Why Mortgage Modifications Have Failed

The current crisis in housing has become a laughable tragedy. Many weakly formed opinions, very little constructive thought and almost no offering of workable solutions.

We’ve tried the “let housing values fall’ plan, and as housing values fell…defaults, walk-a-ways, and foreclosures increased…consumer spending dried up…and unemployment jumped 100%. So that plan has failed.

I never quite understood the let housing values cash plan. Those proponents must somehow be outside of the general economy, because, all of the experts I have read suggested that “as housing goes, so goes the general economy.” Robert Shiller predicted the slide in consumption in his “Wealth Effect” study…and other studies have supported his general conclusions. Perhaps everyone should find the studies and read up.

The subject here, though, is modifications…which were supposed to abate the slide in housing and the economy. Everyone placed great hope on modifications and workouts, and they have proven to be less than successful. Why?

I actually got a chance to have a teleconference with the FDIC’s Chief Economist, Richard Brown, and his team last November. The subject was my modification proposal, “The Plan to Repair Housing”. I may have been the last outside interview prior the issuance of the FDIC’s own Mod-In-A-Box.

The FDIC plan, and subsequent efforts by other industry participants, failed for several reasons, including: Failure to properly estimate the size of the problem; Failure to simplify the solution; and Failure to manage the REO disposition. It’s tough to add FAILURE + FAILURE + FAILURE = and not get FAILURE.

Below is a simple comparison table illustrating several key differences between the FDIC/Industry modification plans, and my “Plan to Repair Housing.” The purpose of this is to lay a foundation for the where efforts will need to be focused if we are to stabilize the economy.

FDIC/Others	Item	Plan to Repair Housing
300 to 600 Billion	Estimated Size of the Problem	3 to 4 Trillion
31%	Target Ratios	27%
Yes	Means Test	No
Complex, Custom, Numerous	Modification Pmt Options	1 Payment Plan choice
Complex, Custom, Numerous	Interest Rate	1 Interest Rate Plan choice
Complex, Custom, Numerous	Interest rate Discounts	Limited, possible rate increases
Practically a requirement	Moral Hazard	Minimal
Yes	Net Present Value test	No
None	REO Disposition Control	Required
Somewhat tentative	Foreclosure Abatement	Required

Further examination and amplification of the key reasons for failure.

FAILURE TO PROPERLY ESTIMATE THE SIZE OF THE PROBLEM: The government has a history of rounding down on negative statistics. During the campaign last summer and fall, the numbers bantered about by the candidates, the agency heads, and the talking heads, was never sizeable enough to really make a difference. My number included mortgages actually in default, plus those who would become “worried” about their jobs, and payment capability. We’re well past the original estimates, and not yet to my estimates. My proposal allowed all homeowners the opportunity for a modification, in trouble or not.

FAILRUE TO SIMPLIFY THE SOLUTION: Here is gets messy. The FDIC plan, and subsequent industry efforts, was designed to formulate custom solutions to each homeowners situation. It has proved to be messy, and worse, because there is little consistency or predictability…and it has proven to be slow and bulky.

• Some homeowners getting 30 or 40 years of fixed rates/payments…
• Some getting 36 months of fixed payments, 10 years of interest only adjustable rates, then amortizing over the last 15 years….
• Some getting 5 years of fixed rates/payments….then the adjustable features begin again…
• Some homeowners get 2% rates…some get 4% rates…some get 5.75% rates

My plan had a single solution. A variation of the FHA 245 GPM….

• Every homeowner gets the same initial payment scenario
• Every homeowner gets the interest rate...today around 6%
• Every homeowner who needs added help gets the same balance forbearance scenario
• Every homeowner gets put into the same basket of loans….

When completed, if it is completed at all, the FDIC program would result in a significant number of really hybrid loan types….and could become a real mess.

When completed, my program would have lumped all of the bad loans, and worried loans, into a single program, which would make identifying these borrowers easy, and management of the servicing far simpler.

Lastly, for most of the loans, there were be no interest rate discount…which limits or minimizes one of the moral hazard issues. Also, by limiting the discounting of interest rates, the long term value of the mortgages is increased for the mortgage holders.

FAILURE TO MANAGE THE REO DISPOSITION: To be fair, I did not discuss this with the FDIC team at my first or second meeting. I held it back, feeling that too much information at one time would be debilitating. That may have been a mistake.

Particularly now that we live in the land of TARP…and financial institutions have been granted a large lifeline, we need to be sure that all of the participants… lending institutions and homeowners, behave fairly and prudently and we must minimize moral hazard on the part of all parties.

