A Bloomberg story gives the not-heartening news that the government-prodded mortgage modifications are producing higher failure rates as the economy decays:
Mortgages modified in the third quarter failed at a faster pace than those revised in the first, and the delinquency rate on the least risky loans doubled, signs of deteriorating credit quality, U.S. regulators said.
Loans modified in the first quarter to help borrowers keep their homes fell delinquent 41 percent of the time after eight months, and second-quarter loans had a 46 percent default rate, the Office of the Comptroller of the Currency and Office of Thrift Supervision said in a report today. Third-quarter trends “are worsening,” the agencies said.
“For the year and this quarter, we saw the same trend that we saw last time: quite high re-default rates, no matter how we measured them,” John Dugan, the U.S. Comptroller of the Currency, said in a conference call with reporters.
Lenders including Citigroup Inc. and loan-servicing companies are adjusting mortgages by lowering interest rates or crafting longer-term payment plans. The Obama administration is acting to help as many as 9 million struggling homeowners by using taxpayer funds to pay lenders such as bond investors, mortgage servicers for reworking the mortgages.
Dugan said higher re-default rates are likely related to stressful economic conditions and new loan plans are not producing significant reductions to make mortgages sustainable.
It’s important to notice what kinds of mods were offered: interest rate reductions and lengthening maturities. These are not very deep mods, in other words.
Mods that offer principal reduction have higher success rates. And Wilbur Ross, a well known investor in distressed companies, is not exactly the charitable sort. As reported in HousingWire:
[Wilbur] Ross has plenty of skin in the mortgage servicing game, as he owns Irving, Tex.-based American Home Mortgage Servicing, Inc., which recently became the nation’s largest third-party servicer with the acquisition of a large portfolio from Citigroup Inc….
Last week, Ross told HousingWire in an interview that he thinks the best way to motivate lenders, servicers, and homeowners work together on modifications requires far more than what’s been proposed so far. In particular, he believes that what’s needed is aggressive principal modifications for borrowers most in need. He has said that his American Home servicing shop has seen six-month recidivism rates below 20 percent — compared to the 50 or 60 percent standard in the industry — because the servicer has been aggressively looking to cut principal balances.
“The price of housing needs to be cleaned out. The Obama administration could right-size every underwater home and reduce principal to fit the current market value of the home. If they are going to deal with it they have to deal with it in a severe way,” Ross told HousingWire. “They also really need to consider all borrowers who are underwater, and not just the ones that have gone into default.”
The Homeowner Affordability and Stability Plan does some of that, but doesn’t go far enough, Ross suggested. “The have to reduce the principal amount of loan, not just nonperforming loans, but also performing ones,” he told CNBC. “Why should a guy who’s not paying benefit, while some poor citizen who’s struggling to make the payments gets stuck with the mortgage?”
His own plan looks something like this:
1. The lender takes a write-down in principal, and the servicer takes a similar hit on any servicing strip on the newly-reduced UPB.
2. After principal reduction, the government guarantees half of the remaining principal the lender now holds.
3. This guarantee of half the principal can now be sold into the securitization market, which will give the lender an income stream on the home again and offset some of the losses the owner of the loan has to take when they write down the principal.
4. When the house is sold, if the value of the home has gone up at the point of sale, the homeowner and the lender share in the profits earned on the gain.
Ross isn’t the first to suggest an home equity sharing plan, and there are clearly strong complexities in how any such plan would be put together, particularly as it relates to second lien holders and/or investors in junior bond classes. But the fact that a large investor with such a strong hand in the servicing business is suggesting it’s possible at all to accomplish is something that perhaps bears more attention than the idea has been getting as of late.
We’ve been arguing for some time that with housing in many market trading at well below peak levels, the bank can offer a principal reduction and still come out ahead. In normal times, the cost of foreclosure means recovery rates of 70% at best. So assuming 50-60% (and that is probably still high), the bank can reduce principal 25% and still come out ahead.
It isn’t simply that a principal reduction lowers monthly payments more (but let us not kid ourselves, that’s a biggie) but it also changes the owner’s perspective. Why should he struggle to make payments on a house that is unlikely to be worth more than the mortgage? Odds are that he is still looking at a foreclosure or short sale as his endgame. That also means he has zero reason to make repairs or routine investments. Conversely, if the mortgage is written down to something much closer to the current value of the house, he has much greater reason to persevere.
