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Making Loan Mods Work

November 29, 2009

The New York Times this weekend reported that the Obama Administration is likely to announce new measures to help beleaguered homeowners stave off foreclosure. Although more than 600,000 owners are in trial modifications under the Making Home Affordable program announced last March, only a few thousand have received final modifications. Trial periods that were meant to last 3 months have been extended to 5 as a result. The performance of servicers varies widely among the 35 who signed up with the Treasury to use the program with the borrowers in their portfolios. Advocates for homeowners and Congress are frustrated with the slow pace and urging more action.

It’s unclear what new measures the Administration might take.  But the weekend’s report comes on the heel of another Times report describing how hedge funds and other investors are profiting from the ongoing crisis by buying distressed mortgages at a discount, refinancing them at a much lower principal amount made possible by their discounted purchase and splitting the difference with current borrowers.  The article details how Fortress Investment Group - ironically headed by former Fannie Mae CEO Daniel H. Mudd -  and other investors are managing to reduce borrower principal by significant amounts while still turning a profit.  There are only limited opportunities to reduce principal under Making Home Affordable; the interest reduction approach that is its chief tool can lower monthly payments but does nothing to reduce the outstanding debt.

The investors’ scheme is clever.  The Obama Administration was advised to follow a similar course in February, 2009, in a policy paper prepared for HUD Secretary Shaun S. Donovan under the auspices of the University of Pennsylvania’s Institute for Urban Research.  Bart Harvey and I co-lead the task force that produced the paper.  We urged the government to buy distressed mortgages directly at a steep discount and then centrally organize the restructuring or dissolution of these debts.  We argued that this would accelerate the process and allow the government to organize effective modifications designed for long-term stability.

But the Making Home Affordable plan instead relies on incentive payments to existing servicers to encourage them to effectively re-underwrite the loans.  It relies on a calculation of “net present value” of the current home that is not transparent and does not seem to adequately account for differences in current values within and between metropolitan areas.  It relies on 35 different servicers all designing new systems for accepting applications, reviewing them, tracking them, and evaluating them.  This has meant hiring thousands of processors who must be trained, and building technology systems that take time and money to design and execute.

Since its inception borrowers have had to put up with faxed applications, frequently lost documents and resubmissions, and opaque decisions.  Some owners even have found themselves facing foreclosure evictions while awaiting approval of their applications or while in trial modifications.  This is either because the servicers’ systems aren’t robust enough to connect the foreclosure and modification operations effectively or servicers stand to earn more through continuing foreclosures even though it is prohibited in their contracts under Making Home Affordable.  Whatever the reasons for these frustrations and failures, the result is anxiety for homeowners and failure to deliver on the program’s promise.

Despite the obstacles and start up delays, Treasury reports show that more than 600,000 trial modifications have been put in place.  Treasury Assistant Secretary Herbert M. Allison told a group of advocates last week that the pace of permanent modifications is lagging way behind expectations.  The department’s focus over the next six weeks will be on moving those numbers up, he said.  But he also reminded the group that servicers entered into the program voluntarily, and the government has only limited options to force action.

Meanwhile, the private investment schemes may end up leaving the government holding the bag in the end anyway, because virtually all new mortgage lending today is backed one way or another by Uncle Sam.  FHA today is the only route for low downpayment borrowers.  If the same borrowers get into trouble on their new loans, it will be FHA that has to pay off the lender and will be stuck with the loans.  If the borrowers have the scratch for a larger downpayment, their loans are likely to be bundled into securities by Fannie Mae and Freddie Mac, and the bonds purchased by the Fed.  If they go bad, taxpayers could end up footing at least part of the bill.

It would have been much simpler and more direct for the government to move aggressively to purchase distressed loans at steep discounts earlier this year.  It could have contracted for the servicing workouts under closer supervision.  It could have offered lenient terms to forestall foreclosures and the havoc they are wreaking in communities.  Making Home Affordable was an important step forward, but its limitations are becoming clearer with time.  The new initiatives anticipated on Monday (November 30, 2009) hopefully will accelerate success.


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