Interest Rate Roundup

Friday, February 13, 2009

Foreclosure moratoriums abound ... but do they work? Plus, more on modifications

The "foreclosure moratorium" wave sweeping through the mortgage world continues to pick up momentum. Just today, JPMorgan Chase, Morgan Stanley and Citigroup announced they would halt home foreclosures through March (the 6th for JPMorgan and the 12th for Citigroup) -- or until the Obama administration rolls out its latest foreclosure prevention plan.

For JPMorgan, no new owner occupied loans will be put into the foreclosure pipeline. Citigroup is applying its halt to Citi-owned first mortgages (and loans Citi services if it has "reached an understanding with the investor") only. It says it will neither complete any foreclosures in the pipeline nor initiate new ones.

You may recall that Fannie Mae began suspending foreclosure sales late in 2008, saying it would work more closely with mortgage services to implement a streamlined loan modification program. The program is targeted at borrowers who are 90 days past due, and it's designed to modify their loans by lowering their interest rates, extending their loan terms, or deferring payments on some portion of their loan principal balances.

Finally, several states have implemented or are considering different types of foreclosure moratoriums, most notably California.

But do these moratoriums really work? My sense is no, not in most cases in today's economic environment. Here's my thinking ...

If the problem is simply that a mortgage servicer is understaffed and overwhelmed with work, then maybe a moratorium does some good. It allows for more attempts to reach borrowers by phone, email, mail, or in person. And if the problem with the underlying borrowers is the STRUCTURE of their underlying loans, then it might do some good.

An example would be so-called "exploding ARMs" -- think 2/28 subprime ARMs here. With those kinds of loans, you might be able to modify them by freezing the rates and payments at the starting levels spelled out in the loan contracts. A moratorium/pause would give both borrowers and servicers the time necessary to work out deals, to provide and verify the necessary asset and income information proving the proposed loan modifications will work, and so on.

But today's foreclosures are being driven by two entirely different forces: Rising unemployment and falling home values. It's not the LOANS (the way they're structured) that are the problem per se. It's that the collateral backing the loans is depreciating and the capacity of borrowers to pay is going down. These trends are leaving more borrowers upside down (owing more than their homes are worth), giving them a perfectly rational reason for walking away. And it's leaving many borrowers without enough income to make their loan payments, no matter what their interest rates or loan terms.

In this environment, stretching out the foreclosure timeline merely prolongs the inevitable. The borrower who loses his job may be better off just getting out from under the house and "moving in with mom" or temporarily renting at a lower monthly cost until his income prospects improve. That's a tough pill for some politicians to swallow, but it happens to be the truth.

Meanwhile, delaying foreclosure in a market where the underlying collateral is losing value is problematic. In simple terms, you can foreclose now and sell a repossessed property for $200,000. Or you can wait out a 90-day moratorium and end up selling when you'll only be able to get $195,000.

Does it really make sense to defer foreclosures in this environment, or does doing so just increase the ultimate losses to lenders, investors, and the financial system? Personally, I'd argue that most moratoriums are a mistake. They don't appear to be slowing down filings permanently, either. When California halted foreclosure filings for a couple of months in the fall, they predictably declined. But filings spiked right back up again once the moratorium expired.

Meanwhile, on the loan modification front, the latest plan from the Obama administration seems to be to subsidize lenders who lower interest rates for mortgage borrowers. It's unclear precisely how this plan would work, though Reuters reported it will apply to borrowers who are not yet delinquent. They would have to have their properties reappraised and would have to prove they are burdened by excessive payments (i.e. their payments are consuming less than X% of their gross income, with X still to be defined).

But before we get too excited, it's important to note we already have several modification efforts underway. And they don't seem to be too successful. The OCC's own figures show very high redefault rates on loans that were modified in early 2008. That stems, in part, from deterioration in the underlying economic environment.

It may also be because modifications simply haven't been aggressive enough. A paper from Alan W. White, a professor at Valparaiso University, found that in a majority of modifications involving subprime and Alt-A loans, lenders are actually INCREASING the total amount of debt borrowers owe -- and RAISING their payments -- rather than lowering both. Some 65% of mods resulted in either the same monthly payment (20%) as the loan originally carried, or a larger one (45%).

How can that be? Many modifications don't involve cancelling the overdue interest and principal payments. Instead, those amounts are added to the loan balance and the entire loan is reamortized. Another finding from that paper, by the way? That loss severities are high and rising. In White's words: "Loss severities increased steadily throughout 2007 and 2008 and are expected to worsen in 2009." That underscores my earlier point that delaying foreclosure just ends up costing the system more money.

If we ARE going to push foreclosures off, then let's make sure lenders and servicers use the time wisely. Don't just let them dilly-dally around with "mushy" modifications. Encourage them to reduce loan principal for troubled borrowers to reflect the very real fact that home prices have fallen sharply. Doing so will give borrowers more incentive to stick around and make their newly reduced payments they no longer feel hopelessly underwater.

3 Comments:

  • Loan mods are a joke. I've seen a dozen or so from different lenders. Some mods are better than others and every bank is different. They all revolve around the same general principals: lowering the interest rate (in some cases only temporarily), extending the terms of the loan, adding late fees and interest to the principal and requiring a downpayment to get the plan started. I have yet to see one that reduces the principal owed. I'm starting to believe that the cram down is the only way to go.

    By the way, hands down the best analysis of the current economic situation. I check your site on a regular basis. Keep up the good work!

    By Anonymous Anonymous, at February 13, 2009 at 9:24 PM  

  • There's two things I'd like to know regarding loan mods. Does it matter if you lied on your original application (committed fraud) and what if "owners" did a cash out refi or spent a huge equity line of credit? Either of those should be an automatic rejection.

    Also, if two families bought similar houses on the same block for the same amount and one can afford the house and the other can't, do you reduce the balance of both or punish the prudent while rewarding the reckless?

    Great blog. Thanks for opening up the comments.

    By Anonymous Anonymous, at February 16, 2009 at 11:21 AM  

  • As a deliberate renter, I am livid. We pay astronomical taxes, only to see that money taken and given to others in the form of subsidized mortgage rates, or (heaven help us) "subsidized mortgage payments"! The idea that the government should take the taxpayers' money and distribute it to select homeowners is fundamentally UNAMERICAN. And worse yet, those that benefit are those that made the poorest economic decisions.

    I can see the reasons to help owners refi if they have some sort of "exploding loan" (ARM or Option ARM, etc), but beyond that I feel home prices should adjust to a level that can be naturally supported by our economy.

    If the government did manage to "stabilize" housing prices, they would just be back to finding crazy programs to "increase affordability" again. Seems to me the only beneficiary of higher home prices coupled with affordability through creative financing are LENDERS.

    By Anonymous deb, at February 17, 2009 at 9:17 PM  

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