Banks Should Forget the Moral Hazard for Now

Wells Fargo (WFC) published “Wells Fargo, NACA Collaborate on Programs to Benefit At-Risk Mortgage Customers” on Friday. Wells cites the Neighborhood Assistance Corporation of America’s (NACA) ability to gain insight into their customers and create effective mortgage restructuring programs to avert foreclosures. Wells will also continue to work with HOPE NOW and other counseling services.

Counseling delinquent homeowners is like your spouse repeatedly telling you did something wrong that you already know is wrong and have already repeatedly acknowledged is wrong. But your spouse won’t stop reprimanding you. The Democrats keep trying to allocate more money for counseling in sympathy. The Republicans say homeowners must honor their mortgage contracts to the bitter end. Both are exerting punishment: the Democrats through unneeded embarrassment and the Republicans through continuous roadblocks to breaking crushing mortgages.

To quote Jim Cramer, “it doesn’t matter where a stock has been; it only matters where it’s going”. Likewise, it doesn’t matter what the mortgage contract says, it only matters how to make it current. FDIC Chairwoman Sheila Bair is restructuring most of IndyMac Federal Bank's problem mortgages to “achieve sustainable payments at a 38 percent DTI ratio of principal, interest, taxes and insurance.” And IndyMac even has an online portal called “Overcoming Payment Challenges” to start the process. In general I have not been happy with Bair’s preemptive strikes on Wachovia (WB) and Washington Mutual, but her direct, pragmatic approach to IndyMac’s mortgage problems is right on target. Forget the moral hazard, forget the embarrassment, and forget teaching homeowners a lesson.

From IndyMac’s website they appear to be fully open for business, and paying relatively high CD and savings rates. Bair seems to be maximizing the taxpayers' investment by creating a truly consumer friendly bank.

Every bank conference call I listen to emphasizes customer relationships and cross selling products. Each brags about their average number of products per customer. If customer relationships are so important then why are they sending their customers to outside counselors? Bank of America has been forced by the courts to directly modify many of Countrywide’s mortgages. Although they have not admitted it, this will be beneficial to them. Why not sell more products to a bad customer turned good?

It all comes down to simple math, not calculus nor advanced psychology. Is the present value of an affordable mortgage less than or greater than the present value of the net proceeds from foreclosure? If the present value of the modified mortgage is greater – just do it and leave the moralizing for later.

Disclosure: Author is long BAC, WB, and WFC.

Comments

[fatcat:]

More smoke and mirrors by the banks and Fed...these troubled loans are performing at 30% if you take out T&I....or less..Hard to run a profit on that.More writedowns or more taxpayer intervention...take your choice..

2008 Oct 20 04:47 AM

[Smalltownba...:]

I have no problem with a lien holder/lender/servicer agreeing to modify a mortgage and accept a lower yield from the mortgage. I do have a problem with the government coming in and determining who gets it and who does not. This is the turning into the sinlge biggest social entitlement program in this Nation's history and both parties are buying into it. If they are using tax documentation to determine eligibility for the write down in payment and principal they will be helping the very criminals who committed fraud by overstating their income in order to qualify for the "liar loans."

This is not a solution but it will certainly be the largest and fastest redistribution of wealth in the history of the new USSA. The Uneducated Socialist States of America. A high percentage of these borrowers will never make their payments regardless of how low you make the payments. You are removing the only club which ever forced them to pay anything and that is the threat of being dumped out on the street. Remove that threat and you are penalizing every honest hardworking citizen who pays their bills and rewarding the deadbeats of society in the worst move in history.

I am a Republican but I recognize that the blind eye to this approaching storm was turned by my own Party with complicity from the Democrats as well. When John McCain came out in the 2nd debate talking about buying up votes, I mean bad mortgages, then modifying them so the homeowners could afford them. I walked out my front door, pulled up my McCain sign and threw it in the trash can. I had just listened to a "Republican" candidate for President propose the largest welfare program in history. If you think $300 Billion would cover it John, you are dreaming.

We need to get the government out of the way and let these deadbeats lose their homes so we can reach the bottom and start over.

2008 Oct 20 09:21 AM

[abritc:]

Some 75% of the ARM-type mortgages used LIBOR as their base, adding a fixed premium to set the total interest rate. The concept was that the base rate would reflect inflation, protecting the lender against any increase in inflation, but simultaneously providing a small decrease in the overall rate for borrowers as the lender no longer had to factor future inflation into his consideration.

But today we find that the LIBOR is no longer a proxy for inflation; rather it is a proxy for fear -- fear that the principal itself is at risk. As a result there are millions of otherwise well-performing loans now put at risk as the underlying loan rate jumps some 3 percentage points above inflation, unfairly costing such borrowers additional hundreds to thousands of dollars per month.

With all the talk about the home prices in decline, and what to do for the relatively small number of borrowers who bought at a peak, we need to keep in mind the millions of additional homeowners who are seeing their loan payments skyrocket by being tied to a malperforming metric.

2008 Oct 20 10:09 AM

[Mr.:]

Unfortunately some banks are not participating, ie Deutsche which I only found out about TODAY even though I have been inconstant contact with IndyMac for the last 7 months! Its funny IndyMac says we do not qualify for a write down/ adjustment because we make to much. Even though they told us to stay in contact and they would be working with us. The house is down 200k in value, I just got forclosed on my other home becuase Citi would not take the 2nd position offer from Aurora on a short sale, I lost my business 8 months ago and I am going chapter 7. I was able to secure another job at much lower pay but could afford the lower payment if they used the 38% rule on a $700,000 note. This is stupid they want people to stay in their homes and we could but as of today its not likely.

2008 Oct 20 06:49 PM

[Tom Armistead:]

Good article. For a long time I felt that the best answer was to go through everything up and down the line and make all the liars responsible for what they did.

The truth is they were dealing with a situation where everybody believed there was 110 cents in the dollar, because houses kept going up, so people lied and nobody checked because it just didn't matter, the system could absorb any amount of abuse and keep functioning. Sometimes people are invited to tell lies, as was the case here, or people look to others to tell their lies for them...

Any system that remakes the deals on an economically feasible basis is going to be good for the economy and prevent a Depression. As the author says, the moralizing isn't going to be helpful.

But going forward the process should be carefully regulated to prevent abuse by all participants.

2008 Oct 26 08:25 PM