Why Loan Mods Fail
Floyd Norris asks an interesting question: Why do so few mortgage mods turn permanent?
He sifts through many of the close-but-no-cigar-answers: There were many bad loans made in the first place; modifying loans to unqualified borrowers isn’t doing much good. Many other small factors are preventing mods from being successful.
Some of the modification techniques are simply laughable: Mods still use declared income, i.e., no income verification of borrowers – hey, lenders, how did that work out the first time you employed that technique? Not too good, right?
Here is the quandary as described by Norris:
“The banks, and the government, are soon going to have to decide what to do about borrowers who are making the modified payments but have not provided the documents after repeated efforts to obtain them. Should the banks just take the money and let the preliminary modification turn permanent? Or should they foreclose?
Those decisions will affect just how fair the program is seen to be. If the banks allow those who do not submit documents to get by without doing so, it will appear unfair to those who told the truth about their income, and paid more than they might otherwise have been required to pay. If they do not, the wave of foreclosures could devastate more neighborhoods.”
Yes, all that maybe true. Unfortunately, it does not get to the central factor of foreclosures and therefore loan mods: You can convert a variable APR to a fixed loan, extend a 30 year to a 40 year. You can even defer some small portion of principal — interest-free – for 40 years or until the house is sold.
And mods continue to fail the majority of the time.
The bottom line is simply this: Buyers paid too much for their homes; Banks lent out too much money relative to value.
And so because of these 2 simple factors, the entire real estate sector is repricing towards a healthy intrinsic value, relative to competitive factors: Income, Renting, and GDP.
Until that process is completed – and all evidence suggests that it is not – then these mods that do not significantly adjust amounts owed are destined to fail.
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Source:
Why Many Home Loan Modifications Fail
FLOYD NORRIS
NYT, December 4, 2009
http://www.nytimes.com/2009/12/04/business/economy/04norris.html
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December 5th, 2009 at 6:43 am
Calculating those numbers is only the first step. After determining the present value of that projected series of payments, the bank then compares it with what it could get by foreclosing. If the bank would be better off by foreclosing, then there is no modification.
In one case I saw, the house was estimated to be worth $227,100, far less than was owed. The present value of the payments to be made under the modified loan was $159,611. modification was nonetheless approved, and the monthly payment fell to $1,004 from $1,877.
What made the difference was the bank’s conclusion that it would get a present value of just $139,568 from a foreclosure, nearly 40 percent less than the estimated value: the low payments were worth more than the alternative.
December 5th, 2009 at 8:36 am
The effect on the pressure and moratoriums on foreclosures for MBS investors is to increase the loss severity. I think the hope is by the administration to make the NPV test basically never show that foreclosure is the best option. Floyd’s example is an excellent on showing that in practice.
I keep wondering who would ever buy a MBS or make a home loan again (outside of government guaranteed mortgages).. especially at these low rates. You are taking all the risk, it isn’t asset based lending if you can’t get your hands on the asset. It is more like a low rate credit card. Banks are being dumped on for not making loans (and once they make them they get dumped on for making them!) but since they can’t figure out exactly what rules apply at any point of time how can they make a loan for six months much less 30 yrs.
FYI, the reason the banks are being pressured into “stated income” trial mods is because the administration pressured them to do it. The servicers who were waiting for the paperwork before allowing a trial mod were publicly shamed in July by the administration. The servicers point was that they only want to do a trial mod if it has a reasonable chance of success but the regulators were having none of it. This will again increase the losses on mortgages.
Here was the shot across the bow letter asking servicers to coming to the Treasury to explain their performance:
http://www.housingwire.com/wp-content/uploads/2009/07/servicer-letter.pdf
Btw Amherst Securities has been pretty good about predicting what is going to happen next:
http://www.housingwire.com/2009/10/14/chances-are-most-hamp-mods-wont-work-amherst/
“While HAMP workouts are keeping the pools of real estate owned (REO) property relatively small, Amherst predicts a low percentage of eventual success of HAMP modifications is inevitable.
“When HAMP is less successful than hoped, and the reality of the housing overhand hit the market – we would expect to see further governmental action,” the report said, noting the most likely course of action is a plan that contains principal forgiveness.”
The containtment of supply hitting the market is the real goal of all these programs, delay the recognition of loss and maintain asset values.
December 5th, 2009 at 9:31 am
“… the entire real estate sector is repricing towards a healthy intrinsic value, relative to competitive factors: Income, Renting, and GDP.”
More “boy in the bubble” evidence. Government support and intervention has created an immune system akin to the bubble for the boy who had no immune system. There’s an awful lot of stuff out there which can hurt us, and it’s pricipally rooted in something called fundamentals. Of course the government would like for us to adapt to life inside the bubble as the new normal. How’d that 1970s movie turn out again???
