Contrary to what voters were led to believe, California took the unprecedented step this month to give banks and struggling homeowners up to $100,000 in taxpayer funds to reduce underwater mortgages.
Originally, banks and lenders were supposed to pay 50 percent of the cost of reducing the principal for those whose homes are worth less than their mortgage. But when the banks refused, California took the controversial step of paying the entire amount, up to $100,000.
"We thought, you know, 50-50 was much more attractive and we'd have much more traction with lenders, and it just didn't turn out to work as well as we would have liked," said Diane Richardson, legislative director of the California Housing Finance Agency.
The program, known as the Hardest Hit Housing Market fund, is part of a $7.6 billion federal effort to help underwater homeowners in 18 states. California received $2 billion. But when banks and lenders who service loans refused to write down even a small portion of the negative equity loans, California decided to use the taxpayer money to pay 100 percent of the mortgage reduction.
Richard Green, a professor of real estate at the University of Southern California, said it's not what taxpayers signed up for.
"I think taxpayers would be furious at the idea that everybody gets completely off the hook for this," Green said. "There are people that say, look, I've been a renter all these years, I've been paying my mortgage all these years, why am I bailing out these people who made a bad decision? I think the politics of it are very combustible."
Back in 2009, President Obama and other lawmakers discussed the "moral hazard" such federal programs represented. If you help some homeowners, will others abuse the system because they know others will pay up the tab? How many borrowers would purposely fall behind on their payments in the hopes of getting an principal reduction is anyone's guess, but mortgage giants Fannie Mae and Freddie Mac recently rejected the idea of cutting loan balances, saying savings did not justify the cost.
"A solution that doesn't take a little bit of flesh from both borrowers and lenders I think is problematic," Green said. "I do think there needs to be a less sum ... of taxpayer money in reducing these balances. I just think borrowers should have to pay for something and lenders should have to pay something for this."
"I don't know where the blame belongs. I mean, we thought we were creating something that was attractive, and banks would participate," Richardson said. "But look at the magnitude of this crisis. If we just step aside and let all these homes go into foreclosure, I mean, I continue to make my mortgage payment, too. And I am acutely aware of every home that goes into foreclosure in my neighborhood, my property values are going down. So if we can help save some of these people, you know, that's to my benefit."
As a result of paying 100 percent of the cost of each mortgage write-down, the number of troubled homeowners California can help from 25,000 to fewer than 9,000. In April, Cynthia Romero, inspector general of the TARP program, criticized the Hardest Hit fund, saying states have misused the money, and she blamed the Treasury Department for failing to require banks and lenders to participate in the program before allocating the money to states. She said states lacked leverage to recruit servicers or banks to play.
California made two other changes to accommodate lenders and homeowners. Banks will now get 100 percent of the write-down money in the first year, not in three installments. Secondly, homeowners will not have to pay back the money if the home is sold at a profit - provided they make their payment and stay in the home for five years.
This is a far cry from this statement Obama made in April in 2009 in Phoenix: "So this part of the plan will require both buyers and lenders to step up and do their part and to take on some responsibility."
The Hardest Hit fund was signed to help those markets where a majority of homes for sale were actually underwater. As of December 31, just 3 percent of the $7.6 billion had been spent, and housing prices in most markets have already begun to recover. Nevertheless, the federal government is not recalling the money.
With so few homeowners being helped some doubt the mortgage write-down will stabilize any market, nevertheless Green says spend away.
"At the end of the day, you have a choice, do you want to be sanctimonious or do you want to solve the problem. And I want to solve the problem. Is this unfair? Absolutely. A lot of things in life are unfair. But to clear out the inventory in certain parts of the country I think it is necessary to do something like principle reduction."
William La Jeunesse joined FOX News Channel (FNC) in March 1998 and currently serves as a Los Angeles-based correspondent.