Subprime Lenders Head the Line for Federal Subsidies

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David Zalubowski / AP

A foreclosure sign in the south Denver suburb of Littleton, Colo.

About two dozen firms that led the country into the subprime debacle are now lined up to receive billions of taxpayer dollars through a federal program aimed at stemming foreclosures, according to a report released Wednesday, Aug. 26.

The report, issued by Washington's Center for Public Integrity, found that at least 21 of the top 25 firms taking part in the Home Affordable Modification Program, or HAMP, were heavily involved in the frenzied lending that led to the subprime blowup. The firms originated or serviced subprime loans, or both.

Under the Treasury Department's program, up to $75 billion will be spent in an effort to prevent as many as 9 million people from losing their homes. "Much of this money is going directly to the same financial institutions that helped create the subprime-mortgage mess in the first place," said Bill Buzenberg, executive director of the Center for Public Integrity, in a statement.

The list of firms expected to get HAMP subsidies reads like a Who's Who of major subprime lenders and loan servicers, including financial institutions that have already received big bucks in the government's bank bailout. Countrywide, which is now owned by Bank of America and was one of the country's biggest subprime lenders, may receive up to $5.1 billion in incentive payments to modify loans.

Others expected to cash in through the program are JPMorgan Chase, which could collect up to $3.4 billion when its EMC Mortgage subsidiary is included, and Wells Fargo, which could get up to $3.1 billion when its Wachovia subsidiaries are included, the report said. Even a former subsidiary of Lehman Brothers, which helped underwrite the subprime toxic loans, is bellying up to the bar, the report said.

However, Bob Curran, managing director at Fitch Ratings, says the government program is needed to curb the tide of foreclosures, and he isn't surprised that many of the firms taking part in the program were involved in the subprime debacle.

"They have the structure and the knowledge to execute the plan, and I'm not sure who else could step in," says Curran.

Without incentives, loan modifications would not get done. "The programs are well behind where the government thought they would be at this point in time, and part of [the reason] is probably the amount of remuneration that these entities receive on a per loan basis," he says.

"Who else is going to do it? Who's in a position to deal with the loans and modify the loans, if not those that are servicing the loans?" he says. "They're sort of stuck with them."

An alternative to HAMP would be the proposed "cramdown" legislation, whereby a bankruptcy judge would be given carte blanche power to modify a loan by lowering the interest rate, reducing the principal amount or extending the term of the loan to make the monthly mortgage payments more affordable to the troubled homeowner. Under this program, firms would not get the big subsidies, since the judge would be acting unilaterally in modifying the loan.

However, the cramdown proposal has not gained momentum in Congress: many fear it would destabilize the mortgage industry in the long term, since lenders would be reluctant to make future loans and bondholders would be reticent to purchase them if the terms could suddenly be changed by a judge at any time. "They'd be much more cautious about who they're going to loan to in the future, for fear that this bankruptcy situation could occur, and it would sour them to some degree on making home loans," says Curran.

As a result, Curran believes the HAMP program is probably the most effective way to stop foreclosures, at least in the short term.

"It gives a portion of the public, which is facing delinquency and default, a way to avoid going into ultimate foreclosure," says Curran.

In the meantime, foreclosures and unemployment continue to tick up. According to RealtyTrac, an online foreclosure database, the number of properties receiving foreclosure notices in July totaled 360,149, up 7% from June and up 32% from the same month a year ago.