Mortgage Modifications Don't Necessarily Offer Relief

As I've been saying since last summer you can't modify, legislate or rescue someone from a mortgage they can't afford. From the WSJ:

Many troubled homeowners are quickly falling behind again on their mortgage payments after their loan is modified, new data from the Office of the Comptroller of the Currency show.

The OCC data reflects actions taken by the 14 largest national banks and thrifts, which together represent 60% of the mortgage industry. Nearly 36% of borrowers were more than 30 days past due on the loan payment three months after their loan was modified and nearly 53% were more than 30 days late after six months, according to the OCC.

"The results, I confess, were somewhat surprising, and not in a good way," Comptroller of the Currency John C. Dugan said in a speech in Washington, D.C. on Monday. Mr. Dugan said it wasn't clear whether the low success rate reflected the fact that the modifications weren't reducing monthly loan payments enough to be truly affordable, whether the mortgages were so badly underwritten that they weren't affordable, even with lower payments, or if both factors were at work.

The high re-default rate raises questions about the effectiveness of current efforts to work with troubled borrowers and comes at a time when the federal government is facing increased pressure to do more to reduce foreclosures.

"Despite good-faith efforts by both the private and public sectors, the foreclosure rate remains too high, with adverse consequences for both those directly involved and for the broader economy," Federal Reserve Board Chairman Ben Bernanke said in a speech last week.

As I've been saying since last summer, you can't rescue/modify/legislate away the reality of people purchasing homes they can't afford; and the fact that people are actually surprised by this indicates how disconnected and clueless activists, politicians and policy makers are about the root cause of the problem. I.e. they're focused on trying to treat the symptom (foreclosures and loan defaults), as opposed to focusing on the root cause (people with mortgages they simply can't afford), because it's either unpopular to admit the latter or they simply don't truly understand the problem.

It would be interesting to see the more complete data set in order to determine the relationship between the kind of financial situation the homeowners were in (overspent, temporary financial difficulties, on the bubble with regards to affordability), the type of modification they received and the results in terms of propensity to go back into default. I suspect such an analysis would reveal that if you separate people who just have oppressive terms (or temporary financial difficulties) from those who simply overspent, you'd have a subset of homeowners that could actually benefit from loan modification.

On a go-forward basis, activists, banks and policy makers need to differentiate between those with temporary financial difficulties (and/or those on the bubble) who could afford their homes with a little bit of help, and those who simply bought more home than they can afford.

This really goes back to the point I made earlier about the need to make mathematical decisions (even if they're unpleasant) that address root causes, as opposed to only trying to treat unpleasant symptoms instead.

Finally as time goes on I suspect the rate of default for modified mortgages will continue to increase, as in the majority of cases all the bank has really done is delay the inevitable.

Sources:

The WSJ: "Modified Loans Do Little to Help Homeowners" -- Ruth Simon, December 8, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[Steve in TN:]

John Hussman has been writing about a solution to this problem. That is, make the terms more favorable, BUT the govt. should be given a portion of the principal of the house to be paid in full when the house is sold. This way they can stay in their house at a fair lower rate. Why can't the politicians understand that this is the only way a bailout will work? Why should these homeowners be rewarded for buying more house than they could afford?

2008 Dec 09 08:55 AM

[Stock Trade...:]

I think the default rates will continue to rise as well. As added pressure to this is the fact that the number of unemployed individuals is rising. The government can modify mortgages all they want, if someone loses their job and stays unemployed for any period of time, the chances of them defaulting on their mortgage rises drastically. The government has been spending time and money to try and prop up the housing market and look what has happened so far! Maybe its time to concentrate on employment which will serve to prop up housing in itself.

2008 Dec 09 08:59 AM

[Mozatta:]

If it looks like a duck and quacks like a duck..you know they saying.
The fact is, if someone is put into a mortgage they have no business being in, nothing will help them. There are a few honest and noble people out there, but the vast majority aren't. It's like allowing a repeated thief access to a small mom-and-pop shop instead of a large retailer. They are still going to steal, it doesn't matter the size of the store.

You have to let people fail. It's hard for us to admit failure and that we were wrong. We have a sense of entitlement and a sense of denial. As politicians and as humans. No one wants to admit they're wrong. Owning a home is a privledge and the benefit of hard work and responsible saving. We need to stop thinking of owning a home as a right and go back to the thought that one needs to earn that home. Get rid of affordable housing, get ride of the CRA. Let home prices go back to where they are suppose to be. Let people get foreclosed on. Let it happen now rather than delaying the inevitable. Once people realize that owning a home is a privledge, not a right..they will begin to realize a bit of responsibility.

