Bank lobbyist Talbott is fighting to narrow new legislation David Deal	5.9 million more foreclosures seen by 2013 Francis Specker/Bloomberg News
Homeowner Smith regrets getting lured in by a subprime loan Michael Kelley	Senator Christopher Dodd Jim Lo Scalzo/Bloomberg News

The bad mortgages that got the current financial crisis started have produced a terrifying wave of home foreclosures. Unless the foreclosure surge eases, even the most extravagant federal stimulus spending won't spur an economic recovery.

The Obama Administration is expected within the next few weeks to announce an initiative of $50 billion or more to help strapped homeowners. But with 1 million residences having fallen into foreclosure since 2006, and an additional 5.9 million expected over the next four years, the Obama plan—whatever its details—can't possibly do the job by itself. Lenders and investors will have to acknowledge huge losses and figure out how to keep recession-wracked borrowers making at least some monthly payments.

So far the industry hasn't shown that kind of foresight. One reason foreclosures are so rampant is that banks and their advocates in Washington have delayed, diluted, and obstructed attempts to address the problem. Industry lobbyists are still at it today, working overtime to whittle down legislation backed by President Obama that would give bankruptcy courts the authority to shrink mortgage debt. Lobbyists say they will fight to restrict the types of loans the bankruptcy proposal covers and new powers granted to judges.

The industry strategy all along has been to buy time and thwart regulation, financial-services lobbyists tell BusinessWeek . "We were like the Dutch boy with his finger in the dike," says one business advocate who, like several colleagues, insists on anonymity, fearing career damage. Some admit that, in retrospect, their clients, which include Bank of America, Citigroup, and JPMorgan Chase, would have been better off had they agreed two years ago to address foreclosures systematically rather than pin their hopes on an unlikely housing rebound.

In public, financial institutions insist they've done their best to prevent foreclosures. Most argue that giving bankruptcy courts increased clout, known as cramdown authority, would reward irresponsible borrowers and result in higher borrowing costs. "What we're trying to do now is target the bill to make it as narrow as possible," says Scott Talbott, a lobbyist for the Financial Services Roundtable. On the defensive, the industry nevertheless benefits from one strain of popular opinion that home buyers who took on risky mortgages—even if the industry pushed those loans—don't deserve to be rescued.

AN INDUSTRY IN DENIAL

However the skirmish ends, the industry's contention that it has done as much as possible to limit foreclosures seems hollow. Some statistics it cites appear to be exaggerated. Even pro-industry figures such as Steven C. Preston, a Republican businessman who headed the Housing & Urban Development Dept. late in the Bush Administration, concede that many lenders have dragged their heels. "The industry still has not stepped up to the volume of the problem," Preston says. One program, Hope for Homeowners — which Bush officials and banks promised last fall would shield 400,000 families from foreclosure — has so far produced only 25 refinanced loans.

Meanwhile, an already glutted market sinks beneath the weight of more foreclosed homes. Borrowers whose equity has evaporated have nothing to tap into if the recession costs them their jobs. Some lawmakers and regulators are calling for a foreclosure moratorium. "People are falling through the cracks," Preston says. "That's bad for communities, bad for the individuals losing their homes, and bad for investors."

In early 2007, as overextended borrowers began to default on too-good-to-be-true subprime mortgages, housing experts sounded an alarm heard throughout Washington. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, wanted to push a bill requiring banks to modify loans whose enticingly low "teaser" interest rates soon give way to tougher terms. But he knew that with Republicans strongly opposed, he lacked the muscle, according to Senate aides. So Dodd did what politicians often do. He convened a talkfest: the Homeownership Preservation Summit.

A who's who of banking executives gathered on Apr. 18, 2007, behind closed doors in an ornate hearing room in the marble-faced Dirksen Senate Office Building. Dodd told them they needed to get out in front of the foreclosure fiasco by adjusting loan terms so borrowers would continue to make some payments, rather than stopping altogether. Foreclosure proceedings typically cost banks about 50% of a property's value. That's assuming the home can be resold—not a certainty when empty houses multiply in a neighborhood. "What are you doing?" Dodd asked the executives. "What do you need me to do to help you modify loans?"

