The Treasury today announced its so-called “Making Homes Affordable Program”.
I am clearly an old fart. The fact that the Treasury bothered to have a logo created for the program (do consumers and servicers really need brand imaging when having money shoved at them?) gives me more than a little pause. I will nevertheless try to keep my prejudices in check.
The program has two elements. The first is a refinancing program which targets 4 to 5 million borrowers. If you are in a Freddie or Fannie mortgage executed before Jan 1, 2009, which you occupy and is your primary residence, congrats, you can refi at today’s low rates with less than the usual required 20% equity.
This post will focus on the second piece, the mortgage mod program intended to help 3 to 4 million borrowers. Recall that the Bushies had several goes at this problem, none very successful, but none of them looked like a serious effort either.
And before we poke and prod this program, remember, in general we are fans of mortgage mods. With lenders facing losses of 30% in normal times, and more like 40-50% given the severity of price declines and longer than usual clearing times on real estate inventory, there should be a fair number of opportunities where the lender could offer a deep principal reduction (20-30%). That would add up to a big enough payment reduction to salvage some borrowers, and still leave the lender better off than if he foreclosed. And this belief has some empirical support. Wilbur Ross, vulture investor (ie, not predisposed to be a friend of the little guy) is an advocate of deep principal reductions based on his success with them as the owner of the biggest third-party mortgage servicer.
Now of course, there is a very big complication with this “gee, there is a win-win space here, so why is no one making mods?” view. The big one is the difference in treatment of a mod (well, at least the principal reduction kind) versus a foreclosure. For a foreclosure, the losses go against the lowest tranches first, and then proceed to higher tranches. However, with a principal reduction, all tranches, including the AAA (or more accurately, what was once AAA) layer.
In many cases, the bank that is running the servicer holds some of that paper and would have to mark it down. Moreover, if mods like this were to become popular, former AAA paper would have to be written down even further. Quelle horreur!
But something sensible, likely to work, but possibly damaging to the fragile banking establishment is to be avoided at all costs (Larry Summers apparently does not subscribe to the widely held economic precept that the highest and best use of a market is to set clearing prices, and in this case, letting prices drop to clearing levels is necessary and ultimately unavoidable. The goal of policy should be to prevent an overshoot on the downside, not to impede the correction).
I have read the Treasury mortgage mod program, and it’s a bit fuzzy on certain details, but there was enough that was troubling without being clear on all the program wrinkles.
First, it appears the program is a five year payment reduction program. While the guidelines are silent here, reasonable people would infer that the payment relief will be added to principal (particularly since the monthly borrower incentive for keeping current, is paid the servicer on behalf of the borrower to reduce principal, which suggests it is to offset principal increases). From the guidelines:
The Home Affordable Modification program has a simple goal: reduce the amount homeowners owe per month to sustainable levels to stabilize communities.
Yves here. I think they mean “pay” when they say “owe”.
The program keeps the previously announced construct of having the lender reduce mortgage payments so they are no more than 38% of income, then Uncle Sam kicks in and provides a subsidy to bring the level down to 31%. Now we get to the doozy:
To ensure long-term affordability, the modified payments will be kept in place for five years and the loan rate will be capped for the life of the loan. After five years, the interest rate can be gradually stepped-up by 1% per year to the conforming loan survey rate in place at the time of the modification.
So effectively, the borrower gets a teaser that over time adjusts to a fixed rate mortgage at current (low) interest rates.
Let’s think this through a second. The borrower is still under water (of course, Bernanke & Co. regard this as temporary misvaluation resulting from irrational pessimism, but the more data driven crowd sees housing prices as having moves way out of line with incomes. And the outlook for incomes isn’t exactly rosy either). The borrower therefore has no reason to invest in the house, including routine maintenance (assuming he can somehow scare up the dough). If the boiler goes, the roof leaks, he has no incentive to fix it. Similarly, if he were to sell the house (let’s say he got a good job elsewhere), he’s still faced with either negotiating a short sale or walking and leaving the bank with the property. Thus for the bank all this does is kick the can down the road, unless we assume a recovery from these levels.
Ah, but we have our good friend inflation! The Fed is desperately trying to create inflation, surely that will take hold, raising nominal prices and lifting some borrowers out of negative equity status.
