Sunday, July 12, 2009

Why Mortgage Mods Aren't Working

Posted on the Business Insider by Henry Blodget:

Obama's plan to save the housing market (and, with it, the economy) relies on mortgage modifications: Specifically, reducing monthly payments so strapped borrowers can stay in their houses instead of getting foreclosed on. It's a nice idea, but it isn't working...

Here's a compendium of the reasons why, many of which are drawn from this excellent Joe Nocera article.

The Obama program is just a drop in the bucket. About 131,000 mortgages have been modified so far, most on a trial basis (the idea is to test whether borrowers can actually make the new payments before making them permanent). That's better than nothing, but it's less than 5% of the 3.5 million foreclosures expected this year.

Mortgage servicers aren't staffed to modify mortgages...they are staffed to accept payments and/or initiate foreclosure proceedings. Modifying mortgages requires a different skill set, namely underwriting analysis. To modify a mortgage, the servicer has to figure out what payments the borrower can actually afford. So far, they haven't been in the business of doing this, and it's hard to turn on a dime. This is why so many homeowners who are interested in modifying their mortgages aren't getting calls returned.

Some delinquent mortgage owners "self-cure"...so why should the bank give something away for nothing when the problem might go away on its own? Anyone would like to pay less if you offer to let them do so. But if you gently say, sorry, you agreed to these terms and we're sticking to them, some borrowers will actually eventually do what they promised to do (which is better for the banks).

A $1,000 government payment isn't enough to compensate servicers for the hassle. A free $1,000 per modified mortgage sounds like a lot, but after one considers the weeks of back-and-forth with the homeowner, the analysis, the paperwork, etc., it isn't.

If banks modify mortgages, they have to write down the value of the loan. This is a big one. Remember, our bailed-out banks are now telling the world that they're profitable again. They're also claiming that their balance sheets have been purged of the godawful loans that they made or bought from 2004-2007. If the banks actually modify a loan, they'll have to admit to their accountants and the public that it's not worth as much as they're currently saying. And that would mean more writeoffs. In many cases, the banks would rather delay the write-down for the 18 months it takes to foreclose.

Many homeowners can't afford to make ANY payments, even smaller payments. Remember, we're dealing with millions of houses that the buyers couldn't really afford. Many of those buyers are now deep underwater on their mortgages. Some have lost their jobs. Modifying these mortgages won't stave off foreclosure. It will just delay it.

A quarter of homeowners with mortgages are now underwater. If you owe more on your house than it's worth, you immediately have a big incentive to just walk away and start fresh. About 15 million homeowners are now in this situation, with more on the way. For these folks, lower payments would be nice, but they don't get at the root of the problem: Even if house prices stop falling today, which they won't, the homeowners will be underwater for years. Why keep making payments on a place you never should have bought in the first place and will never get anything out of when you can just start again?

Many houses have two mortgages on them, and the two lenders' interests are not always aligned. If you borrowed 80% of the value of your house on your first mortgage and then took out a home equity loan for the remaining 20% and your house's value has fallen 30%, your lenders are in different situations. The first has only lost a small chunk of the loan's value. The home-equity lender, meanwhile, has lost everything. In many cases, you need the home-equity lender's permission to modify the first mortgage, because the modification will affect how much the home-equity lender gets back. For obvious reasons, home equity lenders can be tough about this, especially if they're carrying the loan at, say, 95 cents on the dollar on their books when it's actually worth zero. And, if nothing else, it just adds another step to the process.

In any event...

Joe Nocera says that Treasury Secretary Tim Geithner and Housing And Development Secretary Shaun Donovan have summoned the big mortgage servicers to Washington, where they plan to kick the crap out of them for not modifying more mortgages.

If this "meeting" is a success, it will probably result in a new burst of modifications that the administration can tout as a success. Given the scale and challenges of the problem, however, it does not seem likely to make mortgage mods the solution to the housing crash and economic recovery.

What IS the solution?

Mostly TIME. (And, if possible, debt-for-equity swaps).

Banks need to be honest about their crappy loans, write them down, and get them off their books. Homeowners need to assess their situation and figure out whether owning a huge house they couldn't really afford really makes sense...or whether it's better to cut their losses and start again (in many cases, it is). Buyers and investors need to have confidence that the market is shaking itself out, consumers are rebuilding savings, and the economy is getting stronger (not necessarily growing, just getting stronger), before they step in and put money on the line. All this will take time.

To the extent it's possible, the Obama administration might also look into a different modification approach, which results in converting some of the loan to equity in the house. This is the way corporate debts are restructured, and it's more efficient than foreclosures (at least in cases in which the homeowner can afford to stay in the house). In this type of modification, banks or mortgage owners need to cut principal owed, not just reduce payments, so the restructured loan results in less debt, the way a corporate bankruptcy situation like GM does. If they don't cut the principal owed, the homeowner will still be underwater, and he or she will always have a big incentive to quit and walk away.

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