December 5th, 2009 at 9:53 am
“The bottom line is simply this: Buyers paid too much for their homes; Banks lent out too much money relative to value.”
and too much housing was built (amount of homes and size of homes)…all players acted as you would expect when money is so cheap (thanks again Fed)
Paid For By Bunning in 2012
December 5th, 2009 at 9:59 am
@ Steve Barry
“and too much housing was built (amount of homes and size of homes)…all players acted as you would expect when money is so cheap (thanks again Fed)”
Money was never cheap – credit was cheap. And the banks overpaid for the quality of buyer they were getting.
December 5th, 2009 at 10:03 am
The stated income component is scary, along with the 3% down payment requirement on FHA loans. I interpret these practices to mean that the banks and the government are in an “extend and pretend” mode to stave off a housing collapse and a great depression. But, will it work?
I suspect the intrinsic value of housing today is far less than the replacement cost. Sounds illogical, but in essence we may have constructed houses that are of a greater value than the middle class can now afford given their reduced standards of living in the post-home equity ATM era.
December 5th, 2009 at 10:06 am
If the bank would be better off by foreclosing, then there is no modification.
Of course, what constitutes “better off” in the banking world is a slippery thing. By delaying hard medicine, banking execs can preserve their balance sheet for another few quarters, collect their bonuses, and kick the can down to the next sucker that has to look at that mortgage file.
The sooner we start RTC v2 (and resolve the associated bank insolvencies), the sooner things will get back to normal.
December 5th, 2009 at 10:15 am
100% agree with jpm, once they allowed accounting to change banks have held it all back and continue to do so, hoping for that rebound, cause if they don’t get it, sianara, it is why they have built up a cash hoard, banks will not talk to anyone unless you are in dire straits and when they do they try and figure out ways to just prolong
my sister works at cap-one, in mortgage divison they picked up 3 years ago, they really truly and honestly are so far behind it’s not funny, and they have no idea what to do, they are damned if they do and damned if they don’t, the factual numbers are crazy, so they trim a little here, trim a little there, as if someone had a thousand files on there desk and at the end of the month they get told, you gotta close out ten of them, while they hand em another 20 in the new month
December 5th, 2009 at 10:35 am
“By delaying hard medicine, banking execs can preserve their balance sheet for another few quarters, collect their bonuses, and kick the can down to the next sucker that has to look at that mortgage file.”
Yes, indeed. And all with the government’s approval and encouragement. How, pray tell, do we EVER get back to prudent, sane banking practices and a normal market that’s not horribly distorted by government actions?
I fear that it will be a very long time.
December 5th, 2009 at 10:41 am
I have personal experience now.
My children rent an apartment for $2,000 a month
They were served a foreclosure notice – landlord stopped paying mortgage in February
Mortgage was $360k, 10 year interest only. This would represent 100% + of the fair market value of the property at the time of sale two years ago. Today who knows how much it is worth. It cannot be sold.
My take aways:
1) landlord has received $22,000 in rentals, most of which is disposable income to him since he stopped paying the mortgage.
2) the bank must be swamped if it allowed the landlord to skip 10 payments before taking action.
3) the bank will lose a gignormous sum on this property. I guess half the value of the mortgage or more.
And finally, does anyone have suggestions on what my children should do?
December 5th, 2009 at 10:47 am
I have zero direct (and little indirect) experience here, so this is simply a theory…
Missed payments (for whatever reason) become a cash flow issue. The longer the load renegotiation process takes, the worse the situation gets — by the time an agreement is in place, the borrower maywell be in a hole too deep to escape from.
It seems to me that borrowers were getting along fine until the rate resets hit. Now, one can argue whose fault that was (misleading terms? buyer beware?), but, while seeming over simplistic, had the banks simply extended the teaser terms until something sensible and reasoned could be put in place, perhaps we wouldn’t be in the situation we are in.
And, which came first, the chicken (loan resets) or the egg (lost jobs due to banking meltdown)? There’s certainly a feedback loop in play here too.
December 5th, 2009 at 11:35 am
@bergsten
What came first was that overused term, moral hazard.
People over the last 20 years have felt ‘entitled’ to by homes (a completely fraudulent statement since the bank actually owns the home until the mortgagte is paid off) that pushed the limits of their ability to pay. That alone acted as the catalyst for the meltdown, the seed planted that grew like poison ivy.
Instead of buying homes a good bit beneath their ability to pay, three things happened:
1) the buyers by reaching far above their ability to continue to pay, pushed up housing prices to ridiculously unsustainable levels, and appraisers were either ordered or bribed to overvalue the homes to secure the mortgage,
2) the buyers never concerned themselves with the fact of interest rate re-sets and the burden this would place on their ability to pay.