Yes, but we gave those borrowers teasers into fixed, Now the banks have low yielding (maybe negative yielding) assets. But the banks could hedge, correct? Yes, but mortgage hedging is nastily pro cyclical. The Fed was actually relieved when Freddie and Fannie had their balance sheet growth restrained in the aftermath of 2003 accounting scandals because their mortgage hedging is procyclical, and on such a scale that it was systemically destabilizing. So if this program works on the scale hoped for, we all can look forward to big time mortgage hedging whipsawing markets.
And the fine print has another doozy of a provision:
To encourage the modification of more mortgages and enable more families to keep their homes, the Administration — together with the FDIC — has developed an innovative payment that provides compensation that can partially offset losses from failed modification when home prices decline, but is structured as a simple cash payment on every eligible loan. The Treasury Department will make payments totaling up to $10 billion to discourage lenders, servicers and investors from opting to foreclose on mortgages that could be viable now out of fear that home prices will fall even further later on. This initiative provides servicers with the security to undertake more mortgage modifications by assuring that if home price declines continue to occur or worsen, investor losses are partially offset. Holders of mortgages modified under the program would be provided with an additional payment on each modified loan, linked to declines in the home price index.
In other words, if the program succeeds, we may not be so happy with where we wind up in a few years.
But I have my doubts that it will work. First, despite the bribes to servicers, I don’t see strong reasons for them to play ball. These mods will be costly, I am not certain the comp is adequate, and mortgage securities holders may sue.
Second, the redefault rate on mortgage mods that do not have significant principal reduction in the first six months now is high. The New York Times reports that payment reductions are expected to be “hundreds of dollars” a month. Is that really going to make a difference with most borrowers, particularly since the interest portion is tax deductible and these mortgages are recent (ie, the interest component is a high proportion of the total payment).
Third, the program qualifies people based on mortgage payments relative to total income. Some consumers are so up to their eyeballs in debt that a mortgage mod is merely rearranging the deck chairs on the Titanic. So in this version of the program, borrowers with high levels of overall debt (55%= to income) get debt counseling! Let me tell you, someone in that fix is probably beyond hope. In the old days of easier credit, someone paying 29% on credit cards could get a somewhat less punitive rate via debt consolidation. I doubt there is much of that sort of credit on offer right now.
Fourth, second mortgage holders don’t have reason to play ball. From the guidelines:
While eligible loan modifications will not require any participation by second lien holders, the program will include additional incentives to extinguish second liens on loans modified under the program, in order to reduce the overall indebtedness of the borrower and improve loan performance. Servicers will be eligible to receive compensation when they contact second lien holders and extinguish valid junior liens (according to a schedule to be specified by the Treasury Department, depending in part on combined loan to value). Servicers will be reimbursed for the release according to the specified schedule, and will also receive an extra $250 for obtaining a release of a valid second lien.
Fifth, these mods are voluntary. There is enough pressure being applied to banks now on government life support that they will be expected to make a good show of it, but the government has designed the template, and it is not obvious how much latitude banks have in participant selection (and whether they have the skills to make informed choices even if they were motivated to). However, there is limited protection against “mods for the sake of mods”. The servicer gets no incentive payment if the borrower defaults within three months.
The possible real effect of the program may be revealed here:
Servicers will receive incentives to take alternatives to foreclosures, like short sales or taking of deeds in lieu of foreclosure. For those borrowers unable to maintain homeownership, even under the affordable terms offered, the plan will provide incentives to encourage families and servicers to avoid the costly foreclosure process and minimize the damage that foreclosure imposes on financial institutions, borrowers and communities alike. Servicers will be eligible for a payment of $500 and can make reimbursable payments up to $1000 to extinguish other liens, and borrowers are eligible for a payment of $1500 in relocation expenses in order to effectuate short sales and deeds-in-lieu of foreclosure.
An interview with Paul Van Valkenburg of Mortgage Industry Advisory Corp. regarding the Mortgage “Cramdown” Legislation and what does it implies. (Bloomberg News)
Seems to say cram down will assign principal reductions to lowest tranches, but he was hard to understand. This is supposedly the “stick” to force modifications. Query whether have to go thru bankruptcy to get the benefits, or whether voluntary mods will also work.
