Mortgage Modification Programs Have Been Ineffective. Why?

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Influential financial leaders, including Federal Reserve Chairman Ben Bernanke and FDIC Chair Sheila Bair, have recently made strong statements about the ineffectiveness of the mortgage modification programs. For months Bair has been particularly relentless in her efforts to focus the attention of the Treasury Department and other agencies besides her own on dealing more aggressively with "the root cause of the financial crisis -- too many unaffordable mortgages creating too many delinquencies and foreclosures." (From her Statement on 11/18/08 before the U.S. House of Representatives Committee on Financial Services.)

Bernanke joined in with his usual measured but, considering the source, emphatic comments:

Despite good-faith efforts by both the private and public sectors, the foreclosure rate remains too high, with adverse consequences for both those directly involved and for the broader economy. More needs to be done. . . . . To be effective, loan modifications should aim to put borrowers into mortgages that they can afford over the longer term. . . . . [P]rincipal write-downs may need to be part of the toolkit that servicers use to achieve sustainable mortgage modifications.

(From his speech on December 4, 2008 at the Federal Reserve System Conference on Housing and Mortgage Markets.)

Initial Results of Mortgage Modification Programs

Hope for Homeowners

This major federal program was a component of the very high-profile Housing and Economic Recovery Act signed into law on July 30, 2008 and implemented on October 1, 2008. Please see my earlier Bulletin about it. The Act created a new voluntary program within the Federal Housing Administration (FHA) to back up to $300 billion in FHA-insured mortgages to distressed homeowners.

But according to a December 19, 2008 press release by the National Association of Consumer Bankruptcy Attorneys (NACBA), in spite of projections that about 400,000 homeowners would be helped, "there have been only 312 applications to date -- and no mortgage modifications whatsoever have taken place."

And if NACBA seems a one-sided source--it is unabashedly promoting amending the Bankruptcy Code to permit mortgage modifications in Chapter 13 plans--here is Ben Bernanke's assessment from the same speech quoted above, again in his understated language:

Another, more recent program, dubbed Hope for Homeowners (H4H), allows lenders to refinance a delinquent borrower into a new, FHA-insured fixed-rate mortgage if the lender writes down the mortgage balance to create some home equity for the borrower and pays an up-front insurance premium. In exchange for being put "above water" on the mortgage, the borrower is required to share any subsequent appreciation of the home with the government. Although the basic structure of the H4H program is appealing, some lenders have expressed concerns about its complexity and cost, including the requirement in many cases to undertake substantial principal write-downs. As a result, participation has thus far been low.

Hope Now

Here's NACBA's assessment:

This voluntary effort by the industry, promoted by the Administration, has produced more public relations than real results. Homeowners have great difficulties getting answers because the services do not have adequate staff to deal with requests. When some accommodation is reached, servicers virtually never reduce loan principal and often enter into repayment agreements that do not even reduce loan payments. Studies have shown that most of the workouts negotiated through Hope Now provide at best temporary short-term relief from foreclosure, and in a large percentage of cases, the homeowner cannot keep up with payments because the agreement does not adequately modify the loan. As of September 2008, Hope Now worked out loan modifications resulting in lower monthly payments for 266,087 homeowners; loan modifications with the same or HIGHER monthly payments for 226,667 families; and 780,000 short term repayment plans.

FDIC/IndyMac Federal Bank

After the Federal Deposit Insurance Corporation took over this huge mortgage company in July of last year, it implemented a modification program that has been emulated in other private and public efforts. Its goal is "to systematically modify troubled mortgages," "to achieve affordable and sustainable mortgage payments for borrowers and increase the value of distressed mortgages by rehabilitating them into performing loans."

According to the independent mortgage website HousingWire.com:

It’s not clear, however, if that implied modification rate — 12.5 percent of eligible severe delinquencies, and 8.7 percent of total delinquencies — is significantly better or worse than what the former Alt-A lender was seeing before its servicing platform was assumed by the FDIC.
. . . .
Some policy experts that have spoken with HousingWire privately have suggested that if the FDIC’s modification approach at IndyMac is truly and honestly successful, and widely implemented, it will clearly incent performing borrowers to default in an effort to secure below-market interest rates on their own mortgage debt. “Bair and the FDIC are walking a fine line here,” said one economist, who asked not to be named because his view were his own and not those of his employer. “Her program needs to succeed, but not so much so that everyone decides they too ought to get a 3 percent mortgage.”

