Some of the Mechanics of Mortgage Modification

Includes: C, FMCC, FNMA
by: Casey Mulligan

I have summarized reports by Treasury, FDIC, and the Congressional Oversight Panel in the table below. Pooling and service agreements do not permit term extensions beyond a few months, because each mortgage in the pool is supposed to mature at about the same time. Very little of the monthly payment is principal, so there is not much scope for reducing monthly payments by reducing principal. In practice, the principal balance is a actually bit higher after modification because arrearages are added to the previously scheduled principal.

Thus, modifications reduce interest in order to reduce monthly payments to 31% of AGI. As explained in my papers, this creates a marginal income tax rate in excess of 100%.

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Must mortgages be modified according to treasury or FDIC formulas?

Mortgages held by Freddie Mac (FRE) and Fannie Mae (FNM) must. So do mortgages held by banks taken over by the FDIC. It appears that Citi (NYSE:C) agreed to follow the FDIC guidelines with its mortgages as part of the terms of its November 2008 bailout.

For those that are left, participation is voluntary. But we cannot conclude that voluntary participation is equivalent to an endorsement of the FDIC guidelines, because servicers may follow those guidelines merely to partake in the significant Treasury subsidy that goes along with following those guidelines. Treasury has budgeted $75 billion for the HAMP program, which it expects to reach 3-4 million mortgages. That's more than $20,000 of subsidy per mortgage!

The table below summarizes reports by Treasury, FDIC, and the Congressional Oversight Panel as to the type and amount of various subsidies. This list is not exhaustive, but I think the largest part of the subsidy is that Treasury pays half of the amount of a borrower's mortgage payment that causes it to be 38% percent of that borrower's income rather than 31%. For example, if borrower annual income was $50K and unmodified annual housing payments were were $20K, the Treasury would in effect be paying $1,750 per year for five years toward the borrower's mortgage.

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