The Center for Public Integrity published a damning report from a whistleblower on the inside of Fannie Mae’s handling of the Home Affordable Modification Program (HAMP), the Obama administration’s effort to stem the tide of foreclosures by renegotiating terms of mortgages.  Instead of pressing forward with permanent modifications, this former consultant and VP of Fannie Mae alleges, the government-controlled GSE obstructed their progress in order to gain more profit from bonuses paid on trial modifications instead.  Homeowners who could have been helped got dumped in pursuit of government bonus incentives:

Fannie Mae executives bungled their stewardship of the federal government’s massive foreclosure-prevention campaign, creating a bureaucratic muddle characterized by “mismanagement and gross waste of public funds,” according to a whistleblower lawsuit by a former Fannie Mae executive and consultant.

Caroline Herron, a former Fannie vice president who returned to the mortgage giant in 2009 as a high-level consultant, claims that the homeowner-relief effort was marred by delays, missteps and executives preoccupied with their institution’s short-term financial interests.

“It appeared that Fannie Mae officers were focused on maximizing incentive payments available to Fannie Mae under various federal programs – even if this meant wasting taxpayer money and delaying the implementation of high-priority Treasury programs,” she claims in the lawsuit.

The problem starts with a skewed financial incentive at the heart of HAMP.  The government paid Fannie bonuses for trial modifications that lasted three months, but apparently provided no incentive to move those homeowners into permanent modifications.  Under pressure to show that they could turn a profit after the massive bailouts of 2008 and continuing bailouts in 2009, Fannie Mae execs focused like a laser on earning the bonus payments:

Herron charges that Fannie Mae continued in headlong pursuit of “trial mods” even though it knew many had little chance of becoming permanent. As late as September 2009, barely 1 percent of trial modifications had converted to permanent modifications by the end of their three-month trial, a Congressional oversight panel found. Nevertheless, Fannie preferred doing trials, Herron alleges, because it was eligible to receive incentive payments from the Treasury Department for trial modifications it booked before the end of 2009.

As of February 2010, 83 percent of the 1 million active modifications being handled by HAMP were trials rather than permanent arrangements. Barofsky, the special inspector general, criticized HAMP’s focus on trial modifications in a recent report.

In other words, it’s a bit like the sub-prime loan market prior to 2008.  Government incentives pushed Fannie not only to prioritize trial mods over permanent settlements, but also to pull borrowers with no hope of rescue into the program in order to profit off of them.  That wasted resources that could have focused on those homeowners who could still have benefited from HAMP.

Nor was that the only way that the perverse incentives derailed HAMP.  Fannie Mae had asked for an online solution to the documentation problem facing many of the homeowners that was delaying or blocking renegotiation with lenders.  Solutions were quickly identified — and then left to rot on the vine, until Fannie’s execs finally canceled the entire idea:

In July 2009, Default Mitigation Management, a Newport, Ky., company, demonstrated its loan portal to Fannie officials, according to Igor Roitburg, the company’s chief operating officer. Roitburg says his company had developed a portal that was already used by some mortgage counselors to help distressed borrowers and, with a few tweaks, could have helped borrowers communicate directly with their loan servicers. “We were ready to go,” Roitburg told the Center.

Months went by, though, before Fannie issued a formal request for proposals from software developers. Then, around the start of 2010, Fannie and the Treasury Department abruptly canceled the bidding process. In a letter to U.S. Rep. Geoff Davis of Kentucky, a top Treasury official explained that as the bidding process neared its end, Fannie identified a need for “broader capabilities” in the portal and “determined not to move forward with a borrower portal at that time.”

Herron’s lawsuit accuses Fannie executives of “actively working against” the borrower portal idea. Fannie was reluctant to move quickly to make it easier for homeowners to provide extensive documentation to their loan servicers because it wanted to continue processing less-documented trial modifications, she alleges.

Small wonder that HAMP has turned into an embarrassing failure for the Obama administration.  Special Inspector General of TARP Neil Barofsky has sent up more than one warning flare on this program; it appears that Caroline Herron may have some of the answers about the waste of taxpayer funds it has turned out to be.

Addendum: CPI also has a useful timeline for HAMP and Fannie Mae’s bailout: