Monday, October 11, 2010

Moratorium for What? (Alan White on Credit Slips)

Originally posted on Credit Slips:

There is little to be accomplished by halting foreclosures and sales in process without some plan resolve the 5 million seriously delinquent mortgages other than by foreclosure sale. While something can be said for delays that stretch out the process of dumping more unsold homes into a saturated existing homes inventory, we are only about one-third of the way through the crisis at present (having foreclosed or forced the sale about two to three million homes since 2007). If a moratorium is to do some good, it has to result in diverting some foreclosures to better resolutions.

The two most attractive alternatives, refinancing and modification, seem to have failed already. The Administration’s HARP and HAMP programs continue to post disappointing numbers. In light of HAMP’s failure, I am asked frequently, what should we replace it with? Unfortunately there really are no other, better solutions. We can either dump another 12 to 24 months’ supply of homes on the resale market, or modify enough mortgages to make a difference. Treasury must either enforce its HAMP contracts with the banks, or fire the current servicers and transfer distressed mortgages to servicers who can do the job properly.

Modifications have not succeeded in bringing down the 5 million distressed mortgages number in part because of the massive failure of the big banks to do their jobs. In the present context, their job is to rework existing mortgages so homeowners can repay them. Modified mortgages that reduce payments are now succeeding at a rate of 65% to 75%, compared with 40% for 2007 and 2008 modifications, which typically increased or deferred payments. We know from Treasury’s monthly reports that a homeowner’s chances of getting a temporary modification, converting to a permanent modification, and getting timely action at those two stages depends hugely on which bank or servicer handles their mortgage. The variances in HAMP performance are appalling, and are clear proof that far more could be done than is being done to divert distressed mortgages out of foreclosure.

The case for modifications gets stronger every month, not only because redefault rates are declining, but because the two other key variables in the economics of foreclosure vs. modification are steadily worsening. The rate at which unmodified defaulted mortgages fix themselves, the self-cure rate, has declined from 5% or more per month to less than 1% per month (foreclosure roll rate Charts tab). Loss severities, the percentage of mortgage balances not recovered at foreclosure sales, continue to rise, and are now in the 60% range. What this all means is that even a mortgage modification that was uneconomical a year ago might be net present value positive today.

Proposals to refinance all existing Fannie and Freddie mortgages to take advantage of low interest rates and reduce payment burdens are fundamentally equivalent to across-the-board modification of those mortgages. From the homeowner’s perspective, it makes no difference whether her existing mortgage is converted to a 4% fixed rate and stretched out to 30 more years, or it is refinanced with a new, 4% fixed rate 30-year mortgage. For the economy, the refinancing program produces a few more transaction costs that will create a few jobs for title clerks and document processors, but that hardly justifies the additional debt that refinancing necessarily creates. The point is to reduce America’s home debt, not to keep postponing it.

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