Quite a few housing market experts have argued that principal modifications to viable borrowers are the best way to resolve the housing market malaise. In the stone ages when banks kept the mortgages they originated, mortgage modifications, including principal mods, were standard practice when a borrower got in financial difficulty but was still salvageable. And because these restructurings were done behind closed doors, no one but the banker and his grateful customer were the wiser. But now that servicer bad incentives have meant they don’t do mods unless cajoled or bribed by the government (and not much even then), the topic has entered the public debate.
It had appeared that any principal mod program was going to come over the dead bodies of the banks, who have been feigned compliance with various Federal programs but either dragged their feet and/or gamed the schemes. So it was surprising to read that the acting head of the FHAF, Edward DeMarco, is considering what amounts to a principal mod program implemented through bankruptcy courts.
As Shahien Nasiripour reports in the Financial Times:
The Federal Housing Finance Agency is “actively considering” a plan that would call for Fannie and Freddie to allow homeowners in Chapter 13 bankruptcy proceedings who owe more on their housing debt than their homes are worth to pay zero per cent interest for five years, subject to approval by bankruptcy judges, according to a letter to Congress dated Monday.
If you were to use a market rate mortgage starting today, five years of payments with 0% interest is roughly 17% of principal. The amortization with a regular payment schedule would be 3%, so you have a 14% difference. Now with typical loans seasoned a few years, the difference between the two amounts would be somewhat less. As reader MBS Guy wrote, “This won’t solve the problem in Nevada or Florida, but it isn’t a bad start if it can be accomplished without congressional (or Administration) approval.”
The FHFA is fixated on minimizing losses, so they have presumably taken the view that taking a modest loss is better than a foreclosure. These mods may not be deep enough to make as much a difference as one would hope. But it may also serve to reopen the debate on the cleanest way to cut the Gordian knot of badly designed securitization contracts and disempowered investors: that of bankruptcy cramdowns. If GSE borrowers can get mods in bankruptcy, why are other borrowers, who account for half the mortgages outstanding, left out?
And how will the private mortgage market ever come back if GSE mortgages offer this important protection to homeowners, and private label mortgages don’t?
The other interesting part of this proposal is that the FHFA wrote to Congress. This is the second end run of the Administration for being unduly friendly to banks that has come to light this week (the earlier one was the HUD inspector general ignoring the usual channel for prosecutions, the Department of Justice, and teaming up with New York attorney general Eric Schneiderman instead). One has to assume that DeMarco is lining up allies in Congress, since the Obama Administration is not backing the plan. Again from the FT:
But the White House said the initiative is not under consideration, angering members of Congress who have tried to get the Obama administration to devote more attention to the slumping property market.
It’s better late than never to see some regulators realize that business as usual on the mortgage front will result in only greater losses to homeowners, the economy, and ultimately, banks. Let’s hope DeMarco succeeds in moving his plan forward despite Team Obama. If nothing else, this idea demonstrates that more can be done than is being done.