Will this week mark a turn around in the way politicians address the foreclosure crisis? Probably not, but the Boston Federal Reserve’s report last week on the lack of loan modifications being executed by lenders should signal to those in Washington that demanding banks help homeowners stay in their homes has to pass one basic test first: it must make financial sense!

Pols from both sides of the aisle in Congress thought they had easy prey to chastise last year as the economy spiraled out of control and the Treasury bailed out banks left and right. Bankers and lenders not only had to cease risky lending and succumb to new regulations, they had to help those homeowners who never should have thought about buying a house stay in said houses at any cost. Namely, by renegotiating those subprime and Alt-A loans down to monthly payments that would stem the record number of foreclosures.

Last November, Congressman Barney Frank, D-Mass., said at a House Financial Services Committee hearing that servicers weren’t participating enough to help keep borrowers in their homes, and he called for legislation to force them to do so.

“We have not seen servicers participate in any significant way,” Frank said.

Well, the Boston Fed found out why lenders were a little hesitant to help out those homeowners. It wasn’t due to the tangled securitization of the loans, either, according to the report, authored by Manuel Adelino, Kristopher Gerardi and Paul S. Willen.

“The problem is that renegotiation exposes lenders to two types of risks that can dramatically increase its cost. The first is what we will call “self-cure” risk. More than 30 percent of seriously delinquent borrowers “cure” without receiving a modification; if taken at face value, this means that, in expectation, 30 percent of the money spent on a given modification is wasted,” the report claimed.

“The second cost comes from borrowers who redefault. Our results show that a large fraction of borrowers who receive modifications [40 percent to 50 percent] end up back in serious delinquency within six months. For them, the lender has simply postponed foreclosure; in a world with rapidly falling house prices, the lender will now recover even less in foreclosure. In addition, a borrower who faces a high likelihood of eventually losing the home will do little or nothing to maintain the house or may even contribute to its deterioration, again reducing the expected recovery by the lender.

“Thus, one cannot evaluate a modification by simply comparing the reduction in the interest rate on the loan or in the principal balance with the expected loss in foreclosure. One must take into account both the redefault and the self-cure risks, something that most proponents of modification fail to do.”

It is about time someone pointed out to Washington that capitalism is not only alive and kicking – it still works!

We applaud the Boston Fed’s report. If the housing market is going to rebound, it is going to need new homebuyers – with arguably better credit than lenders have allowed during the bubble – to take advantage of all those foreclosed homes out there. That means the owners who should never have been owners to begin with need to be kicked out, and the fresh blood moved in. Difficult, we agree, with unemployment near 10 percent nationwide, but prices haven’t bottomed out yet, and those with good credit who can afford to buy shouldn’t have their options limited – and $75 billion in tax dollars wasted – on “homeowners” who have really become government-backed squatters.

So what’s the next step for Congress? One of the report’s authors has some advice: Senior Economist Paul S. Willen told the Boston Globe the government should give “money directly to struggling borrowers to help them with their payments, rather than to lenders that are averse to working out the troubled loans.”

At least one politician may have seen the light: “Frank … said he is holding a hearing on his proposal to provide government loans to homeowners who have lost their jobs and can’t qualify for loan modifications and other help because they don’t have income,” the Globe reported.