Some from the industry denied a foreclosure problem existed, including Sandor E. Samuels, at the time chief legal officer of subprime giant Countrywide Financial. They vowed to continue selling loans with enticing introductory rates as well as those requiring minimal evidence of borrowers' income. "We are going to keep making these loans until the last second they are legal," Samuels later told a fellow participant.

On May 2, 2007, Dodd's office issued a "Statement of Principles" stemming from the summit. It outlined seven vaguely worded industry aspirations, such as making "early contact" with strapped borrowers and offering modifications that could include lowering loan balances. The principles had no effect, some summit participants now concede.

Much of Dodd's attention shifted to his campaign for the Democratic Presidential nomination. Senate Banking Committee spokeswoman Kate Szostak says Dodd aggressively pursued the foreclosure issue, but "both the industry and the Bush Administration refused to heed his warnings." The lawmaker accepted $5.9 million in contributions from the financial-services industry in 2007 and 2008.

Asked about his role at the summit, Samuels confirmed in an e-mail that he "did speak—formally and informally—about the performance" of subprime loans. But he declined to elaborate. He now works as a top in-house lawyer for Bank of America, which acquired Countrywide in July 2008.

A major reason financial institutions and investors are so determined to avoid modifying loan terms more aggressively has to do with accounting nuances, say industry lobbyists. If, for example, a bank lowered the balance of a certain mortgage, there would be a strong argument that it would have to reduce the value on its balance sheet of all similar mortgages in the same geographic area to reflect the danger that the region had hit an economic slump. Under this stringent approach, financial industry mortgage-related losses could far surpass even the grim $1.1 trillion estimated by Goldman Sachs in January. A desire to postpone this devastating situation helps explain lenders' intransigence, says Rick Sharga, vice-president of marketing at RealtyTrac, an Irvine (Calif.) firm that analyzes foreclosure patterns.

By mid-2007, Bush Administration officials were deeply worried about the financial industry's unwillingness to confront the growing catastrophe. Even banking lobbyists say they realized that their clients had lapsed into denial. The K Street representatives agreed that Treasury Secretary Henry Paulson needed to step in, says Erick R. Gustafson, then the chief lobbyist for the Mortgage Bankers Assn. "It was like an intervention," he says. "We had to get Treasury involved to get the banks to give us information."

That summer, Paulson, a former CEO of Goldman Sachs, summoned industry executives to the Cash Room, one of Treasury's most elegant venues. There, beneath replica gaslight chandeliers, Neel T. Kashkari, a junior Goldman banker whom Paulson had brought to Treasury, urged industry leaders to move swiftly to keep more consumers from losing their homes. Bankers know how to adjust interest rates, extend loan durations, and, if necessary, lower principal, said Kashkari, who has temporarily remained in his post. A couple of months later, Paulson summoned the executives again, this time to his conference room. "We told them we need to get over the goal line," recalls a former top Treasury official. "Cajoling is a euphemism for what we did. We pounded them."

One product of the Treasury conclaves was the Hope Now Alliance, a government-endorsed private sector organization announced by Paulson on Oct. 10, 2007. Lenders promised to cooperate with nonprofit credit counselors who would help borrowers prevent defaults. Faith Schwartz, a former subprime mortgage executive, was put in charge.

WINDOW DRESSING?

The alliance got off to a shaky start. An early press release contended that there had been more foreclosures nationally than the Mortgage Bankers Assn. was conceding at the time. "We looked like the Keystone Kops," says an industry lobbyist. Soon it became apparent that the program was primarily a public-relations effort, the lobbyist says. "Hope Now is really just a vehicle for collecting and marketing information to the Treasury, people on the Hill, and the news media."

In a press release last Dec. 22, Hope Now said it had prevented 2.2 million foreclosures in 2008 by arranging for borrowers to catch up on delinquent payments and, in some cases, easing terms. But the data don't reveal how many borrowers are falling back into default because many modifications don't, in fact, reduce monthly payments. The alliance doesn't receive this information from banks, says Schwartz.

There's reason for skepticism. Federal banking regulators reported in December 2008 that fully 53% of consumers receiving loan modifications were again delinquent on their mortgages after six months. Alan M. White, a law professor at Valparaiso University, says the redefault rates are high because modifications often lead to higher rather than lower payments. An analysis White did of a sample of 21,219 largely subprime mortgages modified in November 2008 found that only 35% of the cases resulted in lower payments. In 18%, payments stayed the same; in the remaining 47%, they rose. The reason for this strange result: Lenders and loan servicers are tacking on missed payments, taxes, and big fees to borrowers' monthly bills.

