naked capitalism

Before we get the usual objections to mortgage modifications, I need to remind readers that in the old fashioned days of banking, when bank kept the loans they made, it would be unthinkable NOT to modify a mortgage or any other loan when a borrower got in trouble, assuming the borrower was viable. “Viable” means that the borrower still has enough income to pay enough that the bank still comes out ahead by modifying the loan rather than other recovery strategies, which for a mortgage loan means foreclosure.

This isn’t charity, it’s good business sense.

Many commentators have pointed out that mortgage servicers are the big reason mods aren’t happening. Most mortgages in recent years were securitized, and the servicers are not the investors. With loss severities (finance speak for losses on the original investment amount) at 70% and higher on a foreclosure, a principal mod in the 30% to 50% range is a clear win-win.

But servicers have lots of reasons not to go there. First, they get lots of fees upon foreclosure and have organized streamlined processes to make it a profitable activity for them. Second, they are obligated to keep advancing principal and interest when borrowers default. Technically, they can stop when the borrower looks irredeemable, but in practice, they keep advancing P&I until they reach the mortgage balance. So they also are driven to foreclose to recover P&I advances. Third, they are just not set up to do mods. Not only do their contracts not allow for them to collect fees to do mods, but for a mod to have any hopes of success, you need to do some borrower assessment. Servicers are factories, highly routinized, so doing anything on a one-to-one basis is difficult given their operating parameters.

These first three reasons have gotten some attention in the media and blogosphere. But a fourth reason has not gotten the attention it deserves. Borrowers don’t trust servicers, and with good reason. It’s virtually impossible to get consistent answers from servicers. If you have an error, even with the intervention of an attorney, it seldom gets corrected. And the horror stories from HAMP both showed the borrower worst fears to be fully warranted and further damaged their already bad reputations. Accounts of banks requiring borrowers to submit the same paperwork multiple times because they “lost” it were legion. Even worse, homeowners were instructed to become delinquent to qualify, then told they were going to get the mod (or even receiving a written mod offer) while they continued to receive foreclosure notices. The servicer would tell them to ignore the foreclosure notices, only to find it was the legal notices, not the servicer reassurances that mattered, and they’d lose the home.

Mistrust of servicers is old news to anyone in this space. Even the Bush administration sought to involve mortgage counselors to serve as the front line in mortgage mod assessment, precisely because the counselors had the right skills (experience in dealing with borrower budgeting) and were perceived to be trustworthy. Another approach, created by NACA, has borrowers bring documents to a specialist, who uploads them to a server so the servicer who can verify them, then works with the borrower to enter household income and expense data into a spreadsheet so that the servicer can see how much cash flow the borrower has, which is crucial to understanding whether they can afford even a restructured loan.

The New York Times, in an article on the Cleveland program E.S.O.P., again underscores the need to find someone other than the servicer to assess and work with stressed borrowers. Key extracts:

ESOP (which stands for Empowering and Strengthening Ohio’s People) engages loan servicers or lenders and borrowers, acting as a good-faith intermediary between the parties, so it can effectively negotiate sustainable mortgage “workouts.”…

One thing that distinguished ESOP from the government’s program, as well as other mortgage counselors, is how it holds lenders accountable. It has gotten several large companies, including Bank of America, CitiMortgage, Ocwen Financial Corporation, and Litton Loan Servicing, to sign “fair lending agreements” which spell out the terms of their working relationship. In its agreements, ESOP requires that lenders provide a single point of contact, someone with decision making authority. Without this access, ESOP says, homeowners get bounced around the bureaucracy, making little progress, and files simply vanish, frequent complaints from borrowers who seek to take advantage of the government assistance. ESOP also insists on a defined escalation process for cases it believes are mishandled. Some agreements give it the right to appeal all the way to a lender’s chief executive.

ESOP also succeeds by adding a human element. They bring executives from banks and loan servicers on community tours, where they get to meet their homeowners and see the effects of their policies. These neighborhood tours almost always strengthen ESOP’s partnerships with lenders. Countrywide (now owned by Bank of America) signed an agreement after senior executives took a tour of Slavic Village, an area on the east side of Cleveland where a third of homes, many of them foreclosed by the lender, remain vacant, boarded up, stripped and ransacked, demolished, or occupied by squatters and drug dealers.

So why don’t the banks refuse to sign the agreements or take the tours, and just foreclose? ESOP uses both a carrot and a stick.

The carrot is that ESOP genuinely helps its lenders do something they are not structured to do well: communicate effectively with a large number of distressed borrowers… The state of Ohio’s foreclosure prevention program, “Save the Dream,” forwards its applications from homeowners to loan servicers and tracks the companies’ response rates. In its 2009 report (pdf, p. 16), the response rates for Chase, US Bank and Wells Fargo were all less than 2 percent. By contrast, Countrywide’s rate was 72 percent and Ocwen’s was 85 percent. The latter two have signed agreements with ESOP.

When it comes to dealing with borrowers, ESOP has two major advantages over lenders. First, while lenders have many competing interests, ESOP specializes in saving homes. Second, borrowers tend to trust ESOP ─ which is a free service ─ so they provide more comprehensive and truthful information, the key to a solution. They also know that ESOP can tell when a lender is offering a reasonable deal or trying to take advantage of their situation. In many cases, ESOP gets better information than lenders do — clients are more forthcoming about things like credit card debt and cell phone bills, for example… Finally, ESOP doesn’t press lenders to do workouts that homeowners can’t sustain, which builds trust among their partners, too.

In its dealing with homeowners, ESOP is both compassionate and tough. The goal is to help clients take control of their lives, not to cushion them from reality. If three phone calls to a client go unanswered or a document requested fails to arrive within five days, the file is closed. The tough love approach works. In 2009, 5,011 homeowners walked into ESOP’s offices and 63 percent complied with all information requests.

One of the casualties of the financial crisis has been trust in banks. Borrowers are understandably wary of cooperating with a party that is at best bureaucratic and uncaring. Parties like ESOP, which can show banks the benefits of behaving better towards borrowers, and convince borrowers that it is a fair broker, serve as an important remedy in the foreclosure crisis.