Ten Reasons to Hate Mortgage Modifications

I’ve been noodling this post for a week and finally decided to buckle down and write it. Not because modifications and foreclosure moratoriums have become politically correct, but simply because there aren’t any compelling reasons that I’ve seen advanced so far that convince me that it will do anything substantive to change the current economic environment.

Let me say up front that if the owner of a mortgage decides it in their best interest to modify a loan, then more power to them. My objection runs to efforts by the government to coerce modifications from the private sector or to use public funds to induce private holders of mortgage securities to modify when foreclosure might be the more rational business decision.

So here, in no particular order, are ten reasons why I hate the mortgage modification concept.

1. It Won’t Work: The loan modification process has rarely been successful on any sort of scale. Life changing events (illness, divorce, death of a breadwinner, etc.) from which one can recover are usually the circumstances that allow for a successful modification. The expectation that mass modifications of mortgages for those who never had a chance of properly servicing their debt in the first place is a pipe dream.
2. The Next Generation of Homebuyers Gets Disenfranchised: A decline in the price of housing is viewed as something akin to the plague while declines in other goods, say crude oil or its derivative, gasoline, is applauded. In fact, the decline in the price of housing is opening up opportunities for the next generation of buyers. Arresting the decline punishes them unjustly.
3. No Price Discovery: Price discovery will occur no matter how long it may be deferred. Modifications on a mass scale will inevitably experience a high degree of failure, prolonging the search for a bottom.
4. Mortgage Rates Soar: Abrogating contracts either through the use of the bankruptcy courts to cram down principle or jawboning servicers will destroy investor confidence in mortgages as an investment vehicle. The attendant risk premium that will be attached to home loans will drive interest rates to credit card levels.
5. Valuation Becomes a Guessing Game: Principal write-downs will inevitably become a matter of privacy and the market will have no mechanism to establish the relative worth of similar properties. Absent good public information, the ability to determine value will become impossible. Buyers are likely to be highly reticent to buy in such a market.
6. Distortion of Market Relationships: If home prices are artificially supported via modifications the relationship among different levels of housing is going to be distorted. There is a natural economic relationship that is market driven. Alter the relationship artificially and the move-up market evaporates.
7. Picking Winners and Losers: Government decides who wins and losers in this one. Don’t expect the rules to be written objectively.
8. Where’s the Fairness?: How do you explain to the homeowner who didn’t lie about his income, who has been making his payment despite being under water and who hasn’t engaged in serial refinancing that his tax dollars are going to be used to bail out the miscreant who did one or all of the above?
9. Moral Hazard: Maybe we should just retire this phrase. But if we do intend to maintain a market economy then the sense of personal responsibility and consequences for foolish actions has to be left intact.
10. Gaming the System: The American people have become quite adept at gaming the system. If indeed mass modifications are to be the rule then count on them to do the math and figure out if quitting a job or missing a few payments might make good economic sense. This is a nation that figured out” liar loans” pretty quickly. Don’t bet against them to get the best of the government.

Feel free to add your own ideas to this list.

Comments

[Jon Smirl:]

Nothing down == renter. If payments aren't being made then a quick foreclosure is no different than an eviction and eviction happens all of the time. Negotiate with the bank to not destroy your credit.

If you can't make your payments then you bought more house than you could afford. Temporary assistance is not going to make the problem go away. Quick foreclosure will.

2008 Nov 25 08:47 AM

[Smalltownba...:]

I think you covered the bases very well. I agree with every word you have written and have been making most of these arguments to anyone who will listen for the last several months.

According to servicers 25% of modified loans are going delinquent after 1 payment meaning the process is a complete and utter failure. After multiple payments the delinquency rate exceeds 50% according to LPS who has been heavily involved in the servicing of modified loans.

We need the government to get out of the way and let homes find their current real value in the market place. Every action that is taken to manipulate loan performance and uphold value is prolonging the pain indefinitely and potentially deepening this crisis.

2008 Nov 25 09:34 AM

[D-D:]

Very good article, the only right thing to do is to let the housing market correct itself without any interference. Granted, this approach will be very very painful to the overall economy, but at least, it won't be be patch-work
DD
valuestockinvestors.bl...

2008 Nov 25 12:11 PM

[catbird:]

Okay...Now let's see the other side...How about doing a "Top Ten" David Letterman list "Why We Love Mortgage Modifications" ending with #1 "To Correct Predatory Loan Clauses".

2008 Nov 25 01:53 PM

[Ransome:]

It is unclear about the default rate being relevant. It is my understanding that many of the loan modifications were workarounds without changing terms. Clearly many of those late in the game were unwitting straw buyers used to produce loans for securitization. The loans were dishonest and the investors and processors should take a haircut. This is not capitalism at it's finest. From what I understand, only those that can support an honest loan will be given a second chance.