It was my feeling then, and it is today, that foreclosures need to be abated during this process. Along with this, we need to also abate the short sale process. We needed to remove pricing power from distressed homeowners, and from foreclosing lenders.

From various studies I have reviewed on this subject, foreclosures impact on neighborhood values is estimated to be in a range of 25-45%. To me, that is too much power and influence to give to either of these parties.

My proposal on this matter is that lender REO sales, or lender managed/participated sales (short sales) need to be priced within the middle of the range of the subject neighborhood. In other words, Main Street gets to set housing prices…not the institutions.

There would be several interesting results from such an implementation.

• First, lenders would be, for now, in the current market, eager to perform a workout with a homeowner. Fast.
• Second, lenders would be, in the future, more prudent in their lending decisions, having lost the ability to undercut the market to clear bad loans from its books.
• Third, the shadow buyers would have to quickly enter the market, now that the free fall in prices has stopped, and, with non-stressed sellers more in control of pricing…it would actually restore the real negotiated market.
• Fourth, it would stop balance sheet hemorrhaging for both homeowners on Main Street, and for financial institutions.

I have always felt that no modification plan, even my proposal, would be enough to turn the tide in housing, and lead to stabilization in the broader economy, unless supported by a more managed REO disposition program.

Comments

[I need more...:]

Here's an easier plan. Let home values fall to levels dictated by market realities, and keep the @#$% government out of it, utterly and completely.

Jul 10 09:21 AM

[Mark from R...:]

Would like to hear more about your conversations with the banking regulators. Like why didn't they see the problems with the pay option ARMs mortgages out of BankUnited, Downey, WaMu, IndyMac and Golden West (Wachovia) until all of these institutions failed. When all of these institutions' originations were almost 100% pay option ARMs as early as 2005 and 2006, didn't the regulators think that there could be a problem down the road or at least see what this type of mortgage was doing to home and condo prices in California, Las Vegas and Miami? How crazy was it to let someone finance 125% of the purchase price of a house and then not expect all these mortgages to blow up and take the banks and the housing market with them.

Jul 10 10:20 AM

[MattZN:]

Meh. The author seems to believe that there is actually something the government can do to 'fix' the mess, when there wasn't. There is no way to fix the mess other then to let it run its course. The time to fix the mess was 5 years ago. All the government can do now is try to mitigate it a bit for the people on the edges (which is what Obama is doing), and try to avoid a confluence of macro events (which is what Bernanke has been focused on) and that is pretty much what they have done.

Bernanke actually managed to pull off holding off inflation long enough for the home prices to bottom. If you think we're in a mess now just consider what would have happened if inflation had shot through the roof while home prices were still falling!

There's nothing Obama can do for people who have lost all their income. Those people are not going to be able to pay their mortgages, ever. There is something he can do for people who still have income sources but are right on the edge of disaster due to poorly chosen mortgages, and he's been doing it. It might not be a solution to the problem for the masses, but it's important edge case to try to keep the middle class of America intact because those are the only people capable of driving a recovery.

-Matt

Jul 10 12:36 PM

[Realista:]

If BANKS do not Foreclose .. and delay taking Title ..

1. to Avoid Property Taxes and/or Condo Maintenance fee,

2. to Avoid Writing Down mortgage loan to current value

3. to Hold REO off market until prices rise..

The Unrealistic High Price versus Current Market Value...
only FURTHER PROLONGS HOUSING DECLINE !

They Will Pay For Fraudalent ARM Liar Loans !

Jul 10 05:31 PM

[Mabeldenton:]

I own a condo and have an outstanding balance of $140k, consisting of $104k primary and $36k secondary. I took the home equity to consolidate debts. At the time the property was valued at $163k but now it is valued at $134k. I'm looking to sell because i am engaged and will be moving into my fiancee's home. Check obamamortgage2009.blog... If I have a buyer who offers me within say $5-7k of the outstanding, can i agree to assume a loan on the residual and pay the bank the difference over time with interest? The same bank holds both mortgages.

Jul 11 12:21 AM

[Loan Survivor:]

The world's biggest Ponzi scheme EVER is what Wall Street did to homeowners. They gave them crazy mortgage products that artificially drove up housing values while the government was bribed to look the other way.

When the housing bubble popped, these people got to keep all their bonuses and walk-away from their failing institutions.

Of course, the government then stepped in to prop up most of these institutions.

Now, the taxpayers will be stuck with the bill. If you're a taxpayer that also owns a home - tough luck. No one really wants to help you. You get the bill for the bailout and on top of that, you're also stuck with an upside down home.

