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One of the objectives of government loan modification programs is home preservation. Home preservation is achieved when loan modifications are used to keep borrowers in their home. The desire to keep borrowers in their home must make economic sense to both the investor and servicer.

There is a movement to provide homeowner relief by allowing bankruptcy courts to force the borrower and servicer to into attempting to mediate a solution. The servicer would be required to make a good faith effort at offering a loan modification; whether good faith requires the servicer to be willing to modify the loan may be an open question under this legislation.

We already have HAMP and individual lender/servicer programs in place; do we really want yet another variation of HAMP (through bankruptcy courts)? While legislation mandating mediation between the parties sounds benign, there are several serious problems with this approach to the loan modification problem.

First, having a mandatory mediation assumes that a borrower would be better-off in their home as an owner than as a renter. Given the prevalence of negative equity and the large supply of vacant and rentable property in the country, it is highly likely that many borrowers would be better off renting. Homeownership is expensive and not for everyone since it has always been a risky investment. Just based on tax reasons, many households are in a very low marginal tax rate already; hence, the interest and property tax deduction is thrown away or valued at a low rate. Renting is more efficient in terms of taxation. When you combine the tax disincentives with the risk of homeownership, borrowers would often be better-off renting and getting a fresh start.

As Raphael Bostic, HUD’s Assistant Secretary for Policy Development and Research, stated in a recent Washington Post interview,

"In previous eras, we haven't seen people question whether homeownership was the right decision. It was just assumed that's where you want to go. You're not going to hear us say that."

Second, a mandatory mediation adds additional costs and delays to the process, a process that is already severely strained. The average time to liquidation of a house averages 17 months already (costing the investor/lender lost interest and asset value declines). If bankruptcy becomes more appealing to borrowers because of the mandatory mediation, we would expect rather onerous delays in moving borrowers to foreclosure. Furthermore, the mandatory modification may result in borrowers bypassing HAMP (or lender/servicer programs)