Yves, thanks for distilling some key points about the mortgage mod program. Looks like deja vu all over again. The same teaser trickery, ballon payments, etc. that got us into this mess is now being peddled by the federal government. The government may have a hard time prosecuting all the mortgage fraudsters when defense attorney can point to the government doing the same thing.
Next time, when we have another round of millions of mortgage mod “homeowners” who can’t pay their rising monthly payments, the “homeowners” will complain “Hey, we did not suspect anything. We followed the rules…the government’s rules. We trusted the government.”
Frankly, I do not give a flying fart in space how bizarre and complicated they make all of this nonsense just so long as it all ends up being totally “neg am” to the debtor, so that no debtor gets into a position where he/she can book a future capital gain as a result of some other taxpayer gifting him/her any part of the investment whatsoever.
Moral Hazard: [var.]
That aspect of primordial human behavior which rewards failure at the expense of many. Also see Communism.
I tend to agree with the previous commenters. Socialism in a sick and twisted way. Why not have simple and clear rules to start with? And where did this “Home sweet home” fetish originate? Why is home ownership worshiped so much more than many other values in this society? I am with Willem Buiter. Let people walk away. Remove all direct and implicit subsidies. Why do people feel bad about renting?
Thanks for trying to clarify this mountain of regulatory spagetti.
Too complex to fly, is my impression.
Banks should have to take writedowns straight against capital.
I don’t see the holders of second liens being willing to take losses any sooner than they have to. These will typically be complete wipeouts.
Also, debt forgiveness is taxable as income. I know that there are programs like the Mortgage Forgiveness Debt Relief Act of 2007, but do not know when they expire or how far they reach. Even if there is relief at the federal level, there is the state level to contend with. And tax liabilities are full recourse, unlike second liens.
Here’s a different plan. Offer a second route to foreclosure that takes only 10 days. Pay any homeowner who agrees to permit it $6,000 toward their moving expenses.
“Thus for the bank all this does is kick the can down the road, unless we assume a recovery from these levels.”
Japan II. Financial legerdermain got us into this, and the bankers (i.e., the FED, the gubermint bankers) still believe in it – something for nothing.
Details of the Mortgage Program released by Treasury:
“To reach the target affordability level of 31%, interest payments will first be reduced down to as low as 2%. If at that rate the debt to income level is still over 31%, lenders then extend the term or amortization period up to 40 years, and finally forbear principal at no interest, until the payment is reduced to the 31% target.
Treasury will share the costs of reducing the payment from 38% DTI to 31% DTI dollar for dollar.”
In other words, cut the interest rate to 2%, extend the loan to 40 years, defer principal payments back into the balance interest free, with the Treasury picking up 50% of the cost of the above.
Yves, as always you’ve hit the nail on the head. Like so many of the other programs rolled out, the essence of this is the avoidance of price discovery. As such, it is doomed to fail; the most it can do is postpone failure. Eventually, price will be discovered.
This program looks to be especially doomed. At first blush, it seems that about 80-90% of mortgages won’t qualify – too far underwater, borrowers don’t have adequate income, the loans aren’t with Fannie or Freddie, there are 2nd’s or HELOC’s that would be wiped out so they won’t cooperate. I foresee some people getting their 2% mortgages and their principal reductions, and a WHOLE lot more people who can’t, and will scream bloody murder that their neighbor has gotten a killer deal, and they can’t – and are subsidizing their neighbor’s killer deal. I can’t understand why the Administration would design a program that, for every one person it benefits, there are 8 or 9 other people screaming “Where’s MY 2% mortgage and bailout??!!”
Feels like Obama exhausted all of his political skills getting elected, and is now throwing up nothing but airballs. This will land with a thud.
was a GREAT post.
I’m stuck in an ARM that we entered into a few years ago, and thanks to the current credit crunch we can’t refi into a fixed rate mortgage now. I’ve made every mortgage payment on time, but I don’t qualify for either of these plans. I sympathize with those who can’t pay their mortgage due to job loss (we were nearly in that boat several years ago when my wife lost her job), but they won’t be benefiting from this program either (since they’ve got to demonstrate they can pay the lower premiums, can’t do that with no job).
ISTM that only the ones who are “flipping” will benefit from this, precisely the people who should be foreclosed on.
We are so screwed. The paragraph where you explained why mods aren’t a win-win scenario is just scary. Hard to see how the banks can be saved when they either get a significant haircut in the foreclosure or even their highest rated bond holdings take a hit if they mod. Oh yeah, there’s going to be a recovery in the second half.