2008 Dec 09 09:50 AM

[axelrod608:]

The "fix it" crowd ignores the fact that liar's loans were being made in large numbers well into 2007. The last of these will reset interest rates in 2012. Thus, foreclosures of homes will continue in large numbers into 2013. Policies that ignore facts and reality are destined to fail. The federales don't have enough money to "fix" this problem. Home prices will remain depressed until ALL the problem loans have been fixed. 2015 is my best guess.

2008 Dec 09 09:58 AM

[John Preston:]

Actually, Larry,

if the housing situation is abated properly,

consumer spending would, hopefully, rise,

which creates jobs, hopefully,

and as the hosuing goes up in value, home-buyers in waiting will begin to engage, hopefully...

and then builders will begin to build,..hopefully..

The economy needs hope to function...its not all math

2008 Dec 09 10:10 AM

[ArnoldCountry:]

Sadly, loan modifications that solve the problem are a myth. As you point out, modifcations that do not make the loan more affordable will fail, regardless of the underlying reason why the loan is unaffordable in the first place. Compounding the problem is the back room aspect in that the pooling and servicing agreements do not allow for substantial modifications anyway. Anything of any substance would require the servicer to purchase the loan at full principal value which they cant and wont do if they did it. The underlying securities for the loan require any changes to the pooling and servicing agreement to have a majority voite of all of hte owners of the securities, which wont happen either. Loan modifications beyond something quite simple is an absolute myth and has misled homeowners, whether they could afford the loan or not, that there is all this help out there for them, when there is not.

2008 Dec 10 10:33 AM

[kebu77:]

Arnold Country, you are correct.

Servicers make more money on dragging things out and going to foreclosure that they do on loan mods. Their "prosperity" business model doesn't contemplate default rates that do real harm to investers. Their call center fire-walls block meaningful discussions with loss-mitigation staff, etc.

I was 3 payments late on my 7%ARM (sched. to reset in a yr. at 10%), due to a local housing depression that almost destroyed my business, when my uncle proposed a loan mod to the servicer - -

- - With his 805 FICO, he would co-sign
- - Change to fixed 15-yr 6.5% to accelerate principal reduction
- - Principal bal. lowered to 87% of current bal.
- - $10,000 cash bal.-reduction payment to deal with cash-flow issues and fact that the proposed lowered principal bal. was still $10k under water

In my ignorance at the time, I didn't realize how inflexible the servicer's arrangement with the investors apparently was. We offered to replace a subprime mtge with a prime one in a market where house prices were dropping $10,000 a month, a deal clearly in the interest of the investors.

14 mos. after refusing our offer (w/o even a counter), they now have accepted a deed-in-lieu w/ full debt forgiveness, and investors will lose multiples of the discount we were proposing, well over $100k after selling expenses.

A servicer-lender system that worked in prosperous times has failed. The structural barriers to meeting the common interests of borrowers and lenders/investors will require legislation, including allowing bankruptcy judges to modify loans on principal residences, as a counter-weight to the barriers.

2008 Dec 11 02:02 PM

[LateDave:]

Sorry to be coming to this so long after the fact; I suspect I am writing this for myself alone.

The last two comments are valid and important.

The underlying concept behind all of these bundles is so fundamentally defective that there is no way to correct the situation except to take each of the bundles, disassemble it, individually screw each investor for the full amount of each investment, and then process each of the loans in the bundle by transforming it into a viable instrument: determine a realistic value for the house it represents and establish a fixed-rate mortgage for that amount.

Since both the face values and the interest rates are defective in substantially all of these mortgages, the original lenders and the subsequent bundle buyers must take a bath for the inflated numbers. Finally, the original sellers--builders, real estate agents, previous owners, developers, speculators--must give back enough of their inflated profits to flatten the market at the level at which it belongs.

This is a gigantic task. To do otherwise puts the U.S. in the position of either Japan during its decade-long real estate deflation or of Russia during the mad Ponzi cycle that followed the "death" of the USSR. We may be able to avoid both of these if we show unlikely wisdom.

This does not address medical insurance, systemic manufacturing employment contraction, foreign wars, or petroleum futures speculation, all of which contribute to the overarching air of crisis and must be resolved to return America to a '50's air of prosperity.

2008 Dec 15 11:26 AM