Why isn’t that happening? Ah, those pesky securitizations. Although investors litigating to block mods is the oft-given reason for not taking this course of action (a presumed to be high number of securitizations either bar or restrict mods), my impression is servicers simply have not wanted to fight this fight (they have clearly defined compensation in the case of foreclosure versus no rewards for mods, save the fees under new government programs). Paying legal fees to fight investors is an even more dubious business proposition (it’s a near certainty they can’t charge those expenses to the securitization trust, and it would thus come out of their bottom line).
That is a long winded way of saying I doubt that there has been much study by legal talent as to how to overcome mod restrictions in servicing agreements. Given the high level of fraud (in a small sample, Fitch found evidence of fraud in every loan file it examined), there might be ways to persuade investors they have more to lose than gain by pursuing this line of legal action.
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1. The lender takes a write-down in principal,
Great plan. Will *never* happen until all the Bankster bailouts – esp. that of AIG – are stopped dead. Until then lenders say “talk to the finger!”
More good money after bad. How long does it take to learn? Probably the results so far are a bellwether for what will happen when the results come in for the big bank bailout. Unless by some chance the global macro-economy re-ignites, this is all just a formula for bigger disasters down the road.
Could Congress use legislation to force principle reductions without lender consent?
If sliced-and-diced securitized loans are commercially impossible to renegotiate then cramdown by legislation might be the only way forward.
I get more and more frustrated when I read things like this, because the basic problem becomes ever more clear: nothing can be done so long as the FIRE sector continues to exist in anything like its current form.
I refer to both structures and personnel.
This is simply a physical obstacle to any real moving forward.
It’s obvious that the FIRE sector has always sought to place itself outside the law, and largely succeeded (in their hands, “the law” by now is a hijacked weapon against the people). It is in fact a purely antisocial, outlaw element, and society should treat it the same way it treated society.
So it’s extremely frustrating that after all the education we’ve had here there’s still so little movement toward any kind of real solution.
Not only are we still mired in the same old politics, but even this truly picayune obsession with legal technicalities, all in order to coddle those who completely broke legal faith with us.
Can’t we at least begin moving to the recognition of the fact that we are now in a purely political realm, no longer a legal one?
(To obsess over legalities is just making the political choice to do nothing and maintain the corporatist status quo.)
Mods that offer principal reduction have higher success rates.
Call me a wild eyed contrarian, but maybe those troubled mortgages should be marked to market. Thus, if your $400k wonder is now worth $300k, then your loan is reset once to the latter.
Endgame, let the government come in and do all the paperwork after they have bought all three times.
Fist time, bank bailout.
Second time, insurance company bailout.
Third time, HUD, FHA guarantees.
There is a lot on the table already, they have to digest that first. Can’t be bothered to actually think about what is going on….
Principle write-down means that the banks will have to actually realize an actual loss vs the mostly paper losses the gov’t has been papering over… and I don’t think our fragile system is quite ready for that yet. Let’s print another billion.
I’m actually really surprised that the banks haven’t forced legislation to legally break up the MBS bundles. A rational company would want the easiest, most straight forward framework to deal with this mess as possible… and that fact that they do not do that tells me they have no confidence in how that is going to end.
Kick the can down the road… extend the recession a couple more years… hello Japan.
Yves,
One of the other issues is that in some cases the foreclosing party does not even have standing to be in court. This is because they cannot show the note, i.e. proof that they are the actual holder. Without that, bankruptcy judges have been staying foreclosures.
I suspect that in many cases there were fraudulent loan originations. In these cases the originators sold the same note several times, and of course, never provided any paperwork. Once the quiet title action goes through, the homeowners may end up with the title. This may be the best outcome possible. Except for the banks. Oh well. I guess Limbaugh and his pals can continue to try to pin the blame on the evil brown people.
Even if principal writedowns make sense for the banks in a cost benefit analysis v. foreclosure, there will be widespread political resistance across the country.
There is a broader question of fairness here. It comes down to a fundamental asymmetry that even a non-sophisticated bumpkin can see. Imagine if the government were to have said the following during the boom, “the recent price appreciation for housing represents an unearned windfall and as such we will now impose a 100% tax on all inflation-adjusted capital gains for housing”. There would have been a revolution. Yet now, with the market heading the other way, we want asset price floors and principal reduction. You can’t have it both ways. The system cannot work if all upside is privatized and all downside socialized. The markets are too large for the government to be in the business of providing guaranteed returns on investment via the general fund. And what of renters, many of whom are in the lower and middle classes?
