Foreclosures: The Problem That Won't Go Away

By James Kwak

With everyone hoping for positive GDP growth in Q3 and Goldman Sachs analyst Jan Hatzius now predicting growth at an annual rate of three percent in the second half of the year, the banks, investors, and politicians are all hoping that that nasty problem of foreclosures would just go away already. Unfortunately for everyone – especially the people losing their houses – there’s no reason for it to go away.

Unemployment is always a lagging indicator, and given the record low number of average hours worked, it will turn around especially slowly this time. Until then, people will continue to lose their jobs and wages will remain flat, and any small rebound in housing prices is unlikely to help more than a few people refinance their way out of unaffordable mortgages. So unless the other part of the equation – monthly payments – changes, the number of foreclosures should just continue to rise.

Calculated Risk provides this great chart from Matt Padilla (see the CR post for definitions of the categories):

The foreclosure problem has gotten a little more press recently as the Treasury Department attempts to follow through on its “name and shame” campaign to pressure mortgage servicers to modify more loans.

There seem to be two main explanations for why more loans are not being modified. The New York Times recently reported that for the servicers at the center of the process, it is simply more profitable to make fees off of delinquent loans than to foreclose on them and give up that stream of fees. On this theory, the cash incentives being provided by the government are simply not big enough to change their financial incentives.

The servicers prefer to argue that their hands are tied by the investors who own the mortgage-backed securities that have swallowed up the mortgages. On this theory, the Pooling and Servicing Agreements that govern these securitization trusts restrict the ability of servicers to modify mortgages. However, an article by Karen Weise in ProPublica yesterday casts serious doubt on this claim. Weise follows a household that is trying to get a modification of their mortgage, serviced by Wells Fargo (WFC), under the Making Home Affordable plan. Wells Fargo claims that it cannot modify the mortgage under those terms because “the investors need their money,” and instead proposed a different modification, which would increase the loan principal by $80,000. However:

researchers at UC Berkeley’s law school looked at the contracts covering three-quarters of the subprime loans that were securitized in 2006. The researchers found that only 8 percent prohibited modifications outright. About a third of the loans were in contracts that said nothing about modification, and the rest set some limits but generally gave the servicers a lot to leeway to modify, particularly for homeowners that had defaulted or would likely default soon.

And that is the case with the loan in question, for which the servicer need only make a “reasonable and prudent determination” that the modification is in the investors’ interests. What’s more, in this case, “Deutsche Bank [trustee for the securitization trust] spokesman John Gallagher said servicers are ’solely responsible’ for deciding all modifications.”

According to Weise’s article, the administration anticipated servicers’ fear of being sued by investors, but a key phrase in the proposed legislation was removed by Congress as a result of lobbying efforts. Servicers would probably have preferred the phrase be left in, but the end result is it gives them a convenient excuse for failing to modify mortgages – which, as the Times pointed out, is often in their own financial interests.

It will be interesting to see if the administration chooses to take serious action to reduce foreclosures, or whether it sticks to a “name and shame” strategy that is likely to be ineffective.

Comments

[Mad Hedge F...:]

More to come. Deutsche Bank has put out a report on residential real estate that will raise the hair on the back of your neck if you still own your own home. Prices have not hit bottom and have another 14% to fall by 2011, putting in a 42% fall from top to bottom. By then, almost half of all mortgage holders in the US will be underwater. The top underwater cities in the US is not good news for the Land of Fruits and Nuts, where lending was the most aggressive and imaginative:

Merced, CA 85%
El Centro, CA 85%
Modesto, CA 84%
Las Vegas, CA 81%
Stockton, CA 81%

The murder weapons in these nearly home equity free cities break out as the following:

Option ARMS 89%
Subprime 69%
Alt-A 66%
Jumbo 46%
Conforming 41%

These forecasts tell us that a second stimulus package is a sure thing, that unemployment will soar over 10%, and that a “W” shaped recession is a lock. Gee, do you thing the stock market might go down on this?

Aug 07 02:51 PM

[Xela99:]

The pandemic of foreclosures is now on the back burner of the american mind, with health reform and other topics of interest flooding the media.

The Gov needs to extend its 10% or up to 8,000 USD rebate to more than just first time buyers,that would allow more people to jump into the market and get investment properties,i am not encouraging someone to spread themselves to thin and take on the daunting task of renting and supporting another mortgage but this could create more opportunities for middle class people to speculate on urbanization and commercialization of property.

Aug 07 04:10 PM

[Fighting Yoda:]

Peter Schiff for Senate:
www.schiffforsenate.co...

Aug 07 07:14 PM

[Kacey:]

Good read. I was just thinking about the administration's dilemma. It is really a tough one when you think of all our challenges.

Aug 08 09:02 AM

[Hexan:]

It's also a relevant fact that many mortgages are not serviced by the investment trust that owns the servicing. The large investors use contract sub-servicing, like Dovenmuehle.

Sub-servicing firms are chosen by the investor and have a disincentive to please the borrower. They work for and at the will of the trust. If they hurt the investment (e.g. the mbs), they will lose the client's business.

The governments shame report may have the unintended consequence of driving sub-servicing work to the firms least effective at modifications.

This, of course, does not apply to banks like Citi and Wells, which service their own loans.

Aug 08 10:16 AM

[Dave136:]

LOL! "“name and shame"...wow! Now THERE'S a program with real BITE to it.....NOT!!

Lenders simply have NO INCENTIVE to modify a mortgage. Sure, some lenders are hampered by the investor involved, but it's a minority to be sure. The main reason is, lenders would rather see their books "cleaned" of these "BAD" borrowers, bite the small (relatively) foreclosure costs...and move on.

And the government is there to help them out wioth TARP funds to make it easy to do just that...

Only, in the long run, they will only hurt themselves as property values are destroyed and more borrowers are fed into the foreclosure furnace...

Aug 08 06:37 PM

[Allan Frain:]

...and on the backs of said underwater home owners rest shopping mall revenues and consequently the CRE market.

Aug 09 01:30 AM

[a. palmer jr.:]

It seems that the way we solve problems here in America is just to focus on a new one. Health care is front and center now...that takes care of foreclosures,cash for clunkers, crooked investment people, the deficit, housing crisis, Obama's citizenship, illegal immigration, the wars, etc. When we get tired of talking about healthcare we'll go on to something new. I wonder what the next problem is that we won't solve.

Aug 09 11:24 PM