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Here, in a nutshell, is the trouble with loan modifications.

Mortgage lenders don’t try to rework most home loans held by borrowers facing foreclosure because it would probably mean losing money, a study released yesterday by the Federal Reserve Bank of Boston concludes. . . .

One of the study’s coauthors, Boston Fed senior economist Paul S. Willen, said the government would be better off giving the money directly to struggling borrowers to help them with their payments, rather than to lenders that are averse to working out the troubled loans.

Well, yes, loan mods would result in losses for banks, wouldn’t they? So do foreclosures. The question ought to be which results in lower losses. Am not sure why the Fed’s conclusion is such a revelation. . . .

In any event, according to the study, just 3% of delinquent loans studied were modified on terms that resulted in a lower monthly payment for the borrower. Another 5.5% were modified, but without lowering monthly payments.

And, as other studies have shown, the benefits of modification to either borrower or lender are not entirely clear: 45% of modified loans subsequently went delinquent again, even as 30% of un-modified loans later cured. Notably, securitized loans were just as likely to be modified as loans held on lenders’ balance sheets, so you can’t blame lack of mod activity on the servicers.

Meanwhile, economist Willen’s suggestion that government get around banks’ reluctance to modify loans, by giving money directly to delinquent borrowers, is—oh, what’s the word?—insane. I can’t imagine a better way to induce current borrowers to default en masse to qualify for the next round of direct government handouts.

Plus, the political backlash would figure to be long and loud. The guy needs to get out more. . . .

Source: Boston Fed Concludes That Loan Mods Result in Losses: Duh!