3) never factored in even a tiny bit of the unforeseen.
The only obligation one has to an offer that is deliciously tempting is to turn it down, with extreme prejudice.
In that, they have met the enemy and it is them.
Unfortunately, our politicians bought and paid for by the bankers have seen fit to burden the entire population with the egregious errors, bonheaded selfish moves, and idiotic instant gratification on the rest of the responsible among us who saw thru this housefest and did not participate.
For that, for taking the lenders and borrowers losses in the trillions and without our consent, dumping their obligations on the rest of us they ought to be executed.
December 5th, 2009 at 11:36 am
Tangentially relevant, and as short as possible:
36 year-old son of a very log-time friend. 2 teens, wife w/low paying job. Affordable mortgage (very low end house in high-demand area), good job (UPS – 12 years), health insurance, car loan. Has heart attack. Gets triple bypass. Complications from surgery (not from heart attack itself), off of work for 180+ days. Loses portion of coverage for meds due to lack of hours/eligibility. Begs and borrows for 6 months to cover expenses. Negotiates with creditors for payment plans. Bank holding car note refuses to negotiate. The money simply isn’t available to pay the car note. Car gets repo’d. Bank now owns a 3 year-old family car (nice!) and loses income (they’ll never get as much, or near as much for the car as an adjusted payment amount and/or plan would have realized). Currently paid up with all other creditors, bought banger for less than 1 payment on the other car.
WTF?
December 5th, 2009 at 11:49 am
@flipspiceland — no argument from me, but…
“My” issue is not how we got to where we got to, but what was (and is being) done about it.
A close friend likes to say that when your boat is sinking, some people start bailing, and others start drilling more holes.
I think that a slower, more carefully considered “solution” to the upcoming (yes, “upcoming” — loan resets weren’t exactly a secret) financial disaster might have been better than everybody just grabbing whatever they could get for themselves.
That, right there, is the moral hazard (isn’t it nice how, when something unspeakably awful happens, somebody comes up with a nice sweet catch phrase?).
December 5th, 2009 at 12:03 pm
Should be an interesting week…rumors are that Japan may start selling treasuries to prop up the dollar vs. the Yen (as I speculated would happen eventually)
http://market-ticker.denninger.net/archives/1693-Here-It-Comes…-Sovereign-Treasury-Sales.html
…meanwhile treasury is issuing over 70 Billion in notes next week. That may go over like a lead balloon…I doubt Japan will be bidding them up. Gold, as I have been writing for awhile, may be in for a tremendous drop. Y/Y gold demand is down 34% and speculation is at very high levels…and Chinese pig farmers are hoarding copper. Wonder how that will unwind?
December 5th, 2009 at 12:31 pm
Steve Barry,
Sorry, but I am at a loss. If Japan sells Treasuries wouldn’t this weaken the dollar?
December 5th, 2009 at 1:58 pm
bsneath,
send a registered letter in the mail explaining what happened to them, supply all contact information and copy of the lease contract, i’m assuming they put down some type of desposit, so they are getting screwed also, offer to stay w/no deposit for alot less money, and agree they will move with a 30 day notice, offer but do not provide references and pertinent credit and income information, obviously you can call first, but follow up with letter…………imho, it will depend on a manager two levels above who you talk too, and what the bank is doing, they might be writing a bunch of stuff off at year end and will not care
December 5th, 2009 at 1:58 pm
Yes, and if Japan sells enough Treasuries, it could collapse the dollar. As far as what your kids should do, I recall reading an article in the NY Times (which lets you search their archive if you register) about what to do if you are a renter in a foreclosure situation, and I recall that it said the renter should pay their rent into an escrow account, preferably established at the mortgage lending institution.
Back to loan mods. I showed someone an 2006 Countrywide option-arm deal yesterday, and looked at one particular unmodified loan. The minimum payment was based upon an interest rate of 1.5%, even though the nominal rate was around 6%. Each month that the borrower made the minimum payment, the principal balance on the loan goes up by the difference. There is mathematically no way to modify this loan other than to drop the principal balance significantly (or extend it to 200 years). When is the Treasury going to figure this out?
December 5th, 2009 at 2:08 pm
“Sorry, but I am at a loss. If Japan sells Treasuries wouldn’t this weaken the dollar?”
It would spike up interest rates, which would send dollar soaring. It would also send a message that the US can no longer spend above its means.
December 5th, 2009 at 2:18 pm
MA, 36 y-o guy sounds like he could have been a client. Could be a composite of a lot of people we see. Bankruptcy means test is based on previous 6 months of income, so low disability pmt income and family of 4 may very well have qualified him in his state. A bk atty might have been able to file for him and get the stay before the car got repo’d. The ding on his credit from the repo is fairly bad, albeit not as bad as ch 7. But an option to consider for anybody in that situation.
