Boston Fed: We Don't Understand Foreclosures

Jul. 08, 2009 7:03 AM ET12 Comments
Tom Lindmark profile picture
Tom Lindmark

If you’ve read it once, you’ve read it a thousand times. It’s the meme that it’s in the best interest of banks to modify loans and reduce principal since they will lose as much or more through the foreclosure process. Well, some fellows from the Boston Fed decided to see if that was indeed true, and guess what, it’s not the way the real world works.

Their study covers a lot of loans (60% of the mortgages originated between 2005 and 2007) and presents some conclusions that are not going to make anyone feel very comfortable about the housing market. Here is a summary of their findings:

  1. Of the mortgages they reviewed only 3% had a modification that involved a principal reduction and only 8% received any sort of modification. That’s exceptionally low when you consider that half the loans they reviewed received foreclosure notices and 30% were actually foreclosed upon.
  2. This one flies in the face of another piece of conventional wisdom. There was no statistical difference in the rate of modification between loans held privately and loans that had been securitized. Let me repeat that, no difference. After all the wailing about securitization as the evil spawn that stands in the way of homeowners getting a modification, it turns out it makes no difference.
  3. Now here is what they found with regard to the foreclosure versus modify thesis. I am going to excerpt their findings rather than paraphrase:

Since we conclude that contract frictions in securitization trusts are not a significant problem, we attempt to reconcile the conventional wisdom held by market commentators, that modifications are a win-win proposition from the standpoint of both borrowers and lenders, with the extraordinarily low levels of renegotiation that we find in the data. We argue that the data are not inconsistent with a situation in which, on average, lenders expect to recover more from foreclosure than from a modified loan. At face value, this assertion may seem implausible, since there are many estimates that suggest the average loss given foreclosure is much greater than the loss in value of a modified loan.

However, we point out that renegotiation exposes lenders to two types of risks that are often overlooked by market observers and that can dramatically increase its cost. The first is “self-cure risk,” which refers to the situation in which a lender renegotiates with a delinquent borrower who does not need assistance. This group of borrowers is non-trivial according to our data, as we find that approximately 30 percent of seriously delinquent borrowers “cure” in our data without receiving a modification.

The second cost comes from borrowers who default again after receiving a loan modification. We refer to this group as “redefaulters,” and our results show that a large fraction (between 30 and 45 percent) of borrowers who receive modifications, end up back in serious delinquency within six months. For this group, the lender has simply postponed foreclosure, and, if the housing market continues to decline, the lender will recover even less in foreclosure in the future.

Before I add my two cents worth to this take a look at the implications that the Boston Fed group draws from their study:

We believe that our analysis has some important implications for policy. First, “safe harbor provisions,” which are designed to shelter servicers from investor lawsuits, are unlikely to have a material impact on the number of modifications and thus will not significantly decrease foreclosures. Second, and more generally, if the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily “preventable” foreclosures may be far smaller than many commentators believe.

There’s little point in belaboring the obvious point here. The administration’s plans for mortgage modifications would appear to be much less achievable than they have, at least, indicated they would be. To the extent success in preventing foreclosures is part of their recovery plan this study might indicate that piece is at least in peril, which would of course render the rest of the plan somewhat less effective. So far as the mortgage market goes, it’s fair to assume that it is in for perhaps even a rougher ride than even the most pessimistic might have projected.

From a different perspective, this is a reaffirmation of sorts to be careful about taking as gospel everything you read in either the MSM or the blogosphere. To all of us it’s a lesson we too often forget about assuming something to be true simply because it makes superficial sense. And to the administration and the bureaucrats who design these programs it should serve to caution them that what looks good in a D.C. committee meeting might not square with the real world.

This article was written by

Tom Lindmark profile picture
About a year ago, a company asked me to write a daily blog for them. I told them that I’d never read a blog and had absolutely no idea how to write one but sure, if you want to pay me for it, I’ll give it a shot. It was either my good or bad fortune to start at the beginning of the credit crisis. Good because there was a lot to write about, bad because they didn’t really want me to chronicle and opine on the disaster of the day. Guess who won that standoff. But I was hooked on blogging, so I started my own blog, called it But Then What and here we are. I’m not sure that credentials mean much when it comes to writing about things but people seem to want to see them, so briefly here are mine. I have an undergraduate degree in economics from an undistinguished Midwestern university and masters in international business from an equally undistinguished Southwestern University. I spent a number of years working for large banks lending to lots of different industries. For the past few years, I’ve been engaged in real estate finance – primarily for commercial projects. Like a lot of other finance guys, I’m looking for a job at this point in time. Given all of that, I suggest that you take what I write with the appropriate grain of salt. I try and figure out what’s behind the news but suspect that I’m often delusional. Nevertheless, I keep throwing things out there and occasionally it sticks. I do read the comments that readers leave and to the extent I can reply to them. I also reply to all emails so feel free to contact me if you want to discuss something at more length. Oh, I also have a very thick skin, so if you disagree feel free to say so. Enjoy what I write and let me know when I’m off base – I probably won’t agree with you but don’t be shy. Visit my blog or follow me on twitter at

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