Consider the case of Ocbaselassie Kelete, a 41-year-old immigrant from Eritrea who called Hope Now last fall. Kelete, a naturalized U.S. citizen, bought a $540,000 townhouse in Hayward, Calif., in November 2006 with no down payment and 100% financing from First Franklin Financial, a subprime unit of Merrill Lynch. At the time, he and his wife earned $108,000 a year from his two jobs, with a pharmacy and an office-cleaning service, and hers as a janitor. Kelete says First Franklin and his realtor convinced him that he could afford a pair of mortgages, one with a 7.5% initial rate that would rise after three years, and a second with a fixed 12% rate. His monthly payment would total $3,600.

"WORK WITH ME"

"The realtor said, 'Just make sacrifices for two years. Home prices will go up, and you can refinance at a lower rate,' " Kelete recalls. He regrets signing a mortgage he couldn't afford—a mistake many people made during the subprime craze. Home prices didn't go up. He lost his office-cleaning job. First Franklin modified his loans, but added on property taxes it had failed to collect earlier. Kelete's monthly bill rose to $3,900. In October 2008, he called Hope Now. A counselor set up a conference call with First Franklin. The lender's representative said Kelete should get another job or give up the house, the borrower says. Kelete responded that he'd already lost his second job cleaning offices and couldn't find another in a faltering California economy. "Why don't you work with me?" he asked First Franklin. The lender declined. The Hope Now counselor said there was nothing more to do. "Foreclosure is the only future I see," Kelete says. A spokesman for BofA, which acquired Merrill in December, declined to comment, citing the borrower's privacy. After BusinessWeek's inquiries, however, First Franklin contacted Kelete about lowering his monthly payments.

Hope Now's Schwartz acknowledges she is fighting an uphill battle. By her calculation, 45% of the borrowers her organization advises still end up in foreclosure. "If I seem frustrated," she says, "it's because we are dealing with nothing but an exploding problem." She has a full-time staff of four in Washington; 500 counselors participate in the industry-funded hotline. "You shouldn't take it lightly, what we have achieved," Schwartz says. She bristles at suggestions that the statistics she disseminates are misleading. "I print what I know," she says, noting that some of her bank members aren't forthcoming about loan modifications. "It's like herding and juggling cats."

By early 2008 it was obvious that Hope Now wasn't halting a significant percentage of foreclosures. Democrats in Congress began gathering ideas for a government-sponsored remedy. Many of those ideas came from the industry. Lobbyists and congressional aides referred to one concept as "the Credit Suisse plan." Another, "the Bank of America plan," would allow borrowers to refinance mortgages with loans guaranteed by the Federal Housing Administration. Representative Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, had solicited BofA's advice via an old Boston acquaintance, Anne Finucane, the bank's chief marketing executive and a politically active Democrat. He assigned several aides, including Michael M. Paese and Rick Delfin, to work out the details.

Francis Creighton, a Democratic former staff member on the Financial Services panel who had gone to work as a lobbyist for the Mortgage Bankers Assn., negotiated with Paese and Delfin. Creighton's Republican colleague Gustafson huddled with aides to such GOP lawmakers as Representative Spencer Bachus and Senator Richard Shelby, both of Alabama.

Before long, the anti-foreclosure provisions were being altered in ways the industry favored. Shelby, the ranking Republican on the Senate Banking Committee, along with other Republicans insisted on the pro-industry language in exchange for their support, aides say.

In the end, the program included stiff up-front and annual fees and a requirement that homeowners pay the government 50% of any future appreciation in the property's value—all of which made it much less attractive to borrowers. Moreover, the banks' participation was made entirely voluntary; there was no way to pressure them to cooperate.

Congress approved Hope for Homeowners on July 26, 2008, as part of a larger measure imposing restrictions on the mortgage finance firms Fannie Mae and Freddie Mac. At the Mortgage Bankers Assn., lobbyists gathered in Gustafson's corner office to lift plastic cups of wine in celebration.

