As of October 2010, HAMP (the Treasury Department’s Home Affordable Modification Program) had generated about 520,000 active permanent loan modifications, far below its stated goal of modifying three million mortgages and helping to staunch the housing crisis. The program has been mired by bureaucratic delays and chaotic foreclosures triggered by trial payments (see: “HAMP (…ered) Recovery and the Flood of Foreclosures: Why Banks Can’t Lose”).

Double Standard In Loan Modification

HAMP is famous for sinking homeowners under piles upon piles of paperwork. Banks, on the other hand, receive as much as $1500 per HAMP loan modification in subsidies from the federal government without having to produce any proof that they actually own the mortgage in question.

HAMP participation does not require banks to provide any physical proof of a note underlying a property. Zip. Nada. Do the banks even own the mortgages they participate in modifying? Who knows.

Many lenders pooled and securitized their loans, then sold the securities to investors. Some of these lenders could still produce physical proof of a mortgage even though they had sold it to investors. How is that even possible? An excellent question.

It is really quite simple but could have messy consequences.

Who Owns What

Some lenders simply failed to deposit the notes in the mortgage pool and no one noticed. They got the money but forgot to hand over the goods. What would you call that in the real world?

According to court testimony of an executive at Bank of America, Countrywide (now owned by Bank of America) sold what it claimed were mortgage-backed securities but kept the notes underlying the loans. It did so not by oversight but as a policy.

In a lawsuit brought up in the United States Bankruptcy Court in Camden, N.J., an executive at Bank of America said that Countrywide’s practice was

to maintain possession of the original note and related loan documents.

Investors in mortgage backed securities can sue lenders for failing to fulfill their contractual obligations and force them to buy back the loans they failed to hand over.

There is a possibility that this could actually happen at a larger scale. There are many cases in which proper procedures for setting up mortgage securities trusts were not followed. Now there will be mortgage modifications based on missing documentation or false premises. How can a bank modify a loan if it does not own it?

The Congressional Oversight Panel concludes in its report:

Claimants will contend that the securitization trusts created securities that were based on mortgages which they did not own(…) Since the nation’s largest banks often created these securitization trusts or originated the mortgages in the pool, in a worst-case scenario it is possible that these institutions would be forced to repurchase the M.B.S. [mortgage-backed securities] the trusts issued, often at a significant loss.

This would also mean that HAMP subsidies already paid out by the government would have to change hands.

But there is a larger issue at stake. If these lenders had followed proper procedures, they would not be able to legally receive government subsidies for modifying loans they no longer own.

Should courts force these banks to buy back the securities they had improperly (or fraudulently) set up, not only some weaker banks but even the nation’s biggest financial institutions could be shaken.

It is not yet clear whether this is going to affect borrowers who have successfully received their HAMP loan modification, but should lawsuits materialize at a larger scale, it could bring the program to a screeching halt.

You can read the full report by the Congressional Oversight Panel right here.