I can think of a way whereby the servicers wouldn’t
be unhappy defending their modifications against
investors. Make the investors challenge each mod
as a separate event, one CUSIP ID at a time. It might
clear their heads.
If the principal is written down, I assume that Ross, etc would expect an immediate tax write off.
Nothing wrong with that.
But what of the homeowner’s who received the principal reduction? This is “forgiveness of debt” amd therefore ordinary income according to IRS/
Do you expect them to come up with the 10-30k at the end of the year that would be the tax owed on these “meaningful” reductions?
It’s fair to say that this might put a damper on the stimulus efforts.
OK…so you come up with some other plan (just what we need…more plans and more complexity)…
The homeowner pays the tax back over time? Not gonna work for obvious reasons. Just another drag.
How about this: Tax break for the banks, but no tax on homeowners? A massive 30-40% nationwide principal reduction. This is the stuff of a biblical holiday…and also the stuff of the Book of Revelation for the dollar.
OK, so the government comes in and tells banks and investors to write down the principal and…”oh yeah, you get no tax break either. Just do it.”
So, according to Ross, we have the following:
“They have to reduce the principal amount of loan, not just nonperforming loans, but also performing ones,” he told CNBC. “Why should a guy who’s not paying benefit, while some poor citizen who’s struggling to make the payments gets stuck with the mortgage?”
And we are left with the following:
1. All banks and investors—even those who didn’t screw up MUST write down the principal on these loans.
2. And no tax write off, either.
3. And property owners get quite a nice windfall, thank you. Now, if we could only find a way to make sure that the males (and white ones for good measure) get extra extra special treatment we’ll really have something here.
And let’s not even begin to address what constitutes a “meaningful” write-down. If the loans are written down to the values of today, then the homeowners will still be underwater tomorrow. So, if they want to stop the slide, the calculus dictates they’ll have to write down below market, so that by the time the house market gets its footing, the loan balances and FMV will actually have intersected.
OK, then. Good luck with all that.
Yves…. with all due respect, you’re missing the point on this one. The reason why borrowers aren’t being offered principal forgiveness is the same reason why *EVERY* bailout thus far undertaken has at its core been structured to return 100 cents on the dollar to creditors. That is, our financial system is so levered that lenders can not afford their debt obligations being anything but “money good”. This isn’t a failure of securitization… this is the holders of the bonds not allowing the forgiveness and hiding behind “securitization” as their excuse.
Look at what happened in Japan… they had the same problem. Instead of reducing the balance of a loan, they did insane things like converting them to 100 year, 1% IOs that people will to their children. All done in a ridiculous attempt to return 100 cents of every dollar originally lent.
The simple fact is that if every loan was reset to the current value of the underlying home, it would immediately bankrupt the entire banking system. Is that what should be done? ABSOLUTELY. But will it? No… for the same reason that AIG was bailed out… for the same reason JPM took over Bear’s liabilities… for the same reason Wells Fargo stepped into the liabilities of Wachovia. Etc, etc, etc…
It sucks, but until we allow capitalism to work we’re going to be stuck in this rut forever.
The Ross solution misses several issues the largest is that the reduction is based to current market value rather then the homeowners ability to pay. If one applies the 28%/36% mortgage afford ability scale to the majority of these situations then the bank is far better off to take the home into foreclosure.
These programs all suffer from the same limitations that is they are back door attempts to limit bank losses in the name of keeping people in there homes which even after any debt reduction the current homeowner would have NO equity in the home! They also do not address the 2nd and 3rd home that folks have acquired to game the system.
John Hussman (Hussman Funds) has been proposing something similar to the Ross plan for some months. Government pays off the difference between market value and the loan principal to the lender, then takes a lien against future appreciation of the house value. The lien stays with the house until paid off, so if the mortgage holder sells any proceeds left after settlement have to be applied to the lien.
No doubt this would be complicated, especially with the securitization of the loans. But this approach would address the underlying problem we face – too much debt to pay with too little income to pay it (as in Exhibit 12 of the Richard Koo presentation Yves links to today). Bailouts are making good on the losses recognized to date, but little is being done to prevent ongoing write-downs.
