Quelle Surprise! Treasury Mortgage Mod Program Produces Zero Permanent Mods

For the record, zero is a very impressive achievement, so we have to give the Treasury department credit where credit is due. From Bloomberg:

More than 650,994 loan revisions had been started through the Obama administration’s Home Affordable Modification Program as of last month, from about 487,081 as of September, according to the Treasury. None of the trial modifications through October had been converted to permanent repayment plans, the Treasury data showed. That failure is getting the administration’s attention.

Treasury was clearly trying to blunt criticism of this program by having some new measures ready to go, as discussed in the New York Times yesterday. But the goose egg results, per Bloomberg today, are, even by the low expectations for this effort, a remarkably poor showing. And give the complete failure of the Bush, then Obama Administration efforts to get more mortgage mods within the considerable confines of current practice, why should we expect a different outcome?

The mortgage mod program is yet another ill-conceived effort to solve the problems borne of faulty technology, namely securitization. The FASB came out with a memo in 2004 that warned that warned about subprime loans and the current head of the FASB has questioned the entire premise of securitizing risky mortgages. In a 2008 roundtable, FASB chairman Robert Herz remarked:

In securitization accounting, there’s been in place, as part of the rules, a device called a qualified special-purpose entity (QSPE). It basically was a notion that if assets were placed into a trust, a vehicle, and then interests were issued out of that vehicle to various forms of security holders, what are called beneficial interest holders; basically the form of that vehicle, that trust, was to collect the proceeds on the assets and then remit them to various security holders. They were fairly passive, and the rules talked about how the powers would be very limited-entirely specified up front–and I think that worked for a fair amount of time.

But 1 think what we’ve learned in the last three to five years is in residential mortgages (also to a certain extent in commercial mortgage space and some other assets) that these assets are not passive in nature. Certainly, the subprime assets that were put into these vehicles called “Q’s,” with a lot of hindsight, because they took a lot of management when they went bad in terms of the servicing or having to restructure the loans, modify them, do all sorts of workouts. That clearly was not intended. I think the lesson learned here is that they were not actually “Q-able.”

Yves here. Now there may be remedies to prevent this sort of problem from occurring in the future, but that does nothing to solve the wee mess we have now. Residential real estate prices are sufficiently under water in a most markets that for a viable borrower (meaning one who still has a steady source of income), a deep mod can be a win/win. And before readers get moralistic, this isn’t charity, it’s practicality. In real estate downturns in the stone ages when banks held mortgages on their balance sheets, banks routinely did mods. And even in our current environment of more highly levered consumers, this practice 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 it was pretty obvious that the Obama mortgage mod effort would not produce much in the way of results. First, it provided subsidies to servicers, but much less than they would make from foreclosing. That means the banks have every reason to use the Treasury initiative to amass a track record that mods do not succeed (independent of whether they might succeed, as Wilbur Ross has shown they can).

Second, the program offered only a five year payment reduction program, with the lender then able to step up the interest payments to the fixed rates in effect at the time the sorta-mod was entered into. That does not do enough for the borrower. the redefault rate on mortgage mods that do not have significant principal reduction in the first six months now is high. When the initiative was announced, he 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).

Moreover, if a homeowner has negative equity, he still faces a big bill when he sells the house. What incentive does he have to work to keep current on the mortgage, or to invest in the house?

Now most people have focused on lack of servicer incentives, infrastructure, and experience to do mods, but we have another impediment, which the Treasury interest-only modification program clearly tried to work around. Losses are distributed differently in a mod than in 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.

The interesting bit here, however, is the complete goose egg in the way of results. Most banks do own some mortgages they originated, and they should be able to renegotiate those freely. The failure to do so suggests either that they are concerned that modifying delinquent mortgages might require them to write down similar paper and/or they simply aren’t set up to do mods and are not really interested in creating the infrastructure to do so (and again note that what Treasury tried to create was a “mass mods” template, to reduce the work required by the lender).

The Administration did not throw its weight behind the only idea so far that could have cut this Gordian knot, which was to allow for the modification of mortgages in bankruptcy (the concept, which is well established in commercial bankruptcies, is to write the mortgage down to the current value of the collateral, and treat any remaining mortgage balance as unsecured credit). So now that this voluntary program is turning out to be an embarrassment, what will Team Obama do next? Back to Bloomberg:

“We are taking additional steps to enhance servicer transparency and accountability as part of a broader focus on maximizing conversion rates to permanent modifications,” Treasury spokeswoman Meg Reilly said in an e-mail yesterday. The Obama administration plans to announce additional steps tomorrow, including new private-public partnerships and resources for borrowers.

Given that “public private partnerships” has meant “large subsidies to banks that produce perilous little in the way of results,” I would not hold my breath. And the measures suggested in the Times verged on laughable:

“The banks are not doing a good enough job,” Michael S. Barr, Treasury’s assistant secretary for financial institutions, said in an interview Friday. “Some of the firms ought to be embarrassed, and they will be.”