There are two classes of people in this country - the rich & their government pawns, and everyone else.

We've gone from the Dark Ages where the average person was a serf tied to a noble's land, to the Finance Ages where the average person is a serf tied to the debt they've been hoodwinked ito by the "nobles" on Wall Street.

Jul 11 09:11 AM

[Rico44:]

MattZN; You really didn't just say "Bernanke actually managed to pull off holding off inflation long enough for the home prices to bottom.", did you? Bottom? When? Now? Somehow, I think that is more than just a little overly-optimistic! Check back mid-2010 and see where your average home prices are at that point....

Jul 11 11:00 AM

[rm:]

[We’ve tried the “let housing values fall’ plan, ]

Have we? When? Every federal initiative has been presented as a means to "backstop" housing prices.

[“as housing goes, so goes the general economy.” ]

So you advocate propagating the fake, bubble economy at whatever costs?

[The FDIC plan, and subsequent industry efforts, was designed to formulate custom solutions to each homeowners situation.]

Again, wrong. The FDIC plan was designed to STREAMLINE the process. As was the latest "Obama plan." The best way to handle these files- if you're looking for sustainability- is to do so on a case-by-case basis. Nearly every action taken to address this situation, by both the servicers and the feds, has been to figure out a way to handle the onslaught without having to provide adequate capacity increases.

A "one size fits none" approach, whether your proposed flavor or someone else's, will not make things better.

You're proposing a 6% rate with no NPV analysis. So if we can't get a win/win, you've now filled a niche: the lose/lose solution to the housing crisis.

[My proposal on this matter is that lender REO sales, or lender managed/participated sales (short sales) need to be priced within the middle of the range of the subject neighborhood. ]

Are you saying that they're "giving these homes away" by offering them at prices below their market value? Are you kidding me?

Your basic premise seems to be that if we can support housing prices, that the economy will be fixed. You're wrong. Housing prices were pushed far too high due to a number of artificial influences.

I, for one, have had enough of the "If we manipulate the numbers enough, we can pretend that everything's peachy" approach.

Let's not pretend. Let's just face the fact that homes are no longer worth their 2004 prices and get on with a REAL recovery, as opposed to a fake, engineered one.

Jul 11 11:46 AM

[bigmoney:]

some folks are worried about hyper inflation. With housing, we already had that, so to speak, at least relative to cash. Letting the debt bubble implode, housing will revert to the mean, and the recent inflation + tommorows deflation, it will all be a wash. If a bubble is blown, and government props up the bubble, then inflation isn't coming, its long since arrived.

Jul 11 12:30 PM

[HerrHansa:]

The only reason the banks like any of these plans are that they can find a way to not devalue nor default the RMBS. The banks next option is creating new RMBS from new loans selling foreclosed properties. It is about keeping the cash flow going on MBS while avoiding excessive write-downs. The banks have no incentive to lose money.

Jul 12 04:56 PM

[Mr. Ed, Jr.:]

The author believes that it is somehow the role of government to prop up home prices. With tax dollars, of course.

What is missing is the understanding that the housing market wasn't stable, then suddenly and inexplicably crashed -- it crashed because it was driven into the stratosphere in a national frenzy of foolishness.

Where was the government (and the author) when the housing market was rocketing higher ? Should price restraints have been put in place ? Or is it only the role of government to prop up markets after they have peaked ?

What our government is doing now is not about "good governance"-- it is about politicians scrambling to save their cushy jobs. They know that there are enough voters who will, indeed, vote them out of office in favor of someone who comes along and says he will enact laws to save them, the rest of us be damned. So it becomes a contest of foolish, idiotic, and absolutely useless ideas-- all funded by the taxpayers.

It is not a surprise that plans to "save" housing prices are not working. Houses were driven up to unrealistic prices, affordable by few of the people who bought them.

It may be very painful for a time, as prices come back to a realistic ratio to incomes, but those prices are coming back down no matter what silly program politicians devise with our tax dollars.

Only then we will have a truly healthy housing market.

Jul 12 09:55 PM

[Radardoc:]

"I never quite understood the let housing values cash plan. Those proponents must somehow be outside of the general economy, because, all of the experts I have read suggested that “as housing goes, so goes the general economy.” "

The problem is that during the bubble, the economy was flying high as a kite. Unfortunately, the flight was based on fantasy. We were borrowing from our future to finance our cars, vacations, and granite countertops. The bill is now due with interest.

I agree with the premise “as housing goes, so goes the general economy." Housing is in the toilet and going deeper. Where does that leave the general economy? Not a pretty picture I'm afraid...

Jul 13 11:58 AM