FHFA, the bizarre federal agency running our nationalized mortgage funders Fannie and Freddie, announced a proposal last week that would surcharge mortgages in five states – New York, New Jersey, Florida, Illinois and Connecticut, with a 30 basis point (0.3%) fee. The ostensible reason? It claims Fannie and Freddie lose money in those states due to long foreclosure delays. New York and Connecticut, not coincidentally, have two of the most successful foreclosure mediation programs going.
FHFA’s move is clearly political, and a product of its foreclose-above-all ideology. FHFA makes two incorrect assumptions – that foreclosure delays are caused by state laws, and that foreclosure delays in the current environment increase Fannie and Freddie losses.
First, the causes of foreclosure timelines in various states are complex, and often the result of mortgage servicer failures, not legal system failures. Some have suggested that the delays in Florida are a simple consequence of the fact that servicers don't want to dump more unsold foreclosure properties on the market, so they are holding off on pushing cases through the pipeline. Why current borrowers should pay for these problems is not clear.
Second, the effects of foreclosure delays on losses are not obvious. Certainly, foreclosure delays will increase losses on a home if it is eventually sold at a foreclosure sale. However, most loans in foreclosure do not result in a foreclosure sale. Loans that end up with almost any other outcome will usually result in lower losses to the investor. For example, a short sale at today’s market value will normally produce a smaller loss than a foreclosure sale. Likewise, a payment plan or modification, if it makes any sense, will produce a smaller loss. That’s why these alternatives are called loss mitigation. If a foreclosure delay results in loss mitigation, then by definition, losses are reduced, not increased.
For FHFA to credibly determine that total losses on delinquent loans are higher in some states than others, it needs to compare not only the losses on foreclosure sales, but also the loss reduction from foreclosure alternatives. For example, a dataset I have examined for non-GSE loans shows that 22% of delinquent New York loans were modified, compared to 12% in speedy foreclosure state Arizona. In the land of unreality where FHFA dwells, all homeowners with plausible alternatives to foreclosure are identified and given loss mitigation alternatives. In the real world, homeowners and their advocates are painfully aware that without measures to delay foreclosures, mutually beneficial workouts don’t happen, and wasteful foreclosure sales go forward.