And again the critical word from NACBA:

This effort covers 65,000 borrowers who are more than two months delinquent on their mortgage, but doesn't reduce the outstanding debt in any meaningful way and therefore has not attracted much interest. So far, 7,200 homeowners have modified their loans under this program. And, after a two-month moratorium on foreclosures pending the modification program, IndyMac foreclosures in November skyrocketed 242 percent from October, according to Mark Hanson of the Field Check Group.

Why Mortgage Modification Programs Are Ineffective

1) Many commentators have focused on the now-familiar complaint that with securitized mortgages, which include a disproportionate amount of the troubled loans, the multiplicity of owners make negotiating modifications virtually impossible. The owners often cannot agree or cannot even be found, and simply do not respond to modification pleas.

In Ben Bernanke's cautious words:

[D]espite the substantial costs imposed by foreclosure [on mortgage holders], anecdotal evidence suggests that some foreclosures are continuing to occur even in cases in which the narrow economic interests of the lender would appear to be better served through modification of the mortgage. This apparent market failure owes in part to the widespread practice of securitizing mortgages, which typically results in their being put into the hands of third-party servicers rather than those of a single owner or lender.

In more direct terms, by New York Times' business columnist Joe Nocera:

You see, all of these programs deal only with “whole loans” — that is loans on the books of the institutions, unencumbered by securitizations. So far, the attitude of all involved when it comes to securitized mortgages is to throw up their hands and say — “it’s too hard to deal with!” And it may well be: mortgages that were sold to Wall Street and wound up in mortgage-backed securities have been sliced and diced and sold and resold to investors with varying risk tolerances. They are serviced by people who owe a fiduciary duty to all these investors, no matter what their place on the risk continuum.
. . . .
The situations borders on the absurd. Investors will not allow mortgage modifications that would hurt them more than some other investors — thereby insuring that everyone gets hurt even more as foreclosures continue.

2) Modifications are stymied because the key players, mortgage servicers, risk investor lawsuits if they modify mortgages.

In NACBA's words:

The servicer has obligations to the investors who have purchased the mortgage-backed securities through pooling and servicing contracts, and the interests of these investors conflict. Servicers are hesitant to modify the loans because they are concerned that it will impact different tranches of the security differently, and thereby raise the risk of investor lawsuits when one or more tranche loses potential income. At least one servicer has already been sued. Under the current system, the legally safest course for the servicer clearly is foreclosure.

Bernanke echos this same concern: "The problem is exacerbated because some modifications may benefit some tranches of the securities more than others, raising the risk of investor lawsuits."

3) Simultaneously acquired second mortgages stymie voluntary modifications.

NACBA put it well:

Perhaps the most intractable problem is the fact that a third to a half of all 2006 subprime borrowers took out piggyback second mortgages on their homes at the same time they took out their first mortgages. In these cases, the holders of the first mortgages have no incentive to provide modifications that would free up borrower resources to make payments on the second mortgages. At the same time, the holders of the second mortgages have no incentive to support effective modifications by waiving their rights, which would likely cause them to face a 100 percent loss. The holders of the second mortgages are better off waiting to see if a borrower can make a few payments before foreclosure.

4) Mortgage holders and servicers have not been structurally designed or trained to modify, but rather to collect and foreclose, and these structures can only be re-engineered to a limited degree in an extremely short period. As a result, even when the intentions are good, these organizations have been overwhelmed by the volume of modifications needed.

Again, from Ben Bernanke: "the sheer volume of delinquent loans has overwhelmed the capacity of many servicers, including portfolio lenders, to undertake effective modifications."

5) Finally, the incentive structure for mortgage servicers in most cases greatly favors foreclosures over modifications. This is perhaps one of the most important and least recognized reasons for so few modifications. (See my upcoming Bulletin of January 26, 2008 on this crucial problem.)

An insightful article bylined "Servicers Profit While Investors Face Losses" states:

An environment of increasing delinquencies provides servicers with incentives to pursue their own self interests at the expense of investors and borrowers. Existing compensation structures, lack of oversight, informational asymmetry and consolidation of the mortgage servicing industry ensure servicers can act in their own interests with limited impunity.

(from RGE Monitor, named one of the world's best economics websites by BusinessWeek, The Economist, Forbes and the Wall Street Journal.)

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys