Patricia Greenberg’s townhouse in Irvine, California, was losing about $10,000 a month in value when she received a letter in February 2008 that looked too good to be true: An investor was offering to cut her $472,000 mortgage by 26 percent and her monthly payment by a third.
“I didn’t want to get involved in a scam,” says Greenberg, a cosmetics saleswoman for Orlane Inc., who had bought the house with no money down eight months earlier.
It was no ruse. New York hedge fund manager Ralph DellaCamera Jr., says he’d purchased the mortgage for 60 cents on the dollar and forced the originator, MLSG Home Loans of Reno, Nevada, to eat the loss. Protecting his investment, DellaCamera lowered Greenberg’s debt to keep her in the home. She now pays $2,400 a month instead of $3,800 and plows some of her savings into upgrading the Cape Cod-style residence.
One in five borrowers in the $10.5 trillion U.S. mortgage market owes more than their property is worth, according to First American CoreLogic Inc., a real estate data company based in Santa Ana, California. Ten percent or fewer have benefited from the principal reductions that Ron D’Vari, former head of structured finance at New York-based investment adviser BlackRock Inc., says would help solve the mortgage crisis.
“You have to take the poison out of the water at the source,” says D’Vari, 50, who is now chief executive officer of his own firm, New York-based NewOak Capital LLC, which advises mortgage investors. “You have to go to the borrower, and you need to create liquidity at the borrower level.”
So far, recovery plans by the federal government and private lenders have avoided writing down mortgage loans to market values in the worst slump since the Great Depression.
30 Percent Drop
Home prices have dropped 30 percent since the market peak in June 2007, according to New York-based Radar Logic Inc., which tracks real estate sales in 25 markets. December 2009 contracts traded on the company’s RPX index signal a further 16.5 percent decline this year.
If not for the government commitment to recapitalize U.S. banks under the Troubled Asset Relief Program, lenders’ losses would exceed their capital by $400 billion, estimates Nouriel Roubini, a professor of economics at New York University’s Leonard N. Stern School of Business.
While the government and banks agree that loan restructurings are their best defense against an increase in the record 2.3 million foreclosures last year, Roubini’s calculation shows that forcing lenders to write down the value of their distressed mortgages to cash values would render banks insolvent.
Bankers also say that reducing homeowners’ mortgage balances precludes lenders from sharing in the properties’ eventual recovery and creates an incentive for all borrowers to seek concessions, even those who aren’t in danger of defaulting.
“It suggests enormous and lasting damage to our mortgage markets and real estate values, which as a homeowner I don’t particularly want to see,” says Gary Townsend, 57, a former federal banking examiner who is now CEO of the investment firm Hill-Townsend Capital LLC in Chevy Chase, Maryland.
President Barack Obama announced a $75 billion rescue plan Feb. 18 that promotes more affordable monthly payments for as many as 9 million borrowers through government-subsidized interest rates and extended loan terms up to 40 years. The administration is scheduled to release more details today.
Obama also endorsed “cramdown” legislation that would authorize bankruptcy judges to renegotiate the terms of distressed borrowers’ mortgages closer to market values.
Homeowners would have to exhaust all other options before using the bankruptcy court to reduce their loan payments, House Majority Leader Steny Hoyer said yesterday.
While buying time for the financial system to stabilize and the economy to recover, the government program steers clear of restoring homeowners’ lost equity, which is a more effective method of stemming foreclosures, according to research by Credit Suisse Group AG and Goldman Sachs Group Inc.
Less than 1 percent of the 88,830 modifications tracked by the California Department of Corporations from January through September last year included reductions of principal. By comparison, 47 percent of the restructurings lowered borrowers’ interest rates, according to the state agency.
One in 10 revisions from a national sample in November included decreases in principal, wrote Alan M. White, an assistant law professor at Valparaiso University in Valparaiso, Indiana, in the paper, “Deleveraging the American Homeowner: The Failure of 2008 Voluntary Mortgage Contract Modifications.”
Bank resistance to more aggressive action was reflected in a December study by the Comptroller of the Currency, a federal banking regulator. After six months, more than 55 percent of the loans modified last year re-defaulted, that report showed.
