Banks in Denial

By Alan White

At a Congressional hearing yesterday the major banks that now control most of the mortgage servicing in the U.S. made it clear that they are very unlikely to write down the mortgage balances of homeowners facing foreclosure. Chairman Barney Frank responded by saying that if the Hope for Homeowners program, taking effect October 1, does not elicit voluntary write-downs by mortgage servicers, Congress will take stronger measures to make it happen. I presented some of my research showing that fewer than 2% of mortgage modifications in the past twelve months have reduced principal balances.

Congress enacted the Hope for Homeowners program in July. It offers homeowners facing foreclosure and owing more on a mortgage than their home is worth the chance to get a new, lower FHA mortgage. The plan depends, among other things, on the willingness of mortgage servicers, acting for investors, to accept less than full payment on existing mortgages. This voluntary write-down (to 90% of the current market value) assumes that servicers will act rationally, given that foreclosed houses are now selling at losses of 40% or more. One should be careful, however, about assuming rationality.

FDIC Chair Sheila Bair began the proceedings with her usual steely but soft-spoken presentation, and described how IndyMac, now under FDIC conservatorship, is aggressively seeking out mortgage borrowers and offering them interest rate and payment reductions to prevent foreclosures. IndyMac is achieving an average payment reduction of $400 monthly and bringing borrowers’ debt ratio down to 38%, and is proactively identifying candidates for the new FHA refinance program. The FDIC could use IndyMac to set a new paradigm for mortgage modifications for the rest of the industry to follow.

FHA commissioner Brian Montgomery assured the Committee that FHA will be ready to roll out the new “H for H” mortgages on October 1, and aims to sign up 450,000 homeowners eventually.

The following panel, representing Wells Fargo, JPMorgan Chase, BankofAmerica (jokingly described by Chairman Frank as the only BankinAmerica) and Citi, assured the committee of their good intentions. When pressed, however, by freshman Congresswoman Jackie Speier (D CA), the bankers admitted that they preferred not to write down mortgage balances. Adjust the interest rate, yes, postpone principal payments until later, sure, but take 10% off the loan balance, rather than foreclose at a 40% loss? This was described as the least-preferred option, and none were willing to answer what percentage of their loan mods involved any principal write-down.

The problem with the banks’ exclusive focus on achieving affordable monthly payments is that a homeowner with even a really really low rate (4%, for example) but whose $300,000 mortgage sits on a house worth $200,000 is in an untenable situation. If the homeowner needs to move, refinance, or has a temporary income loss, she has few if any options. While we hear much about the moral hazard of giving homeowners a break on their balances, the homeowner whose balance is NOT written down faces a huge moral hazard – the incentive to walk away.

The banks, however, are clinging to the idea that Mr. and Ms. Homeowner will carry on trying to pay their $300,000 mortgage until the market value of the house comes back from $200,000 to $300,000, hopefully in a year or two. The problem with this is that it may be ten years or more before we see values returning the levels of a year ago.

On a more macro level, American homeowners simply cannot sustain the current $10+ trillion in mortgage debt. There are only two ways to bring mortgage debt back into line with incomes: (1) foreclose all the $300,000 mortgages on $200,000 houses, let the houses sit in inventory and dump them on the market for $150,000, effectively replacing the old mortgage with the new buyer’s lower mortgage amount, or (2) adjust the balance of the current homeowner. The industry is now using option (1) to deleverage the American homeowner, evicting millions of Americans and devastating neighborhoods and entire cities in the process.

Comments

[Doug Jones]

Loan modifications, even with pricipal balance reductions, are almost ALWAYS the least cost
workout option for the investor as compared to short sale or foreclosure.

The point is that the loss has ALREADY occured... it just hasn't been realized in an accounting
sense. Congress should act to allow the servicers to quickly make decisions that are in the
best interest of the investor, including loan modifications with principal balance reductions
where that maximizes the Net Present Value as compared to the other options.

If we don't have widespread loan modifications quickly, then we will soon be in a self-feeding
negative sprial in home values because new bank REO will exceed total sales. That will happen
in California starting in OCTOBER (next month).

Loan modifications not only minimize the cost to the investor, but they keep the home off the
market and out of that inventory overhang that is driving home values relentlessly lower.

Also, they are a market solution... they don't cost the taxpayers a dime.

DOUG JONES
Santa Ana, CA

[Tux the Penguin]

I think you are far to willing to overlook the huge moral hazard that writing down the mortgages would make (not to mention the tax effects of being released from that liability...).

But aside from that horrible problem, I don't think the write-downs should be so easy. I list of conditions that should be attached.

1. You must qualify for the new mortgage based on your income, 25% rule and all that "traditional" mortgage logic.

2. The mortgage should reset. You now have a new 30-year mortgage. IE, you have no equity until that first payment clears.

3. The bank should be allowed to put a lien of some kind on the house to collect any sales price in excess of $200,000, up to $100,000 (to collect what they wrote-off).

I could go on, but I think you all see my point. But that'll never happen.