Two months after the collapse of Lehman Brothers, there has still been no broad-based action to help restructure delinquent mortgages and slow down the flood of foreclosures; the Fannie/Freddie plan announced earlier this week is a very small first step, because it is limited to a small portion of the mortgages outstanding – those controlled by Fannie and Freddie, which tend to have relatively low default rates anyway.

Sheila Bair, head of the FDIC, said that that plan “falls short of what is needed to achieve wide-scale modifications of distressed mortgages.” Apparently frustrated by the failure of negotiations with the Treasury Department, yesterday the FDIC posted its mortgage modification proposal to its web site (Washington Post summary), basically breaking with the rest of the administration and hoping the Congressional Democrats can make it happen.

Continue reading “FDIC Takes Mortgage Proposal to the Public” →

JPMorgan recently announced a program to offer loan modifications to 400,000 homeowners with a total of $70 billion in mortgages. The program is roughly similar to one announced by Bank of America as part of a settlement with state attorneys general of investigations into Countrywide (acquired by B of A): JPMorgan is offering to convert option ARM mortgages, one of the most poorly-conceived and worst-performing products of the housing boom, into fixed-rate mortgages at lower rates and potentially with lower loan balances. From the WSJ article:

The mortgages affected by J.P. Morgan’s program represent 4.7% of the home loans it owns or that are serviced by one of the bank’s units, EMC Mortgage Corp. While the program to give these mortgages easier terms is likely to cost J.P. Morgan billions of dollars in interest payments and loan fees, it is also likely to save the bank from the costly and lengthy process of foreclosing homes and selling them.

This is more evidence that banks see mortgage restructuring as being in their own economic interests, for reasons I’ve described earlier. (As an aside, Yves Smith wonders why banks are only offering modification programs now, when it seems like the government is about to act.) Unfortunately, it’s also more evidence that modifying whole mortgages owned by one bank is easier than modifying securitized mortgages owned by many parties who may have competing interests; this program is only aimed at mortgages owned by JPMorgan, which are a tiny fraction of the volume serviced by that bank.

Given the small scope of the program, government action is still almost certainly necessary. But private action has at least one advantage over government programs. When the government acts to encourage loan modifications for delinquent mortgage holders, millions of “responsible” homeowners who are not delinquent on their mortgages will scream. No one expects private sector banks to do anything other than act in their own interests, and so they don’t have to worry about being seen as fair.

News sources are reporting more details on the possible mortgage restructuring plan for distressed homeowners first mentioned by Sheila Bair in her Congressional testimony last week. The basic outlines of the plan are:

• Lenders would agree to reduce monthly payments to be affordable, perhaps based on a percentage of the homeowner’s income. The reduction could be achieved by reducing the interest rate, reducing principal, or extending the term.
• If the amount the homeowner could pay would result in a mortgage worth less than the foreclosure value of the house, the loan would not be modified and the lender could foreclose.
• The government would then partially guarantee the new mortgage and absorb part of the loss if the homeowner defaulted.
• The numbers of 3 million homes and $600 billion in total mortgage value are being thrown around.

This is roughly consistent with the principles we outlined earlier: the lender gets more than it would have gotten in foreclosure, the homeowner is better off than being on the street, the community benefits because there are fewer foreclosures. There are three key issues that still need to be negotiated.

1. How much will homeowners be expected to pay? Too much, and the lenders will not have to write down their loans very much, and the government will be on the hook for risky mortgages; too little, and the lenders will not participate.
2. How do you solve the securitization problem, that is, the current inability of many servicers to modify loans that are owned by other parties? This may require a new law in and of itself (one suggestion here).
3. How do you decide which homeowners are eligible? If people who are delinquent get cheaper mortgages and people who are struggling but paying on time don’t, the latter will scream. It is still in the interests and hence within the rights of the lender, the delinquent homeowner, and the government to do the deal, but that won’t reduce the indignation.

There are also a couple of enhancements to the program that could be considered. First, shouldn’t the government – by which we mean the taxpayer – get something for its guarantee (besides the satisfaction of knowing that it’s doing what’s best for the country)? The homeowner and the lender are both better off than they would be otherwise (homeowner on the street, lender forced to foreclose), and the government is worse off (because some of these new mortgages will fail). The government could get a share in the future appreciation of the house, for example.

Second, to protect against default by the homeowner on the new mortgage, the government could secure the loan against his or her future earnings, because the government already has an enforcement mechanism it can use: the IRS. This would protect the taxpayer’s interests.

Finally, one note of caution. Loan modifications should work for some proportion of delinquent homeowners, but there are probably millions of homeowners who have no chance of paying any mortgage on their houses that would be acceptable to their lenders. People with option ARMS who made minimum payments and then saw their mortgage rates reset upward by several percentage points will not be able to pay anything close to what lenders will require not to foreclose. In conjunction with any mortgage restructuring plan, there also has to be a plan to manage the flow of properties onto the market, because a flood of foreclosures will only cause prices to plummet further. It seems like there are so many things to do, but that is the price of the situation we are in.

Update: Here’s another proposed solution to the securitization problem.