Those familiar with Hope for Homeowners anticipated that its fine print would discourage all but a few borrowers. "We knew it was likely to have limited appeal," says Preston, the former secretary of HUD, which oversees the FHA. George Miller, executive director of the American Securitization Forum, a Wall Street trade group, calls the program and its 25 refinanced loans "useless" because of the onerous details.

BROKEN BILL

Shelby, for his part, never expected Hope for Homeowners to accomplish much, according to Republican Senate aides. He agreed to it to gain Dodd's support for greater regulation of Fannie and Freddie—and only when assured the program wouldn't drain tax dollars. "My consistent aim throughout this crisis has been to protect the American taxpayer," Shelby told BusinessWeek in a statement. He accepted $565,000 in contributions from the financial-services industry in 2007-2008.

Frank, whose industry contributions totaled $948,000 over the same period, says he became skeptical Hope for Homeowners could achieve its initial goal of helping 1 million people. But he expected much more progress than the mere 25 refinancings that have occurred so far, according to HUD. He blames Republicans and the industry for undercutting his legislation. "I didn't have the votes to do more," he says.

The Massachusetts liberal hasn't given up hope of repairing Hope for Homeowners. He is working on changes that would cut borrowers' up-front fees and provide bonus money for mortgage servicers that agree to participate in the voluntary program. Frank aides Paese and Delfin aren't assisting with the fixes: They have left their congressional staff positions for lobbying jobs with the Securities Industry & Financial Markets Assn. in Washington. They say they are observing the one-year federal ban on speaking with their former boss about business they did on the Hill.

In the first days of 2009 it appeared that progress might be possible on a different front. A slumping Citigroup came back to the Treasury Dept. for a second round of bailout money. Bowing to pressure from regulators, Citi broke ranks with its rivals and dropped its opposition to bankruptcy cramdown.

Senator Dick Durbin (D-Ill.), who since 2007 had led unsuccessful efforts in Congress to give bankruptcy judges authority to modify home loans, dispatched his senior economic policy adviser, Brad J. McConnell, to talk with lobbyists for JPMorgan Chase and Bank of America. "Each agreed to take [the idea] back to their folks to see what they could do," says a person familiar with the talks. Citi's concession, the imminent Obama inauguration, and intensifying public hostility toward big banks contributed to an atmosphere Democrats assumed would be conducive to compromise.

TALKING POINTS

By the time McConnell talked to the JPMorgan and BofA representatives the next day, however, "they had gone on full defense mode and started to complain about how lousy a deal Citi had struck," says the person familiar with the exchanges. Bank opposition, Durbin says, "was very shortsighted in light of the mess they have created in our economy."

In the following weeks, banking lobbyists launched a renewed attack on the cramdown legislation, enlisting as an ally Republican Representative Lamar Smith of Texas, among others. Apart from Citi, "the industry remains united in that bankruptcy cramdown would destabilize the market" by creating widespread uncertainty about the value of numerous troubled mortgages, says Steve O'Connor, senior vice-president for government relations at the Mortgage Bankers Assn. His group is distributing talking points to key congressional aides laying out reasons why "Congress should defeat bankruptcy reform legislation." These include the argument that if lenders can't be confident that loan terms will survive, they will raise rates and reject riskier borrowers. Industry lobbyists are organizing home state bankers to pressure moderate Democrats they hope will be receptive to limiting the kinds of loans eligible for cramdown. One target: Senator Evan Bayh of Indiana.

Stefanie and James Smith of Santa Clarita, Calif., fear they may need the help of a bankruptcy court if they are to keep the subdivision home they bought for $579,000 in November 2005. Stefanie, 37, a university human resources coordinator, and James, 40, a federal law enforcement agent, borrowed the entire amount in two subprime loans that required a total monthly payment of $3,000. A representative of their lender, Countrywide, told them not to worry, says Stefanie: They would be able to refinance in a year.

By mid-2007 they were running late on payments, and refinancing options had dried up. With their monthly bill scheduled to jump to more than $4,000 this January due to a rising mortgage rate, Stefanie contacted Countrywide last summer. She asked for a loan modification so they could avoid default. In December the lender said it would be willing to increase their payment by $600. That was better than the scheduled rise of $1,100, so the Smiths agreed.

