Modifying the mortgage terms of delinquent homeowners is one of the most debated concepts in Washington right now.

FDIC chairwoman Sheila Bair wants massive, across the board modifications -- slashing hundreds of thousands of borrowers' interest rates and monthly payments NOW -- long before they fall into foreclosure.

House Financial Services committee chairman, Barney Frank, is threatening mortgage lenders with tough new regulations if they don't modify customers' loan terms quickly enough to keep them out of foreclosure.

Even the Bush administration has jumped on the bandwagon, calling for widespread loan fixes, even offering $800 cash incentives when loan servicers do so.

But here's a politically sensitive question: How well do modifications really work?

Rob Dubitsky, a top researcher for Credit Suisse Group, says they're not as effective as you might think.

In a study of reports from 19 major mortgage servicers, Dubitsky found that one third of all borrowers who received modifications fell back into serious delinquency within eight months, according to the American Banker trade publication.

For borrowers who received what Dubitsky called "traditional" medications to their mortgages -- rate cuts or reworking of terms that added late fees and back payments onto borrowers' principal balances -- fully 44 percent RE-defaulted within eight months.

They either had to be given new and easier loan terms … or they simply went to foreclosure.

Only outright reductions of loan balances -- something most lenders are reluctant to do - reduced the re-default rate significantly. But even then, Dubitsky found nearly one in every four borrowers later fell behind on payments.

None of this is a big surprise to long-time professionals in the default mitigation business. Joe Smith, president and CEO of Default Mitigation Management of Newport, Kentucky, says wholesale modifications -- as advocated by FDIC's Bair - are likely to lead to higher rates of later re-defaults and foreclosures.

Smith's firm advocates more hands-on, individualized techniques to cure delinquencies, often involving counseling. Mass modifications without individualized underwriting and personal finance counseling, he says, "just pushes the problem down the road."

But don't hold your breath waiting for anybody in Washington -- and certainly not the incoming Obama administration or Congress -- to throttle back on their mass modification programs anytime soon.

And don't expect them to do what's politically much tougher: Ask banks to bite the bullet up front -- write down principal balances early on so they don't have to RE-modify vast numbers of mortgages - maybe over and over again -- to keep owners out of foreclosure.

Published: December 1, 2008

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consmer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.