The Wall Street Journal’s page one story, “Rate Plan Has Skeptics, Fans,” offers little new information about the substance of the program (not surprising) but gives mainly positive reviews.
In case readers somehow haven’t figured it out, I believe this program to be a Bad Idea in any form, although some variants could be worse than others. Since we don’t have the details yet, I’ll limit myself to a few obvious objections that are inherent to any plan along these lines.
Just to be clear: I am not against helping borrowers, particularly borrowers that were defrauded by being told they were getting one set of terms and finding out much to their horror that they had signed up for something different. But this program does not address that problem. Similarly, I recognize that it is generally better to restructure loans if the borrower has reasonable ability to repay, rather than foreclose.
First, and I am surprised the business media has not made more hay of out of the fact that this program is a repudiation of contracts. I don’t see how any investor with an operating brain cell would ever buy an asset-backed security from a US issuer again, at least one backed by consumer assets. Many (likely most) of the subprime ARMs are securitized. The servicers’ ability to modify the loans is defined in the servicing agreement with the investors. The servicer is an agent for the investors. Yet they are now going to modify loans in a program explicitly designed to help borrowers. The benefits, if any, to the investors remain to be seen.
Proponents argue that loan mods will help investors. Loan modifications done in the traditional fashion, of evaluating borrower ability to pay and for those with the wherewithall to make it, coming up with a new structure, is a better mousetrap. But this program is a significant departure from that model. For example, keeping borrowers destined to fail going for another year or two will lead to worse outcomes, since the houses will be foreclosed in an even weaker housing market (housing recessions generally last 3-4 years).
I’m no constitutional law expert, but this approach appears to raise serious Federal-state issues. The servicing contracts are governed by state law. The Journal states that:
A bill introduced by Rep. Mike Castle, a Delaware Republican, would temporarily free servicers from any liability for modifying loan terms. “Investors are still going to get a return and it’s in their better interest to have those loans perform rather than fail,” Mr. Castle said.
Any lawyers in the readership? How can the Feds indemnify parties against claims made under state law?
This whole scheme is an act of eminent domain, except the government isn’t formally seizing property rights, but emboldening private parties to do so. Why is no one calling a spade a spade?
The Journal has another priceless bit:
Peter Haveles, a partner at the law firm Arnold & Porter in New York, said the agreements underlying issues of mortgage securities generally give the servicers discretion to modify loans if they consider that to be in the best interest of the holders of the securities. He said the possible litigation isn’t likely to derail the Treasury plan, in part because of the breadth of the coalition negotiating it.
Huh? The only parties representing investors in the discussions are Freddie, Fannie, and the American Securitization Forum, a lobbying group. An advocacy group is hardly an authorized agent, and Frannie and Freddie are not representative.
The second issue is that this plan is unlikely to yield much relief. As initially presented, the program would fix teaser rates for borrowers who were current on their payments but couldn’t afford a reset (we have the perverse incentive that ones who can afford the increase suffer).
But no one knows what proportion of ARM borrowers are current even on their teaser rates. So we have a huge untertaking with uncertain benefits, and no ability to measure results versus objectives. As Dean Baker pointed out, subprimes are showing substantial default prior to reset, so the universe of borrowers that can be helped may be much smaller than envisioned.
But even when this subset has been isolated, consider the process: the servicer has to make a determination as to whether the borrower can continue to service the loan, and assess whether he would be able to meet the payment after reset. Tell me, how is this any different than the work that needs to be done to make a loan mod? The questions to be answered are somewhat different than in a traditional mod, but the work of evaluating the borrower – looking at the stability of his income, his other financial commitments, his credit history, his motivation level – is the same assessment that take place with a mod (Tanta, if you see this, correct me if I am wrong).
The whole raison d’etre of this program was to avoid doing allegedly too time consuming loan mods. Yet this program appears to commit the servicers to peform the bulk of the labor, meaning assessing borrower ability to perform. Yes, only a subset of borrowers is being targeted, but you didn’t need meetings at Treasury and possible repudiation of contracts to come up with parameters for triage.
But here we have the worst of both worlds. The program appears to require servicers to do pretty much the same analysis that they’d do for a mod, yet forces them into a Procrustean bed of a single mod option. I can see simplifying the mod alternatives so as to streamline the process, but why a single choice? This is moronic, and increases perceptions of arbitrariness and unfairness.
It seems that the objective of this exercise is for the Bush Administration and any Congressmen who care to join the bandwagon to get some headlines and assert that they are helping to keep people from losing their homes.
What is likely to have more impact are far less glamorous measures, ones that might also ruffle the feathers of the mortgage lending industry. Per above, target fraudulent lenders and devise programs for assisting borrowers who suffered; modify bankruptcy laws (as in Chapter 11, judges should be able to adjust mortgages downward if the market value of the house has fallen and possibly even give them latitude to modify other terms). If lack of capacity of qualified staff to execute loan mods is the impediment, would it be possible to devise a crash course to train them in two-three weeks? There are a lot of un and under-employed mortgage bankers and real estate brokers who already know the vocabulary and understand the basic concepts.
It seems that this Hope Now Alliance is just that, an exercise in wishful thinking, rather than a disciplined and programmatic effort to define bottlenecks and problems and tackle them surgically.
Update 12/1, 4:00 PM: There’s a very good post by Elizabeth Warren at Credit Slips on the supbrime plan, “A Non-Bankruptcy Bankruptcy Solution?” Here are a couple of interesting observations:
2. Are the losses confined to the bad guys? The good news about this plan is that it shifts the losses directly onto the investors who took the bad mortgages. The bad news is that there is no clear legal basis for doing this kind of wholesale revision of the value of the collateral and forced revision of the mortgage terms. The lawsuits will fly thick and fast, enriching the lawyers and tangling up the homeowners.3. Are the benefits confined to the good guys? The first reports indicate a sorting based on ability to repay the mortgage. This puts the mortgage lender squarely at odds with every other lender. This plan may send a message: If you dump the credit cards and quit paying the car loan, you can keep a great deal on a home mortgage.
The Hube 
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My question is, were I an investor, what guarantee do I have that helping some unknown number of people stay in their homes would mean that they will continue to be able to pay the mortgage? If they can’t, then the foreclosure will happen anyway, just later in time, and I might then wind up having to sell the property in a general economic downturn for less that if the house was foreclosed now.
Too many people are ASSUMING that this band-aid will fix all the problems we face and will prevent the economy from going south.