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March 6, 2009, 1:00 p.m. EST

Report: Obama mortgage program has some issues

Congressional panel says plan should consider 2nd loans and enforcement

By Ronald D. Orol, MarketWatch

WASHINGTON (MarketWatch) - The Obama administration's new mortgage modification plan is a positive step forward but questions remain about how the government will enforce new standards and what agency officials plan to do about problematic second mortgages, according to a congressional oversight panel report on Friday.

At issue is a $275 billion plan announced Feb. 18 that seeks to help 9 million troubled homeowners by helping borrowers modify mortgages or refinance their loans. See full story.

However, according to the panel's March oversight report, the Obama plan does little to explain how government officials will enforce new standards for banks that must participate in the program. Financial institutions receiving bank bailout funds as part of the government's Troubled Asset Relief Program are required to participate in the Obama administration's loan modification program.

Under the modification program, lenders will be responsible for bringing down interest rates so that a borrower's monthly mortgage payment is no more than 38% of a homeowner's pretax income. After that, the government program would use taxpayer funds to match the amount reduced by the lender to bring a homeowner's payments down to 31% of pretax income.

"While the modification aspects of the plan will be mandatory for banks receiving TARP funds going forward, it is unclear how the federal regulators will enforce these new standards industry-wide to reach the needed level of participation," the report writes.

Second mortgage problems

The report also said the plan did not address the contributory role of troubled borrowers' second mortgages.

COP director and Harvard Law School Professor Elizabeth Warren said in a conference call with reporters that in some situations borrowers with second mortgages may be able to employ the Obama program to modify their first loan, but not the second.

"Second mortgages increase the likelihood of default," Warren said.

In other situations, she added, second mortgages create a real problem for homes that are already in default because the second lender may hold up negotiations about modification between the primary lender and the borrower. Also, she added that the primary mortgage lenders are reluctant to modify mortgages because the benefits of a modification may go to the second mortgage lender.

In some situations, Warren said, second mortgage lenders may have the power to hold up refinancing.

She added that legislators may want to consider legislation that would force the second mortgages to "go away," either by offering incentives to have lenders to modify these loans or through legislation that would say second mortgage holders have no say in refinancing.

Data Collection

The report also took issue with the government's data collection methodology. It argued that a lack of private or government nationwide data about mortgages and loan modification efforts is hampering efforts to develop a thoughtful mortgage modification program.

In a conference call with reporters, Warren asked why it took so long for the Office of the Comptroller of the Currency to release its recent report showing a high re-default rate on mortgages that had been modified in the first two quarters of 2008.

"Why did it take them so long to get that data?" Warren asked. "We've never faced a mortgage crisis like this before where we have so many mortgages held in so many different hands. If there is no quick feedback about how many modified mortgages go into re-default, it is not possible to make mid-stream corrections to the program."

Ronald D. Orol is a MarketWatch reporter, based in Washington.

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