Even as lenders have in recent months accelerated the pace at which they are reducing mortgage payments for borrowers, a vast majority of loans modified through the program remain in a trial stage lasting up to five months, and only a tiny fraction have been made permanent…

“They’re not getting a penny from the federal government until they move forward,” Mr. Barr said

Shaming bankers? What planet is Barr from? The industry is systematically predatory. If they had any concern about public opinion, they’d have used the Bush and Obama efforts as cover to try pushing back against investors in securitization vehicles. Before some of you go on about sanctity of contract, the father of mortgage backed securities, Lew Ranieri, seemed genuinely shocked in the Milken conference in 2008 when other participants said mods were restricted or prohibited in many securitization contracts. Ranieri said they did them routinely. Not only has the industry done anything more than go through the motions, one has to wonder whether they influenced Treasury in the design of the program so as to assure it would not be effective.

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19 comments

  1. David Herr

    The problem with applying bankruptcy cramdown rules to existing mortgages, is that it is a total change in the rules during the middle of the game. I can see such a rule applying to future mortgages, although interest rates would have to increase to compensate for the extra risk. But to take a mortgage where the interest rates were lower because the loan was secured by the property and outside the bankruptcy system, and then make it subject to cram-down, would cause massive problems.

    First, the banks may be able to successfully litigate the constitutionality of such an infringement of their contract rights. At the very least, expect years of litigation gumming up the works.

    Second, most banks would become instantly insolvent if the high tranche paper they hold, which currently is low or no loss, becomes 30% to 60% less valuable because cram-down losses are split pro-rata amongst tranches. If the FDIC is going to have to step in an bail out all depositors, I don’t want them left with crammed-down paper — I want them to be able to get the house, and then either sell it to a new occupant or rent it to the borrower at a market rent and sell it to an investor. In other words, I would want the government to be able to make the maximum possible recovery for beleaguered taxpayers.

    Of course, we could allow the FDIC to grant forbearance to banks who would be even more insolvent after cram-down legislation passed than they are now, but then get ready for a Japan-esque lost 2 decades, with vampire banks sucking the life out of the rest of the economy.

    The real way out of the gordian knot you describe is to cancel the rest of TARP and the stimulus, and bite the bullet with FDIC depositor bailouts. That will simultaneously write down most banking debt, and put what remains on the public debt ledger, but at least the equity and bondholders of the current banking system will be wiped out. All current proposals are aimed at raping the taxpayer to keep current bondholders whole.

    As for the homeownership issue, something along the lines of a right to rent policy, before a house is sold to a new occupant, is humane, just, and economical. In many markets, the market rent for housing has fallen back to a reasonable portion of income, so for all but the unemployed homeowner, this policy could provide housing stability at a reasonable cost.

    1. Doug Terpstra

      It seems to me the rules are already moot, out the window, kaput—shredded over decades as banksters bribed congress, bulldozed sensible New Deal guardrails, paid-off the cops, fired the refs, and opened no-rules casinos. Oh but then, when their rigged market cannibalism, protection rackets and flim-flam loan sharking collapsed, they conveniently jettisoned the last vestige of beloved free market catechism, and within three days, socialized their risks, extorted public bailouts and payed themselves obscene bonuses from the proceeds with smug impunity.

      But now, now we finally sober up and reapply “free” market rules and enforce the all-sacred contracts. Throw Tiny Tim under a bridge in time for Christmas. His dad should have read the damn contract. Humbug!

    2. jkiss

      your ideas are not consistent.
      A cramdown simply sells the home to the existing homeowner at current market value. Why is this worse than selling to an investor? In both cases the bank takes the hit to its balance sheet, but in a cramdown there are far less costs of sale, including fix up, commissions, delay with no revenue or interest, etc. Society also saves money by avoiding moving and related costs.

      The historical fear of cramdowns is that a liberal judge will have too much power to help those he feels sorry for. We are in a national emergency, 1/4 of all homes are underwater, most will likely be abandoned particularly if home prices continue to slide… I see cramdowns as a vital but temporary tool for this emergency. IF, however, cramdowns were made permanent, lenders would be more likely to demand a higher down payment than higher interest rates. It is past time for higher down payments, say 20% minimum.

      Humanely forcing the investor to rent to the homeowner will probably reduce what the investor would be willing to pay, and of course eliminates the competition from those wanting to buy to live in the house.

      1. Skippy

        What happened to crime does not pay eh. All I see is criminals running off with the loot and all you can say is historically judges take a soft side on the subject because the side with the victim really?

        Emergency you say, all bets are off till the planets realign economically (debt ladened suck hole), sanctity of the investor BS, ya spin and some times more that not ya lose, man up fool!

        Skippy…nuthing but cry baby entitled dim-whits me thinks, how much suffering have your ilk created, but once the bead of destiny’s focus upon you and yours becomes untenable ye cry foul, eat thy own manufacture and save a tear for those that you feed off lad or some day me and mine may visit your house. Have a care for those less fortunate one way or another, their lack of understanding will manifest woeful exuberance upon your flesh, or so history laments.