Bernancke and Geithner are doing their utmost to put a floor under the losses by re-inflating the underlying assets. This may work, at least for awhile, but the cost to re-inflate is almost certainly higher than writing down the debt. Re-inflating will help those of us with large asset holdings in 401K and brokerage accounts, but won’t do much for hourly wage earners. My personal datapoint for this assertion are the average 401K balances by age of my company’s employees that I review as a member of the company 401K committee.
The biggest obstacle to such a plan is probably not legal or financial, but rather populist resentment. Anytime mortgage modification is proposed, folks like Rick Santelli complain that we’re subsidizing McMansions for the undeserving. Personally, I don’t know anyone in a McMansion with an option ARM mortgage, but I do know lots of folks working full-time that can barely get buy on reduced working hours, higher medical costs, and a mortgage that consumes the balance of their income.
My vote is to help people directly with debt relief rather than bail-out the banks. I’d rather socialize my neighbor’s losses than a bank’s.
“Government pays off the difference between market value and the loan principal to the lender, then takes a lien against future appreciation of the house valueThe lien stays with the house until paid off, so if the mortgage holder sells any proceeds left after settlement have to be applied to the lien.”
And what occurs if and when the homeowner who has no equity decides to walk when RE continues to decline or default based on job loss,divorce, health crisis? is the new loan recourse? What if he needs to sell but no appreciation has occurred, do they bring money to the closing?
The homeowner is still liable for the RE taxes, maintenance on a home he/she has no equity in. Sounds like a renter with some kind of future option if the home appreciates back above the bubble years.
lineup32,
You’re absolutely correct on a dollars and cents point of view. Most everyone who bought at the market top are unlikely to realize capital gains on their house purchase in any reasonable timeframe.
And yet, many of these people keep making house payments. Why?
(1) They expect a return to the days of 15% house yoy appreciation. Unlikely I think…
(2) They don’t understand the math. Plausible…
(3) They entered into a legal contract and want to discharge their obligations.
(4) They “love” their house.
How do payday loan operations continue to exist? On the completely misplaced good-will of the debtors.
If mortgage holders want to continue to pay but can’t because re-fi is no longer possible on negative equity, we can either counsel them to default or help them out. The “right” thing to do must depend on individual circumstances, but what we’re offering now is next to nothing.
If we can offer debt relief and prevent future financial system cash flow impairment, there could a win-win solution.
I’m not suggesting it would be easy.
Mods with principal reduction will never happen on a large scale. There will be so much squabbling over what is the “market value”, and so on. People act like complete a-holes over $20.00 discounts, imagine what’s going to happen when a note holder and a homeowner try to agree on a “haircut”.
Here is a solution. Tax renters double what they are paying now and use that money to just give the homes free and clear to the folks who are 3 months behind on their mortgage payments. You know the saying.. “these are desperate times and fairness cannot be the reason we make decisions” Of course once crime increases double and no one is charitable anymore don’t blame the folks living in mcmansions for free..
Nic, excellent idea. It gathers a nice punch to throw at those who protest that they would rather socialize the mortgage holders’ losses than the banks. Hello? We have already undergone enormous socialization of the losses of the banksters. We no longer have an either-or option. Moreover, under the plan of creating a taxpayer subsidized plan to socialize the losses of the mortgage holders, the taxpayer is still being robbed to cover the losses of the banks.
Seriously if principal writedowns make sense for the banks in a cost benefit analysis v. foreclosure, then let ’em at it….without crying for taxpayer subsidies. I think the public has the stockholder leverage to force debt forgiveness at the banks’ expense entirely. A KISS solution.
If the banks become “more insolvent” as a result, perhaps they can be as successful as AIG in reclaiming bonuses paid and otherwise display their financial innovation prowess.
And why does the government (i.e., the taxpayer) not participate in gains, if any, when the property is sold? Without my tax money on the line to guarantee half the principal, lenders don’t recover. So where’s my cut?
I continue to fail to see why it is my responsibility to backstop unrealistic promises third parties made to each other, often knowing that the promises were worth less than face value.
I’ve not yet seen any discussion on the negative aspects of equity kickers on the signing homeowner, and I suspect few will be properly cautioned in advance of what they are. In future cases of distressed sale when one of these exists, a lot of folks will really wish they had simply walked away instead.