WASHINGTON—Treasury Secretary Henry Paulson met in private with top lenders and servicers this week to warn them the housing market is continuing to deteriorate and press them for a new solution, several sources said Thursday.

During the 90-minute meeting, Paulson urged lenders to come up with a plan to help so-called “underwater” borrowers, who owe more on their mortgages than the value of their home.


“His goal was to prod us and figure out what was coming next and whether there was anything Treasury could do to help the situation,” said one participant, who spoke on condition of anonymity.


Attending the Wednesday meeting at the Treasury were Paulson; Robert Steel, Treasury undersecretary of domestic finance; and executives of Washington Mutual Inc., Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., Ocwen Financial Corp., IndyMac Bancorp Inc., and Residential Capital LLC.

Though Congressional leaders are working on a plan to help underwater borrowers, Paulson told lenders and servicers that the legislative process is too slow and unpredictable.


Data Laggards


He also expressed frustration with existing aggregate data on the pace of loan modifications, saying it was impossible to determine which lenders were successful at modifications and which were lagging behind. Paulson asked lenders to provide better and more specific data, and said he planned to hold meetings with each company to discuss their individual results.


A Treasury spokeswoman confirmed the meeting but declined to discuss details of it.


“Secretary Paulson wanted to hear thoughts from the servicers as to how their efforts are going and also hear ideas for making the effort more effective,” she said.


The meeting was called last week at the behest of Paulson, participants said, and marked a shift in the Bush Administration’s view of the housing crisis. Nearly a month ago Paulson had appeared to dismiss the problems posed by borrowers with zero or negative equity, saying there was little or nothing to be done for them.


“Let me emphasize that we do not need a systemwide solution for the vast majority of loans where a homeowner temporarily has negative equity,” Paulson said in a speech on March 26. “Negative equity does not affect borrowers’ ability to pay their loans. Homeowners who can afford their mortgage payment should honor their obligations — and most do.”


By Wednesday’s meeting, Paulson’s views appeared to have changed. Much of the meeting, participants said, was dominated by how to help underwater borrowers, including those who choose to walk away from their homes rather than continue to make payments.


“There clearly is a recognition that people walking away from their homes is a problem,” said a second participant at the meeting, who also agreed to speak only on condition of anonymity. “There’s a recognition that the markets are very challenging now and we need to think about different alternatives.”


Psychology on Loans, Write-Downs


The Treasury did not push particular solutions, sources said, but instead asked lenders to come up with their own. Much of the meeting turned on the psychology of borrowers and why some modification efforts have been more successful than others. Some lenders in the meeting argued that the ability to write down the principal of the mortgage to its market value provided more incentive to keep borrowers in their homes than lowering the loan's interest rate. Even with a low interest rate, some borrowers walk away from their homes when they learn their mortgage is worth more the home itself, they said.


“There was a clear recognition that borrowers’ psychology affects the success of various modification approaches,” a source in the meeting said. “One of the goals of the meeting was to talk about how to craft modification solutions that would be viewed as acceptable to borrowers.”


Participants were also tasked to resolve various specific issues related to loan modifications. Treasury asked lenders to create working groups to form best practices on these issues and report back to the Administration soon.


Among the specific issues were the best way to determine the amount of principal reduction and the complications posed by second liens, which often stall or inhibit a loan modification because they are not owned by the same investor group as the primary mortgage. Participants were also asked to develop best practices on payment plans, deferral options, term extensions to reduce payments, and interest rate reductions down to a pre-agreed floor.

Sources familiar with the meeting said Paulson expressed concern that the level of workouts has not kept pace with the rate of foreclosures. A report from the State Foreclosure Prevention Working Group issued Tuesday said that 70% of seriously delinquent borrowers are still not on track for any loss-mitigation plan.


Participants said that report was a topic of discussion with Paulson. "It was definitely the straw on the camel's back," said a source familiar with the meeting. "It was all a part of an effort to get a handle of what's going on. It's another piece of information in an uncertain economy."


According to the Hope Now alliance, from July 2007 through February 2008, 1.2 million homeowners received some form of workout assistance. But a report by Realtytrac, which monitors foreclosure properties, said last week that the number of overall foreclosures this year continue to run almost 60% above last year's levels.


Paulson told lenders he wanted better data that gave a more complete picture of the problem and whether it is being addressed. When industry participants complained that the State Foreclosure Prevention Working Group’s data did not reflect what is actually happening in the marketplace, Paulson appeared sympathetic, but said it proved his point that the industry needs to do a better job reporting its own data. “The Secretary was anxious to get more data,” the second participant said. “We agreed to think about what additional data we can provide.”


Underwater Borrowers


The meeting comes as the Bush administration and Congress explore other ways to help underwater borrowers. The Department of Housing and Urban Development is pursuing administrative changes that would allow such borrowers to refinance into a Federal Housing Administration-insured loan after lenders take a write-down of 90% or 97% of the home's value.


House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd are pursuing a legislative approach that would force a write-down to either 85% or 87%. Rep. Frank’s committee began discussion of the bill on Thursday but will not vote until next week. Sen. Dodd's committee will vote on his bill May 6.


Participants at the Treasury meeting said Paulson was not focused on the Frank-Dodd Plan, but instead said it would be a mistake to wait for Congress to act.

“I didn’t pick up any indication that he was for or against any proposal in particular,” the first meeting participant said. “It was more like, since nothing’s ever a sure thing in Congress, we can't afford to wait.

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