    3. Anon

      Did you seriously just write this?

      “First, the banks may be able to successfully litigate the constitutionality of such an infringement of their contract rights.”

      U.S. Constitution Article I, Sec. 8:

      “To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;”

      The “years of litigation” would include the 20 days required to file and serve a rule 12 motion.

  2. doctorx

    Yves

    Your view that the banking industry is predatory means that your sensible analysis cannot prevail given the PTB today.

    NO permanent repayment conversions. Unbelievable. Couldn’t have written that into a movie script and have anyone believe that failure could be so abject and total.

    Even the Nazis in 1939-40 must have lost a skirmish or two along the way(?)

  3. John smith

    If someone can’t pay their mortgage they should lose their house, pure and simple. Then next time maybe they’ll think more carefully before taking on a debt they can’t service. It’s time for some tough love instead of all this mothering by the government with other people’s money. Let the market work. Never understood why government always has to “do something”. They need to step out of the way and let people get on with their own lives for once. We will never thrive in a dependency culture where the gov is expected to fix every little difficulty we may face in life. We didn’t win WW2 with the gov holding our hands and blowing our noses. What happened to us? How did we get so pathetic?

    1. fluffy

      If someone invests in lots of bad securities, they should have to take the loss. Time for some tough love.

      Too bad tough love only applies to the little guy and not the real criminals.

      Snarky morality towards some folks who, encouraged by every other financial adviser cum blog poster on the planet, succumbed to the last investment opportunity that seemed to have any hope for them, is a bit over the top here.

  4. Ronald

    If the MOD program is a failure then the entire effort to re inflate the market with liquidity is doomed. The numbers for any cramdown will end up in the millions and with it will go any pretext of a healthy RE market. Bubble economics has flamed out and no amount of new regulations nor government programs can reignite it.

  5. kropotkin

    A total change of the rules in the middle of the game? No problem, just get the legislative tapeworms who reformed the bankruptcy law. After every sucker in the country was stuffed to the gills with hopeless debt, our lawgivers replaced restructuring with humiliating reconstruction-style debt peonage. They know perfectly well how to change the rules in the middle of the game.

    1. Eric

      The revisions to the bankruptcy code that I think kropotkin is referring to definitely were designed to benefit credit card companies first and foremost. Still it is kind of hard to feel a lot of sympathy for those who got caught with the rules changing, since you would have to believe that the only debtors with much of a beef are the ones who would planned to go into bk after piling up the debt. During the debate about this revision, there were several exemplary cases of people with medical problems who were relying on their credit limits to keep up an income. They were universally very sad stories, but frequently the individual or family clearly were taking on debt with no intention of honoring it. Hopefully there will be some kind of effective reform of our health care/insurance system that will provide humane solutions for these situations that do not involve the assumption of unpayable debt.

  6. Ray A

    Perhaps the problem has to do with the 90 day “trial” period ending before conversion to permanent. I suspect we’re still in the trial phase. The only way such a program could be an absolute failure, as implied in this piece, is if the 31% of gross guidelines were in fact ignored. But how can that be? In my opinion there are just too many incentives for the bankers not to make it work. Hence my suspicion that the numbers will improve dramatically over time.

  7. Fraud Guy

    My anecdatal story.

    My mod becomes permanent on Tuesday.

    I dropped from a $3400 mortgage payment, not including escrow, to $2300 per month, including $750 monthly tax escrow.

    Principal has not been impacted, though the interest has been dropped to 2.25% for the first 5 years, going up 1% each of the next two, then capping at 5% at year 8, which will still net @ $2700 w/escrow payment.

    Regardless of all other factors, we will now be able to afford our home, so there is at least one success for this program.

  8. bellebelle

    After requesting in March for help, I was offered a modification in late July. I made trial payments, accepted it, got it notarized per instructions, and sent it back happy that they had helped me. But wait! A week later they sent me a letter via fedex saying they decided not to go through with the modification, and to call them (why didn’t they just call me?!) Now I’m back to square one, after having made trial payments, faxed paperwork multiple times, and the uncertainty again. Mine should have been completed, what they did was make me an offer, I accepted, and they then committed breech of contract. And I’m not the only one: http://www.loansafe.org/forum/countrywide-home-loans-tell-us-your-countrywide-story/15277-countrywide-california-attorney-general-settlement-beware-countrywide-home-loans-cancelling-loan-modifications-without-notice.html

    They are just simply not completing them.

  9. Snarki, child of Loki

    Yes, congress changed the bankruptcy rules, to the detriment of average folks. It’s changing the rules in the middle of the game! Unfair! Invalid!

    Clearly, if *I* should ever need to go through bankruptcy, it should be under the rules that were in place on the day I was born. Anything else would be unfair and unconstitutional.

    And just as frakking stupid as Herr Herr’s position.

Comments are closed.