Speaking of second chances, how will the I-Banks repay all the hundreds of billions that the Sec. has invested on our behalf. The economy is tanking, so what low risk investments will generate billions of dollars in profit each year while the I-Banks de-leverage? Seems like a sub-prime loan and the FDIC backing of commercial paper makes the govt. the CDS of last resort. I am beginning to feel that dismemberment of the conglomerate banks and insurance companies is in the cards. Better to be spun off healthy and small and specialized with the potential for growth.

There is concern about the unfortunate spread of foreclosures into conforming fixed mortgages. As job losses increase, people need to move. Watching the housing values spiral down may represent a certain purity of the market forces but a large number, one third?, of recent buyers, regardless of mortgage status, are upside down. With little or no savings, if you need a job, you will walk. After all the work of modifying mortgages, people may still be forced to walk away. If you do nothing, it could get out of control. If you do modify a mortgage, there is a valid reason to modify the value of the loan to reflect present housing conditions. It happens all the time in business.

What about the sanctity of contracts? A smart investor or bank or fund will have CDS protection on a CDO tranche. With enough foreclosures, they get full value return. Why not root for foreclosures and resist loan modifications. Is this why AIG is leaking money? There are reasons other than being a purist for resisting loan modifications.

2008 Nov 25 02:29 PM

[Ronald Pires:]

Interesting. I was skeptical when I saw the title, but the list seems pretty fair.

Of course, a simlar list can easily be made for why they should be done, but I guess that's why "the powers" have not yet set a clear direction on this.

2008 Nov 25 04:23 PM

[SteelerMom:]

Well, the modification worked for me.


I was left with 2 kids and a mortgage payment when my husband left us. Which was fine until the rate adjusted. How would you feel with 2 kids, 1 income and a payment spiriling out of control? So a friend told me about LoanModAssistant.com/ which is a DIY website for loan modifications. My BOAmerica mortgage is now fixed at 5.9% for 30 years which I can easily handle. Better than the 12.5 it went up to. That was the best $199 that I have ever spent. And if the modification didnt work, I had a guarantee from them and get money back.

Sure they arent the cure for everyone, but for people like me, that's the difference between having to move your kids to low income rent, or staying put.


-Steeler mom

2008 Nov 25 06:24 PM

[25 year App...:]

excellent arguments

just a prolonging of the inevitable......

mortgage broker moral hazard is worsening every day.

2008 Nov 25 08:38 PM

[Tom Lindmark:]

Steeler Mom,

I am pleased that it worked for you. As I said in the post, those that do suffer life changing events are the most likely to be helped. You're a perfect example. Thanks for the comment. It reminds me that there are more people like you out there who will take care of their obligations than there are people who want to game the system.

2008 Nov 25 08:46 PM

[fixed incom...:]

Agree with the ten reasons. In case it wasn't emphasized enough, modifications and foreclosure delay through government pressure is simply screwing over the lender. If the lender decides to modify on their own, that is one thing. They will do so when they think it is in their best interest. Therefore any prompting by others is probably not in their best interest.

Foreclosure is the only real leverage a lender has at their disposal when borrowers stop paying. Even if I were a lender negotiating a modification, I would want to have the clock running out on the right of redemption to ensure that the borrower negotiated in good faith. Crap, they already have my money, what else do they deserve?

As noted above, there are cases where a mod might be in the best interest of both parties, ie someone who dutifully made payments, had some sort of financial disruption, but presents a credible plan for getting on track. Even then, the discretion should ultimately lie with the lender with regard to modification or delay of foreclosure.

2008 Nov 25 09:46 PM

[Kunst:]

You bought your house for $500K. Now it's worth 300K. Your payment was $2000 a month. Soon it will be $3000. Your income is $6000 a month.

Now, our government doubles the money supply. Your house is now worth $600K. Your payment goes up to $4000 but hits its cap there. Your income goes up to $10,000 a month (can't win them all).

Instead of -200K equity, you have +100K. Instead of your payment being 50% of your income, it's back to 33%.

This could never happen, right? Better to foreclose on all those dolts who fell into the trap and let those who didn't buy the houses at half price.

The numbers are meant to be illustrative, not exact. Don't snipe at them unless it makes a difference in the end result.

2008 Nov 25 11:46 PM

[James Burns...:]

While many may default there are some who do make it and there is not better alternative at the moment for either party...the bank or the borrower. If they can make a few it delays it being on the bank's balance sheet when properties are not moving at auctions because no one knows where the bottom is in many areas of the country where each month seems to sink lower and another major bailout of an institution or industry takes place.

2008 Nov 26 12:56 AM

[User 321861:]

Please stop judging people seeking mortgage help. They are hardworking individauls with an american dream just like yourself and the banks made it happen for their own selfish interests. It wasn't the consumer that introduced interest ony, 80/20, arms, etc. If they are loosing their homes, they are loosing all of their payments and invesments too not just shelter and dream. Majority of these individual's incomes have had a direct impact with the economy. They didn't make years of arm payments thinking they can't refinance because their house value has dropped more than 20%. They weren't thinking in their right "liar" mind to loose it all at the end and stain their improving credit with foreclosure. These are the people that were taken advantage off. Ask any salesperson, How are sales?

2008 Dec 18 01:32 AM