@bsneath: tenants can usually cause problems which is why a lot of banks are making cash payments to tenants to get out. Usually at least $1,000 or so.
So this is the human reality I see every day so the banks can go fuck themselves repeatedly with the smoke enema as far as I’m concerned. Yes, it pays my bills but the stories are SAD and get to you. Liked Winston Munn’s take on banks overpaying for quality of buyers, but don’t forget the asset bubble. Banks overpaid for both buyer risk of default AND risk of the underlying security interest shitting the bed.
My take on loan mods is that the banks are behaving like the greedy monkey in the Aesop fable. The only way they can get the nuts in the jar and get their hand out is to take one at a time. But they feel their fists around a whole handful and won’t let go because it’s not in their nature. So they end up with their fists stuck in a nut jar and starve to death. THE END.
Can anybody tell me exactly what has been done in the last 15 months to address the problem of pricing all the crap MBS floating around out there? Clearly the banks have gotten theirs in the short term. Anyway, this whole thing still disgusts me.
December 5th, 2009 at 2:35 pm
@Marcus Aurelius
Heart attack @36, w/ triple by-pass????
That comes under one of those unforeseen events that, without taking too much of a risk, I would guess
can be easily seen: He ain’t lithe and lean.
I’ve lived with heart disease for my entire life and that has factored into every decision, re: finance I ‘ve ever made.
If he’s obese, it’s practically a slam dunk he would topple one day soon. Personal habits that disregard
one’s health are playing out today in ways anyone with Health 101 should know about. Health is number one before entering into any long term contract and one chooses to ignore it at their own and in his cse his family’s peril.
The lack of personal responsibility that has resulted in a nation with 66% overweight or obese is a statistic that is simply astounding.
Once the enemy they have met is themselves.
December 5th, 2009 at 3:56 pm
[...] Why Loan Mods Fail | The Big Picture [...]
December 5th, 2009 at 4:03 pm
What if the Govment forced wage inflation by requiring companies to pay degree’d individuals a minimum amount.
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What if the Govment jobs started to say pay 50% more than private sector. Wouldn’t that force companies to try and compete producing more wage inflation?
I understand it would be better for housing/real estate to correct and find it’s bottom but if prices get to low wouldn’t that put us back many years for some that bought in the past 10? Are there any examples of the above two scenarios that have back fired?
December 5th, 2009 at 4:32 pm
Too bad we didn’t try the Home Owners Loan Corporation model and straightforwardly write down the principle. The current schemes are a disorganized ways of getting to the repricing, and they don’t go aggressively enough after the mountain of debt that is between us and any real recovery.
December 5th, 2009 at 8:44 pm
Bergsten at 1149am hit the issue correctly: how do we get the oxcart out of the ditch? I don’t have the mental capacity to answer that. I hope the “smart” people are looking at more than some cookie cutter loan mod approach.
It does seem that some solutions are trying to equalize the pain being felt by the affected parties while fixing the problem. That may be a political goal, but I think it’s unreal, especially if a speedy fix is needed.
December 6th, 2009 at 6:11 am
[...] noted yesterday Why Loan Mods Fail: Buyers paid much more than homes were intrinsically worth; Banks also lent more than they should [...]
December 6th, 2009 at 10:46 am
[...] Why loan modifications fail. (Big Picture) [...]
December 6th, 2009 at 2:53 pm
bsneath — re: torrie-amos Says:
send a registered letter in the mail explaining what happened to them, supply all contact information and copy of the lease contract, i’m assuming they put down some type of desposit, so they are getting screwed also, offer to stay w/no deposit for alot less money, and agree they will move with a 30 day notice, offer but do not provide references and pertinent credit and income information, obviously you can call first, but follow up with letter…………imho, it will depend on a manager two levels above who you talk too, and what the bank is doing, they might be writing a bunch of stuff off at year end and will not care
My version:
send a registered letter in the mail explaining what happened to them, supply all contact information and copy of the lease contract, i’m assuming they put down some type of desposit, so they are getting screwed also, offer to stay w/no deposit for alot less money, and agree they will move with a 30 day notice, offer but do not provide references and pertinent credit and income information,…… send a check for the amount (resonable) you are offering to pay, (maybe base it on the local going rates with some documentation) made out to the owning bank/entity c/o the servicer, and state the next months check will be sent unless told differently. Maybe note the good maintenance you are doing on the property. Watch your bank account for it to be cashed. If it is, you have gone part way to a new contract with them that will require legal work for them to undo.