Nice, Yves. Nobody does better at breaking this out in understandable terms. Thanks
Every one talks about helping people keep their home. The reality is that it is not their home until they get the deed. What is wrong with these people looking for a place they can afford as renters? If the government were to spend at least %10 of what is spending on “home ownership” on a healthy rental alternative we all be better of. But then again banks and government need all these slaves to debt to perpetuate them selves in power
trying to jack the RE market is the government policy. Related to the MOD program which probably will never end is the FHA 3.5% down payment program which here in Calif real estate agents and banks are now using to game the system. Works like this: A house comes on the market so a wanabe homeowner makes a very high bid using FHA 3.5% dn, all they need is a appraiser to move it along, now any conventional 20% down bids are rejected since they are rational based on better preconceptions of market value. Does this sounds like the bubble years? Using your tax dollars?
What a nightmare. We’re going to try and combat a housing market collapse by throwing a public policy masters thesis at it.
I’m with commenter Bill above. States would be well served by drastically expediting their foreclosure processes and the feds should kick in a stipend for “transition” expenses for those throwing in the towel. Fan and Fred can step in and guarantee cheap(ish) mortgages for the stronger hands moving in if needed.
The biggest thing not discussed in the details of the program is whether the mods will be changed from non-recourse to recourse. I read through everything I could find and did a search for recourse in every pdf document at Treasury and there was no mention I could find but in reading Mr. Mortgages Guide to the Truth he says that most likely the loans would become recourse creating debt slaves who cannot sell their houses since they would have to pay the ballon at the time they sell (and that’s just on the 1st lien). Apparently the FDIC has been making loans recourse with the leftovers of Indymac and the Treasury program is modeled after Bair’s mods there.
(Mr Mortgage is moving his site so it’s hard to keep up with him unless you’re on his email list but here is an example of his work at Big Picture: http://www.ritholtz.com/blog/2009/02/mr-mortgages-guide-to-the-truth/ Unfortunately he has 2 more timely posts since this one that discusses the Treasury program directly but I only have email versions)
Combined with the other criticisms Yves notes it seems to be another DOA proposal to me. Anyone who takes the bait is going to get screwed hardcore except for some very special scenarios.
“Seems to say cram down will assign principal reductions to lowest tranches, but he was hard to understand.”
As I understand it, principal write-offs from cramdowns will be taken first from the bottom of the capital structure, as are ordinary principal losses, but that still reduces the credit enhancement for higher tranches. Moreover, modded mortgages weaken the trigger mechanisms that are supposed to protect senior tranches. That’s (one of the reasons) why there’s a cap on them in most securitisation documents, and it could easily cause a write-down for holders. By how much, I don’t know.
Just out of curiosity, what is the problem with the federal government just taking over the mortages from the originators? Instead of owing payments to the bank, lendees would owe payments to the government.
Wouldn’t this help the banks by getting the bad mortgages off their books, and also now you have a sort of federal guarantee of all that securitized debt. As for the “homeowners”, the government can do anything from forgiving the debt and giving them the houses for free, to foreclosing on them and kicking them to the streets. I would prefer turning the houses temporally into public housing, rented by the current occupiers, but the point is there is now more policy flexibility.
It stuck in my mind that Paulson actually said he would "end this housing correction!" in a Dec. 1 2008 speech I saw on video online (URL below)*.
He's used the word "correction" as a euphemism for so long he had no sense of irony when he said it.
The game seems to be big time denial that house prices were bubble prices, because when those fantasy prices stop being propped up, the value of the "assets" based on them — the still undeflated part of the derivatives bubble, still looming in the bowels of banks, and rumbling ominously — will be revealed as the toxic waste that everyone knows it to be.
When that happens, it will be much harder to justify continuing to feed the zombi banks. Admitting that the problem is insolvency rather than illiquidity seems inevitable, but there's still some juice to wring out of the system (e.g. AIG just now!).
So the games continue. Yes?
* My notes:
Paulson on Financial Crisis
U.S. Treasury Secretary Henry Paulson said on Monday that more programs are being developed to stimulate lending but warned a severe financial crisis is stubbornly persisting.