But now they are struggling to pay the higher amount. Countrywide's parent, BofA, declined to comment, citing the Smiths' privacy. After BusinessWeek's questions, though, Countrywide called them to discuss cutting their payments.

Home Wreckers (VIDEO)

What's Holding Back Mortgage Modification?

By Brian Grow, BusinessWeek, 2/23/2009, http://www.businessweek.com/magazine/content/09_08/b4120034100121.htm

One supposed obstacle to sorting out the millions of mortgages that have gone bad is that the home loans have been bought by investment banks, bundled together into bonds, and sold to investors. This widespread process of "securitizing" loans makes it difficult to go back and modify the terms of individual mortgages so that strapped borrowers might be able to continue to make payments, according to mortgage industry experts. In particular, this argument goes, the middlemen known as mortgage servicers, who administer home loans, are contractually prohibited from adjusting interest rates or balances, without risking a wave of lawsuits filed by purchasers of mortgage-backed securities.

But this problem has been vastly overstated, say some industry lobbyists and government officials. "One of the biggest lies out there is that servicers can't take action. They certainly can," says Mike Krimminger, special policy adviser to FDIC Chairman Sheila M. Bair.

Foreclosure Is Cheaper

During the mortgage boom, $7 trillion worth of home loans, including hundreds of billions of dollars worth of subprime mortgages, were packaged and sold to investors in the form of bonds. According to an analysis by foreclosure research firm RealtyTrac, about half of all subprime loans that have entered foreclosure were securitized and sold to investors. In normal times, mortgage servicers, which include giant lenders such as Countrywide and specialty firms such as Litton Loan Servicing, a unit of Goldman Sachs, have a simple and lucrative job: collect payment from borrowers, administer escrow accounts, and forward funds to investors.

But as mortgage defaults have surged in the past two years, these caretakers are under pressure to do more to stop the bleeding by modifying loan terms. Many have balked or dragged their feet, say industry experts, hoping the housing market will rebound. One reason is that servicers earn more, under most current contracts, when they foreclose, compared with when they modify a loan. Adding staff and technology to manage modifications is costly. That's one reason the Obama Administration says it plans to increase incentives for loan managers to modify mortgages in its new bailout programs, expected to be detailed in the next few weeks.

" The cost-benefit calculation of the servicers has been very lopsided" in favor of foreclosures, says Alan S. Blinder, a professor of economics and public policy at Princeton University.

Few Contracts Bar Modification

Contract prohibitions are another argument used by servicers to explain why more can't be done. The claim, however, may be exaggerated. Securitization experts say the vast majority of securitized mortgage contracts, known as pooling and servicing agreements, have few or no provisions preventing changes to loans' terms. In more than 85% of these agreements, "there are no meaningful restrictions on a servicers' ability to modify," says Tom Deutsch, deputy executive director of the American Securitization Forum, a New York-based unit of the Securities Industry & Financial Management Assn., which represents servicers and investors. "Most [mortgage-backed] securities contracts expressly permit or do not prohibit loan modifications."

Intransigence may be driven more by the fear of litigation than explicit contractual obligations. It's not completely unwarranted. In December, investment fund Greenwich Financial sued Countrywide over terms of an October settlement with 11 state attorneys general. The agreement requires Countrywide to modify the terms of certain subprime loans. Greenwich claims that language in 374 Countrywide mortgage trusts created between 2005 and 2007 require Countrywide either to foreclose on defaulted mortgages or to buy them back at face value before they are modified. "Those are Countrywide's only options," says William Frey, chief executive of Greenwich Financial.

Bank of America, which acquired Countrywide in July 2008, has not filed a response to the lawsuit. In a December statement, Bank of America noted that loan modifications have been "occurring for decades without objections or challenges, so we are especially troubled at the timing of this complaint. No one benefits if we allow these homeowners to advance toward ultimate foreclosure. We are confident any attempt to stop this program will be legally unsupportable." A motion to move the case from New York Supreme Court in Manhattan to federal court in New York is pending.

