle amount cause the base amount of the mortgage to continue to grow and grow.

This was a dumb idea on several fronts:

1) The loan servicers don’t give a damn if the loan defaults. In fact, perversely, it is to the servicer’s short term benefit if the loan does go into default because the servicer is then entitled to all kinds of additional fees.

2) The reason the servicers don’t care if the loan goes into default, is that the servicers don’t own the mortgage; so if the mortgage is suddenly worthless, the servicer is not the one taking the loss, the owner of the mortgage is.

3) The owners of these mortgages that have been pooled together and sold off as securities are pension funds and municipalities and college endowments. They don’t own a specific mortgage, just a percentage of a pool of thousands of mortgages held in trust for their benefit. They will take the loss if the mortgage defaults. Or will they?

4) Don’t forget all those “credit default swaps” that we had to bail out AIG for. Many Mortgage Backed Securities have insurance policies on them that are supposed to pay some or all of the loss if the security fails. The insurer has no power to recast the mortgage to mitigate that loss, though. However, the insurers have, or expect, government bailouts and back up guarantees to prevent an insurance industry collapse.

5) What about the Trustee who holds all these mortgages for the benefit of the pension plans, etc., who bought the mortgage backed securities? You would think as a fiduciary for the security holders that the Trustee would have some incentive to mitigate the losses by getting a reduced, but flowing, income stream rather than no income stream at all. But often the trust agreement does not give the Trustee the power to recast these loans.

So, who suffers? The homeowner who does not have a person to negotiate with, the pension funds and school districts who may face a total loss if their securities don’t have insurance or if the government does not bail out the specific insurance company that wrote the credit default policy on their particular security; and of course, the taxpayers because Treasury keeps just giving away and giving away more and more money with no actual performance standards or benchmarks.