Last Update: Mon. Dec. 1 2008 |
Bla bla bla TARP, "We have announced the terms for participation for most non-publicly-traded banks. … applications for private banks are being reviewed and processed now." Bla bla bla "20 billion $ to back credit card lending." "Eligible asset classes may be expanded further…" "GSE – 90 day suspension of foreclosures" we will "end this housing correction" — !
Your interpretation of this plan is inaccurate in many ways, incomplete in others.
Full disclosure: I work in modifications, so I am paying particular attention to these announcements.
“First, it appears the program is a five year payment reduction program. While the guidelines are silent here, reasonable people would infer that the payment relief will be added to principal (particularly since the monthly borrower incentive for keeping current, is paid the servicer on behalf of the borrower to reduce principal, which suggests it is to offset principal increases).”
Well I consider myself a reasonable person, and further think that it is far more reasonable to interpret this borrower incentive as what it is: AN INCENTIVE, designed to encourage good faith participation in the modification on behalf of the borrower and to balance the incentive distribution somewhat between lender, investor and borrower (perhaps more a political consideration than a practical one). Also, I see no reason to assume that “payment relief” would be folded back into the principal. Delinquent amounts, yes. The aggregate monthly reduction in cost to the borrower? Why? This is not standard practice now and I have no reason to believe or “infer” it would be under this new plan.
A small point:
“The program keeps the previously announced construct of having the lender reduce mortgage payments so they are no more than 38% of income, then Uncle Sam kicks in and provides a subsidy to bring the level down to 31%“
Uncle sam subsidizes HALF of the amount to bring the rate from 38% to 31%, or any rate in between.
“Fifth, these mods are voluntary“
Well, as the plan details released yesterday repeatedly make clear, this is misleading at best, if not altogether false. Any participating institution signs a contract with the treasury deparment, binding them to terms of a “Net Present Value” test. If it comes back “positive” the servicer must go through with the mod. Further, although participation in the program is voluntary, any servicers receiving tarp money must participate, and most others have indicated they will participate.
Finally (though not exhaustively), as another commenter noted, the “stick” to these “carrot” subsidies is the cramdown legislation allowing bankruptcy judges to modify loans. This legislation will now require that the lender made reasonable attempts to modify the loan prior to bankruptcy, and the servicer did not offer a reasonable mod.
@IF said: And where did this “Home sweet home” fetish originate? Why is home ownership worshiped so much more than many other values in this society?
I read an interesting post somewhere that historically, home ownership and revolution are inversely related. So the gov wants people in homes to reduce the threat of revolution.
I know it sounds radical, but it made sense to me.
You critical tone isn’t warranted. Yves did make an error on the 38 to 31% part, but I don’t see the rest of the interpretation as unreasonable.
First, the bankruptcy bill has NOT passed, there is considerable Republican opposition and (drumroll) you have to declare bankruptcy! If you are ineligible for a Chapter 7, the repayment requirements for unsecured debt are very onerous. That was the intent of the 2005 changes and nothing in the cramdown provision would relax that.
Moreover, there is reason to think servicers would welcome cramdowns. No litigation risk from the investors, and how they get paid for court proceedings and BK is well specified. I can’t speak conclusively, but everything I have heard suggests they’d do well on the fee front, and they have the procedures set up for this.
I don’t read the guidelines as being as proscriptive as you do. For instance:
“Participating servicers are required to consider all eligible loans under the program guidelines unless prohibited by the rules of the applicable PSA and/or other investor servicing agreements. Participating servicers are required to use reasonable efforts to remove any prohibitions and obtain waivers or approvals from all necessary parties.”
“Required to consider” isn’t a high bar. And we have this:
“Every potentially eligible borrower who calls or writes in to their servicer in reference to a modification must be screened for hardship. This screen must ascertain whether the borrower has had a change in circumstances that causes financial hardship, or is facing a recent or imminent increase in the payment that is likely to create a financial hardship (payment shock). If the borrower reports a material change in circumstances, the servicer must ask about current income and assets, and current expenses as well as the specific circumstances relating to the claimed financial hardship. Each of these elements shall be verified through documentation.”
There will be plenty of cases where a servicer who wanted to could reject a mod due to failure to adequately document income and assets.
We also have the little “incentive” that the servicer doesn’t get paid in the event of a redefault within three months. They need to have discretion to reject mods that look likely to fail.
