The federal government’s program to aid distressed homeowners provides lenders a $1,000 incentive for each loan they modify, with an additional $1,000 per year for up to three years after the modification. Though the program is hoped to spur 20,000 modifications each week once the program gains momentum by the end of August, it is off to a frustratingly sluggish start.

Most lenders, despite hiring additional loan counselors, have not implemented the required infrastructure to process the deluge of loan modification applications. Would-be modifiers are shoved into a bureaucratic labyrinth where submitted applications frequently vanish and overextended loan representatives point applicants down a plethora of procedural dead ends, forcing many applicants to restart the process by submitting new applications from scratch. Lenders are exerting some effort to right the sinking ship of the current mortgage meltdown by accepting the modification applications, but as of yet, they have not developed a reliable system to process them adequately.

The underlying problem in California is that most properties with negative equities do not qualify for the program to allow the lenders to get their $4,000.  The loan cannot exceed 125% of the property’s still-declining fair market value.

first tuesday take: Until Congress places lenders under the rule of bankruptcy judges to ensure loan modifications are completed, few meaningful modifications will take place. A meaningful modification must reduce the amount of the outstanding debt to equal a property’s actual fair market value, encouraging rational property owners to stay in their homes. A reduction in monthly payments without the tandem cramdown of the mortgage debt creates an illusory solution to the negative equity puzzle. Without the mandatory adherence to loan cramdown rulings by bankruptcy judges, lenders have no motivation to forgive any debt taken out by upside-down property owners.

Re: “Paper Avalanche Buries Plan to Stem Foreclosures” from the New York Times.