The Obama administration should consider forcing lenders to make principal reductions for struggling homeowners who owe more than their home is worth, the watchdog overseeing the $700 billion bank bailout said in a report released on Tuesday.

Late last month, the White House announced a significant expansion to its efforts to help homeowners by providing subsidies for lenders who write down principal for so-called underwater borrowers. Those programs are voluntary.

Treasury should consider changes to better maximize its effectiveness, said Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, or SIGTARP.

Barofsky said the voluntary nature of the Home Affordable Modification Program (HAMP) principal reduction plan sets up situations where some borrowers benefit, while others who may be just as deserving, do not.

Giving (mortgage) servicers the discretion to implement principal reduction introduces a questionable inconsistency into the HAMP program and stands in stark contrast to the mandatory nature of the other significant mortgage modification triggers, Barofsky wrote.

The report also urged the administration to consider extending the amount of time unemployed homeowners are forgiven from making mortgage payments as the maximum six months now allowed may not be long enough.

Although no program will assist all unemployed borrowers, Treasury should strive for a program that will at least assist the typical unemployed borrower, the report said, noting the average duration of reported unemployment is more than 31 weeks in the latest recession, the longest stretch since records began in 1948.

RISING TIDE OF FORECLOSURES

Weakness in the housing market and high unemployment continue to weigh on the U.S. economic recovery, though consumer confidence itself is growing.

The Obama administration introduced the $75 billion homeowner assistance program in early 2009, which includes $50 billion allocated from the bailout funds.

After receiving substantial criticism from Barofsky and others, the administration announced in March a major expansion of the program, which has used just a fraction of that money.

Those changes included the principal write-down incentives, and subsidies for lenders to provide forbearance for up to six months for unemployed borrowers.

Barofsky noted that nearly 2.8 million foreclosures were initiated in 2009 and that figure is likely to climb for 2010. In the first quarter, there were more than 932,000 foreclosure filings, an annualized pace of more than 3.7 million foreclosures.

Unfortunately, HAMP has made very little progress in stemming this onslaught, Barofsky said.

As of the end of March, the HAMP program has 1,008,873 total active modifications, including 227,922 modifications that have been made permanent, according to the Treasury Department. That's up from 1,003,902 total modifications and 168,708 permanent modifications through February.

Barofsky also said the program changes and the lack of clear guidelines associated with those changes may end up leaving the government susceptible to increased fraud.

Criminals feed on borrower confusion, and frequent changes to the program provide opportunities for experienced criminal elements to prey on desperate homeowners who have not been educated as to the risks of fraud, the report said.

(Reporting Corbett B. Daly; Editing by Jan Paschal)

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