And you are missing the biggest point, the one made at the top of the post. Mods without deep principal reduction have a high rate of failure. Why should we expect a better outcome here?
This is 5:22, I meant to address dm.
dm, you characterization of the NPV requirement is not correct, It is required only in the case of Imminent Default, as determined by the servicer. That is only a subset of mods, and the servicer is the one that makes the determination of Imminent Default (ie, no formula here, it’s judgmental).
So I’d be careful before accusing Yves of inaccuracy here. Your assertions are debatable. to say the least.
Logos like this can make navigating website easier, so there is a legitimate use for them (not saying that was the intent).
Its not meant to succeed. Its just another pot stirring by gangster government.
Great analysis but we need to put all of these dots of disingenuous BS together.
What we will find is we need a logo with a wealthy elite boot stomping on the middle class and killing off population.
Deception is the strongest political force on the planet.
i on the ball patriot
2 concepts for Stability in our plight…..
I have emailed and faxed the following to a few people in CONGRESS…I am a Commercial REAL ESTATE BROKER IN NEW YORK…LARGE SALES….SHOPPING CENTERS…
MY VIEWPOINT IS AS FOLLOWS…FIRST A QUESTION….
“HOW DO WE STABILIZE THE HOUSING MARKET IN REGARDS TO PRICES FALLING..AND FREE UP MONEY TO JUMP START OR HAVE THE OPTION TO JUMP START THE TROUBLING ECONOMY…
MY CONCEPT…OUR.. THE GOVERMENT IS GIVING BANKS MONEY AT .25% OF WHICH THE BANKS HAVE NOT ALLOWED TRANSPARENCY AS TO THEIR INDIVIDUAL INTERNAL ISSUES REGARDING THEIR ABILITY TO EVEN LEND TO THE PEOPLE..
WHY TRY TO FIX A SINKING TITANIC???PUT IN A 1000 CORKS AND IT WONT STAY FOR LONG….
HERE IS THE HOWIE PLAN …LEND TO “GOOD HOMEOWNERS THOSE WITH LOW DEBT TO EQUITY IN THEIR HOMES MONEY AT “2%” SAY FIRST 250,000 THEN 2.5% NEXT 100,000…
BUT ONLY TO THOSE WHO ARE UP TO DATE WITH LAST 12 MONTHS PAYMENTS AND TAXES….THE 2% IS A 800% HIGHER RETURN THAN .25% AND WITH HIGH EQUITY THE GOVERMENT IS SAFER..
NOW FOLLOW ME…IF WE ARE PAYING SAY 6 TO 6.5% ON CURRENT PAYMENTS AND IN GOOD STANDING WE THE GOOD HOMEOWNER WILL HAVE THE ABILITY AND HOPEFULLY MENTAL STATE TO BUY HOUSEHOLD ITEMS…MAYBE DOWN PAYMENT ON CAR….HOME REPAIRS…ALL WHAT THE AMERCIAN ECONOMY NEEDS TO GET REVIVED AGAIN…..
YES IT IS NATIONALISTIC…..BUT HOUSING NEEDS A CONCRETE BASE,,,THIS CAN DO IT… PRICES WILL STABILIZE…
SECOND CONCEPT…INSTEAD OF GIVING DETROIT 50 BILLION OR SO….AS THEIR ARE 10 MILLION CARS SOLD A YEAR…GIVE GOOD CREDIT BUYERS A 5,000 OR 7500 CO-PAY PAID DIRECTLY TO CAR DEALER FOR EACH CAR BOUGHT….10 MILLIONx 5,000 EQUALS 50 BILLION…
THIS WILL CLEAR THE INVENTORY OFF THE LOTS FASTER…SALES PEOPLE GET COMMISSIONS…GIVING MONEY THIS MANNER ONLY COSTS THE TAXPAYER ONCE…IN THE PURCHASE OF THE CAR SUBSIDIZED BY GOVERMENT….GIVING HELP THRU DETROITS BACKDOOR IS NO GUARANTEE THEY WILL USE IT WISELY..AND STILL THE TAXPAYER HAS TO BUY A CAR HENCE DOUBLE THE OUTLAY………
ONCE THE LOTS ARE CLEARED LEAVE IT UP TO DETROIT TO BUILD BETTER CARS..IF NOT THAT IS LIFE….