As the Treasury and the Department of Housing and Urban Development meet with loan servicers to discuss how to quicken the pace of loan relief in the form of loan modifications the reasons/excuses for their slow rollout are being presented by industry watchers and economists. Faced with increasing frustration on all fronts, the aim of the administration is to motivate lenders and servicers above and beyond the billions of dollars in incentives already promised to modify home loans.
According to some of the reports, government initiatives to step in front of the country’s mounting foreclosure issues are being bogged down because banks and other lenders in many cases have more financial incentive to let borrowers lose their homes to foreclosures than to modify their current mortgages. While policymakers cater to the needs of their constituencies and continue to push for more and faster home loan modifications, some researchers are saying that foreclosure can be more profitable and is a primary reason for the slow pace of loan modifications as the administration’s Home Affordability and Stability Plan (HASP) enters its sixth month.
The argument being advanced by these researchers is that of three types of homeowners that become delinquent on their payments, only one of the homeowner categories is profitable to banks considering loan modifications. The categories are roughly divided equally into thirds and describe homeowners in very different sets of circumstances:
1) The first group is the one that researchers believe that executing loan modifications actually makes sense. These are borrowers with consistent income and employment where mortgage payments have moved out of reach due to interest resets or recasts in payments. Lowering the payments back to a level that fits the borrowers’ budget via a loan modification provides a workable solution for both the lender and the homeowner. This category of borrower works best for the lenders because the concessions required to fix the issues facing the homeowner are relatively small.
2) The second category includes those that are likely to become delinquent again after the completion of a loan modification. These homeowners may have job related issues such as major cutbacks in work hours or commission based positions that are no longer paying what they were when the loan was originated. Other issues may be related to the structure of the mortgage or a home that has lost so much value that there is little motivation for the owners to stay in the home. Researchers say that lenders are reluctant to help these borrowers because delaying foreclosure can make the process more expensive.
3) Members of the third group are those that have become delinquent but then catch up by finding new work, selling other assets, borrowing the money from friends and family, or through sacrifice. Like the second category, lenders are reluctant to work out loan modifications with this group but for a completely different reason; if the homeowners can work their way out of the situation on their own, it makes little sense to reduce their payments even it’s for a short while. “These are the people who will get a second job, borrow from their family to keep up,” explained Paul S. Willen, a senior economist at the Federal Reserve Bank of Boston and an author of its report. “. . . From a cold-blooded profit-maximizing standpoint, these are the people the banks will help the least.”
The report from the Federal Reserve Bank of Boston has received attention from all quarters due to its negative assessment on the prospects for widespread home loan modifications. A deeper look at the data presented in the report provides an explanation, in part, for its dismal findings. One of the biggest problems with the loan modifications included in the study is that only three percent of them lowered the monthly payments of delinquent borrowers, those who had missed at least two payments. Lenders passed on granting modification to those that fell outside the “sweet spot” of hardship, either likely to re-default because of too much hardship or fix the problem themselves because they weren’t experiencing enough of it.
The time frame of the Boston Fed report could have a lot to do with the negative perception of loan modifications. Conducted in 2007 and 2008, the economic conditions were just beginning to contract, possibly lulling lenders into an attitude that the economy would right itself in short order. The Bush Administration, bankers, and industry watchers were in agreement that the mortgage meltdown would be contained to the riskiest of the subprime borrowers and that any economic contraction would be short lived. After all, housing had never led the economy into a prolonged recession before. The reluctance to grant modifications to those that could fix the problems themselves was based on the belief that the economy would turn back to normal and provide ample opportunities to those who had fallen behind. The longevity and depth of the current recession was being underestimated at the time of the report and it’s a virtual certainty that in today’s environment the number of those homeowners that can get re-hired, sell assets, or borrow money to catch up has shrunk considerably.
Another aspect of the recent research reports which was true two years ago but doesn’t apply now is that the selling of foreclosed properties at auction was a foregone conclusion. With 1.5 million foreclosure filings recorded in the first half of the year and another 2 million expected by yearend, the supply of foreclosures goes way beyond the level of demand for them. Whether due to the sheer number of foreclosures or the reluctance to take properties back into inventory, the normal timeline for foreclosures of three months has now been extended out to the point where homeowners have received notices of default but continue living in their homes for months on end in a situation known as “foreclosure limbo”. Regardless of what lenders are saying about their proclivity toward foreclosure, they’re certainly not acting on it.
Another aspect that is striking about the Boston Fed report is that the quality of the loan modifications in the study appears to be extremely poor. If 97% of the modifications did not lower the monthly payments of struggling homeowners, it’s no wonder that the re-default rates were so high. If homeowners were having problems making their payments, keeping them at the same level can hardly be considered assistance. When the Federal Deposit Insurance Corp. took over the failed bank Indy Mac last year, the FDIC began modifying troubled mortgages held or serviced by the company. Richard Brown, the FDIC’s chief economist, said “the agency expects up to 40 percent of those borrowers to re-default.” Even at that rate, he said, the modification program is more profitable than doing nothing. “The idea that 30 to 40 percent re-default is a failure to a program is false,” Brown said.
Mr. Willen, of the Boston Fed, has continued to defend their study’s findings saying “… the government program could boost several-fold the number of seriously delinquent borrowers receiving modifications. But so few people had been getting their loans modified that even a dramatic increase in the percentage would still touch only a small fraction of troubled borrowers. We’re still not talking about a program that will stop a large number of foreclosures,” he said. “We’re talking about a program that, at the margins, will assist more people. It is unlikely we will see a sea change.”
The chasm between the two sides of the argument appears to be based on what kind of concessions are put into the modifications being studied. In the case of the Boston Fed, a tiny slice of the executed modifications lowered payments and a high percentage of them failed. In the case of the FDIC and others, modifications that lowered payments significantly and included principal reductions have had solid success rates. What the numbers of successful modification point out is that principle reductions can play a significant role in keeping families in their homes.
What is needed is an honest appraisal of what is working and what isn’t. Pulling out the worst of the modifications and saying they don’t work looks more like a negotiating ploy by the banks to get more government incentives than anything else. While the banks and the administration waits to see who blinks first, homeowners are losing their homes, spectators of a parlor game that is ruining millions of lives.