By comparison, 28 percent of homeowners whose modifications trimmed their principal by a fifth or more were late after six months, according to research by Diane Pendley, a managing director of Fitch Ratings in New York.
The Obama administration’s failure to close the negative- equity gap means that its plan “will likely join the dud parade of federal rescues,” says John Kiff, an International Monetary Fund economist in Washington.
DellaCamera, 55, the principal of DellaCamera Capital Management LLC, says that government reluctance to force banks to write down the value of distressed loans and securities to prices that buyers are willing to pay creates “gridlock,” delaying bad-debt workouts and an eventual recovery.
“We felt there was going to be an opportunity going forward, not anticipating that it would be as bad and ugly as it is,” says DellaCamera. He says he has bought about $125 million in distressed mortgages, a 10th of his target, through affiliate National Asset Direct Inc., based in San Diego.
Greenberg’s New Deal
Greenberg, 55, the cosmetics saleswoman, says she was making timely payments and had no intention of giving up her residence when NAD loan adviser Sarah Hussion, 34, contacted her early last year. She says she was skeptical at first.
Loan-modification frauds were proliferating, according to the California Department of Real Estate. The state regulator logged 292 complaints against foreclosure-avoidance firms last year and has issued nine desist-and-refrain orders since November, says Tom Pool, the agency’s assistant commissioner.
Greenberg says she warmed to NAD’s proposal after Hussion explained that the value of the house had fallen well below the amount of the loan, and that it was in the company’s interest to head off a default by reworking mortgages like hers.
“If something happened to my job, I would be at high risk of not making my payment,” Greenberg says she recognizes now.
With the national economy slowing and state housing prices in free-fall, declining 42 percent last year, according to a California Association of Realtors report in December, Hussion reduced Greenberg’s mortgage by $121,300 and her interest rate to a fixed 6.375 percent from an adjustable 9.629 percent.
‘Make Them Pay’
The changes allowed NAD to lock in a $65,900 profit.
Ed Goormastic, the former owner of MLSG Home Loans, which originated Greenberg’s loan, isn’t cheering the outcome.
“If we were a lot of other countries, we’d make them pay,” says Goormastic. His company folded in October 2007, a victim of competitive pressures that produced “no-income, no-asset loans” that led to the real estate bust, he says.
Only Charlotte, North Carolina-based Bank of America, under an agreement with 31 states, explicitly pledged reductions of principal on some loans at its Countrywide Financial Corp. unit.
Bank of America said it would modify 400,000 Countrywide mortgages at a cost of $8.4 billion. It is part of a companywide initiative to help 630,000 customers with more than $100 billion in mortgage financing remain in their homes.
The bank added Feb. 18 that it will halt foreclosure sales until the details of Obama’s rescue program are known.
Most loan modifications replicate “the bad-loan structures that created the crisis: things like interest-only loans or having a temporary rate reduction that is going to increase payment shock later,” says Valparaiso University’s White.
“The banks need to flush out all the bad assets, says Louis Amaya, 44, NAD’s chief investment officer. ‘‘Let guys like us buy them, service them, reliquefy them into good loans.’’
The process will ‘‘put a lot of them out of business,’’ Amaya says. ‘‘There’s going to be some hard, short-term pain that needs to happen in order for us to start rebounding.’’
Ernst Henry, 43, a respiratory therapist in Charlotte, North Carolina, responded as skeptically as Greenberg had after receiving a solicitation from NAD early last year.
‘‘My initial instinct was to shred the letter,’’ he says.
NAD’s Hussion says the company bought Henry’s $149,900 loan on a four-bedroom rental property for $94,296, a 37 percent discount from the unpaid balance. Yet with the mortgage market collapsing and the appraised value of Henry’s property declining, Hussion says she struggled to refinance the debt.
Henry balked at her offer to cut the principal by about $50,000, contingent on his paying $8,000 in closing costs.
‘‘I’m giving you $50,000. Give me the eight, stop complaining!” Hussion says she told him, raising her voice.
That got Henry’s attention.
“It made clear sense to me,” he says now.
He took the offer.