Wednesday, February 18, 2009

Proposal Is Heavy on Incentives to Modify Loans

By Ruth Simon and Carrick Mollenkamp (Wall Street Journal):

In its effort to address the foreclosure crisis, the Obama administration is relying heavily on the carrot rather than the stick.

The administration's plan, announced Wednesday, tries to address one of the key weaknesses of previous voluntary efforts by providing financial incentives for mortgage servicers and investors to modify troubled loans.

At the same time, it doesn't fully address some issues that have bedeviled previous attempts to fix the situation, including how to boost modifications of loans that were packaged into securities and sold to investors. Some also say it doesn't do enough to encourage reductions in principal for borrowers who owe far more than their homes are worth.

One of the hallmarks of the administration's approach is a set of financial rewards designed to encourage mortgage companies and investors to modify delinquent mortgages. Mortgage servicers, for instance, will receive an upfront fee of $1,000 for each eligible modification and "pay for success" fees of up to $1,000 each year for three years if the borrower stays current on the loan. The plan also includes incentives for servicers and mortgage holders to modify loans of borrowers who are at risk of falling behind on payments, for instance because of a loss of income or an interest-rate increase.

Borrowers, meanwhile, can receive a principal reduction of $1,000 a year for five years if they stay current on their modified loan.

"This is the first real significant step to try to push servicers to modify loans rather than just cheerleading," said Kurt Eggert, a law professor at Chapman University in Orange, Calif.

The effort also shares some of the cost of reducing borrowers' monthly payments between the mortgage lender and the government.

Some analysts say the administration isn't doing enough to encourage lenders to write down loan balances instead of just reducing monthly payments. Recent studies by Credit Suisse and others suggest borrowers are less likely to fall behind again on their mortgages if both their principal and interest payments are reduced.

Housing counselors praised the administration's focus on making loan payments affordable, but say that interest-rate reductions alone may not be enough to help many borrowers. "For about half the clients that come in to us, an interest-rate reduction down to zero" isn't going to save them from onerous debt, said Michael van Zalingen, director of homeownership services at Neighborhood Housing Services of Chicago. For the other half, he said, the Obama plan "could make a huge difference."

The plan also relies heavily on government-controlled housing-finance giants Fannie Mae and Freddie Mac to help more borrowers refinance loans, including those whose mortgages are near or exceed the current value of their homes. To help such efforts, the administration has agreed to allow the firms to hold up to $900 billion in mortgages and mortgage-backed securities until next year, and to ease rules that bar them from owning or guaranteeing mortgages for more than 80% of a home's value.

But the plan wouldn't help borrowers refinance if their loans aren't already owned or guaranteed by Fannie or Freddie, or if they owe far more than their homes are now worth. Those restrictions could exclude many borrowers in some of the hardest-hit markets, such as California, Las Vegas and Florida, said Chris Mayer, senior vice dean of Columbia Business School. He argues that it wouldn't cost the government more to allow more loans owned or guaranteed by Fannie and Freddie to be refinanced.

It also wasn't clear how far the administration's plan will go in pushing mortgage companies to rework troubled loans that have been packaged into securities and sold to investors. Securitized loans are being foreclosed on at a much faster rate than mortgages held by banks, according to a December analysis by Tomasz Piskorski of Columbia University, Amit Seru of the University of Chicago and Vikrant Vig at the London Business School.

The Obama administration plans to create uniform guidance for loan modifications. "It's clear that the intent of the government is that it does get adopted by a broad cross-section" of the mortgage market, said Michael Heid, co-president of Wells Fargo Home Mortgage. But "private security holders will still have to agree to the principles that are laid out here."

Mr. Heid believes the incentives will help bring investors on board. Other mortgage executives say that may not be enough to spur modifications of large mortgages and other loans that were sold to private investors.

"In those private-label securities, servicers still have a problem, particularly without a safe harbor" that would protect them from lawsuits, said John Courson, president of the Mortgage Bankers Association.

At least two lawsuits have been filed recently in New York and Connecticut courts by investors who have alleged that mortgage-servicing firms mishandled foreclosures or should bear the brunt of losses in modifying loans.

Some investors, meanwhile, say they were disappointed by the announcement. "The whole thing seems like window dressing," said one major bond investor. He worries the program will encourage some borrowers who aren't yet delinquent to seek government help even though they could otherwise afford the payments.

The plan also does little to solve a problem that occurs when different classes of mortgage investors disagree on whether a loan should be modified. "The securitization has split the interest in the home loan among so many different parties that it is difficult for servicers to make a modification without fear that some significant party may sue or do something else that hurts the servicers," said Mr. Eggert of Chapman University.

One step toward making the latest proposal work, he said, would be enabling bankruptcy judges to modify loans, including those packaged into securities, to reduce principal balances and adjust payment plans. This could prove to be the stick needed to get mortgage investors to agree to modify a loan before bankruptcy-court proceedings begin.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.