By Kathleen M. Howley on Bloomberg:
The Obama Administration wants banks to offer loans with easier terms to more than 2 million borrowers in danger of defaulting on their mortgages, twice as many as 2008. That won’t stem the foreclosure crisis if prices keep falling.
A third of owners will walk away when the value of their homes drops 20 percent or more below what they owe, even if they can afford the payments, a situation known as “rational default,” said Norm Miller, director of real estate programs at the University of San Diego School of Business Administration.
Obama has committed at least $50 billion in guarantees for lenders that negotiate new mortgage terms, and proposes putting taxpayer funds at risk for half of $444 billion of loans that would be modified this year. Fifty-eight percent of the modifications made during the first quarter of 2008 ended up back in default, according to the U.S. Treasury’s Office of the Comptroller of the Currency. Unless lenders cut principal owed to reflect the current market value of properties, the same thing may happen this year, Miller said.
“The biggest reason modifications end up re-defaulting is because they are in markets where prices have continued to go down,” Miller said in an interview. “When people are underwater and don’t see an end to it, a lot of them just walk away, even if they can make their payments, because they don’t want to be wiped out financially.”
‘Mod in a Box’
The Federal Deposit Insurance Corp. said it expects 2.2 million loans with an average size of $200,000 to be modified this year. It assumes a re-default rate of 33 percent and 1.5 million fewer foreclosures.
The FDIC’s two-month-old “Mod in a Box” program, adopted by Citigroup Inc. earlier this month, puts the emphasis on using fixed rates to reduce payments to as low as 31 percent of borrower income. The guidelines can be used to adjust mortgages that have been packaged and sold in securities, FDIC Chairman Sheila Bair said.
JPMorgan Chase & Co., Citigroup and Bank of America Corp., recipients of more than $115 billion in government bailout funds, have committed to modifying at least $230 billion of mortgages. JPMorgan and Citigroup said today they will suspend foreclosures until mid-March to give the Obama Administration time to complete details of its loan modification program. Almost one of every five U.S. loans was “underwater” at the end of the third quarter, according to data compiled by analysts at San Francisco- based First American CoreLogic Inc.
The new FDIC protocol uses principal deferral --segregating a portion of the loan into an interest-free balloon payment that will keep most homeowners from selling until prices return to pre-bust levels. It doesn’t suggest reducing principal to reflect the current value of the asset securing the mortgage.
Home prices are down 19 percent nationwide since 2006, according to Denver-based research firm Integrated Asset Services LLC. Prices have dropped by 51 percent in parts of California, the most in the U.S., and by 45 percent in some areas of Florida. Those states also lead the nation in new foreclosures, according to RealtyTrac Inc. in Irvine, California.
U.S. Federal Reserve Chairman Ben Bernanke gave a nod of approval to the FDIC guidelines in a Dec. 4 speech. At the same time, he said principal reduction may be needed in some cases.
“The available evidence suggests that the homeowner’s equity position is, along with affordability, an important determinant of default rates, for owner-occupiers as well as investors,” Bernanke said. “If that evidence is correct, then principal writedowns may need to be part of the toolkit that servicers use to achieve sustainable mortgage modifications.”
Banks have resisted writing off mortgage principal. In a study that covered 20 percent of all modifications in November, just 10 percent involved the “forgiveness” of a portion of mortgage principal, said Alan White, a law professor whose three- year term on the Federal Reserve Board of Governors Consumer Advisory Council ended in December.
The government’s Hope for Homeowners program, created last year to refinance troubled loans into fixed-rate mortgages, has been shunned by lenders in part because it requires them to write down principal to 90 percent of a property’s current value, White said. Lenders have approved only 25 loans under the program, the Department of Housing and Urban Development said Feb. 3. Congress is debating ways to retool it.
Erasing part of a mortgage to reflect a home’s current value creates a “moral hazard” that encourages risky investments in the future, said Evan Wagner, a spokesman for IndyMac Federal Bank in Pasadena, California. The subprime lender was taken over by the FDIC last year and was a testing ground for the “Mod in a Box” program.
“We’re trying to make the financial decisions you made when you bought your house more affordable for you, not undo your bad real estate investments,” Wagner said. “When people say, ‘My home is underwater, therefore I can’t afford it,’ what they are saying is they have buyer’s remorse.”
James Muise of Billerica, Massachusetts, has seen his home’s value tumble $30,000 below his mortgage in the past 18 months. He got a modification last year that gave him a five-year reduction of interest on the 30-year mortgage he took out in 2007, cutting his monthly payment to $1,800 from $2,500. Still, he is on the edge of default, he said.
“I’m working 15 hours of overtime each week and I’m barely able to make the payment on a $280,000 house that has a $310,000 mortgage,” the 50-year-old exterminator said. “When I sit here deciding whether I should pay the heating bill or pay the mortgage, I’m close to handing the keys back to the bank.”
Muise was one of 2,200 people who attended a foreclosure prevention event in August at Gillette Stadium in Foxboro, Massachusetts, sponsored by the Federal Reserve Bank of Boston. Only 46 people received principal reductions from the two dozen mortgage companies in attendance, Eric Rosengren, head of the Federal Reserve Bank of Boston, said in a Jan. 8 speech in Newton, Massachusetts.
“Small modifications are unlikely to prevent foreclosures,” the Boston Fed chief said in the speech, without endorsing any specific modification method.
Only a quarter of the people who attended the Fed-sponsored event got a reduction in monthly payments, and about 50 percent of the cuts were temporary, Rosengren said. Three-fourths of the people who stood in lines that wrapped around the rain-soaked home field of the New England Patriots’s football team left with nothing.
“If I walk away from my house, the bank will probably end up selling it as a foreclosure for $180,000 just to get it off their books,” said Muise, the exterminator. “You’d think they’d say, ‘Hey, maybe if we brought Jim’s mortgage down to $250,000 he could survive these tough times and keep paying his loan.’ But I know that’s not going to happen.”