Rewriting Loans Stems Foreclosures

Despite the fear of lawsuits, some mortgage middlemen are now stepping up efforts to accelerate modification of securitized loans. At Litton Loan Servicing, which handles about $70 billion worth of mortgages, nearly one-third of troubled loan modifications in November involved a reduction in the principal balance, a step that many servicers—and major lenders—have been reluctant to take because it is often the most costly to investors compared to interest-rate freezes and extending a loan's term. Litton says its analysis shows principal reductions led to a 50% decrease in borrowers who redefault on their mortgages, according to recent reports. Litton has declined several requests for an interview from BusinessWeek.

Legislation pending in Congress would offer servicers protection from lawsuits, known as safe harbor. A Feb. 6 letter reviewed by BusinessWeek from the American Bankers Assn. to James B. Lockhart III, director of the Federal Housing Finance Administration, which oversees mortgage giants Fannie Mae and Freddie Mac, says the banking trade group's members plan to redouble efforts to modify securitized loans—and help negotiate with investors on behalf of servicers worried about legal liability. "This letter is going to be held up in part as a plea to investors to recognize this industry (loan modification) practice as a benefit to the overall economy," says Robert Davis, executive vice-president of the trade group. He says the ABA wants mortgage servicers to interpret contract language "liberally."

With Jane Sasseen, BusinessWeek 's Washington bureau chief, and Robert Berner, a senior writer based in Chicago

Foreclosure Follies (Business Week, 03/09/2009)

We got hundreds of responses to "Home Wreckers" (Cover Story, Feb. 23), a look at the banking industry's campaign to delay, dilute, or obstruct proposals to stem home foreclosures. Some readers argued that "delusional" buyers who took out mortgages they couldn't afford don't deserve help. Others lambasted lenders for throwing their weight around on Capitol Hill even as they get billions in bailout funds. We also heard from the Hope Now Alliance, a mortgage industry anti-foreclosure group, which objected to our analysis. The question now: How will bankers respond to the Administration's new $75 billion foreclosure-prevention program? It offers incentives for modifying mortgage loans, aiming to keep more than 4 million people in their homes. — Brian Grow

It's disconcerting to see media reports of the foreclosure fiasco that read as if a natural disaster had befallen the innocents. Taxpayer funds would be better spent on free credit counseling for these folks. "All we want is a mortgage we can afford." Please. Don't we all.
     Michael Harrington
     LOS ANGELES

Two things helped me when I lost my job: My student loan was deferred for six months and my credit union allowed me to miss two payments on my car loan. I am current on both of those bills to date. The institutions that would not work with me: my credit-card lenders and my mortgage lender. Turns out we all lost. I lost my house. I defaulted on my credit cards.... If only [those lenders] figured out what the credit union and student loan people knew.
     Screen name: Kari

Your article is really about the power of lobbyists. Companies taking TARP money should be forbidden to lobby the federal government.
     Screen name: Jim in DC

It's time for those who profited from questionable mortgage lending to accept the risks they created and take their losses. To insist that the principal of a loan cannot be altered is to ignore the risk that underlies all lending. A loan is an investment. Investments grow or shrink. Why should one class of investors insist on being made whole?
     Laurie Gorton
     OVERLAND PARK, KAN.

The title of the article should be, "I want free stuff, courtesy of the banks."
     Screen name: RT

I don't understand why our government cannot make it a condition for the banks that receive the bailout money to first reduce the loan balance to [a home's] market value so homeowners will not walk away.
     Stephen Ng
     TIBURON, CALIF.

Your article underplayed the effectiveness of the Hope Now Alliance, a mortgage industry and nonprofit anti-foreclosure group. In December 2008, Hope Now reported a record 239,000 foreclosure-prevention workouts by its members and the larger mortgage industry. Almost 2.3 million workouts were completed by the industry in 2008.
   Hope Now has helped millions of homeowners avoid foreclosure. It has also helped homeowners who otherwise would not be able or willing to get help with their mortgage problems obtain assistance from counselors and servicers.
   We at Hope Now agree that, with growing economic challenges and rising unemployment, more needs to be done to keep families in their homes. We support the Obama Administration's new foreclosure-prevention plan. But the fact that more needs to be done doesn't change the reality that Hope Now—with help from its respected partners Fannie Mae, Freddie Mac, and the Federal Reserve Banks—has had a strongly positive impact on homeowners.
     Faith Schwartz
     Executive Director
     Hope Now
     WASHINGTON

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