My friend Kevin Drum examines some of the reasons that mortgage modifications aren’t working worth a damn (as in “the mortgage is too damn high”).
If, in the long run, principal reductions really, truly were the most profitable way to deal with underwater homeowners, I’d expect that not only would banks figure this out pretty quickly, they’d be figuring out ways to create securitized bundles of principal reductions to sell to gullible German investors. That well can’t be completely dry, can it?
So why hasn’t this happened? There are a couple of obvious possibilities here. One is that the complicated nature of mortgage securitization simply makes principal reduction too hard. Once the loans have been securitized, tranched, retranched, and re-retranched, there are so many note holders with a legal stake that it’s all but impossible to get unanimous agreement to do a principal reduction. Another possibility is that banks are afraid of knock-on effects: once they start reducing principal in a few cases, their entire customer base will find out what’s going on and start withholding payment in hopes of getting the same treatment. Reducing principal for 10% of their customers might make sense, but banks might be afraid that there’s no way to hold the line there.
I personally think he’s covered the two main issues. With highly securitized debt, it’s not like there is one person at a bank that owns the loan who will make the decision (…it can literally work like that – early in my career I personally managed about $85 million in commercial ORE and pretty much called the shots on everything up to about $8 million). And yes, if banks suddenly started handing out 15% principal reductions, I might think about hitting the bank up and lowering my mortgage by $70K.
But…at the same time, foreclosing isn’t costless. It’s certainly not costless to the households who are displaced (I’m assuming that most of the people being foreclosed on are decent homebuyers with bad luck or bad underwriting skills, not flippers and pure speculators). It’s not costless to the communities they are pulled out of. And it’s not costless to the lenders; the numbers I see suggest that foreclosure pulls about $30 – $50K out of the price of an average home – and if the mortgage is underwater already, that’s a further haircut. That’s not to count the hit to the lender’s books from depreciation and other holding costs…not all of which count to lower the basis when a sale takes place.
It seems to me like we’re doing the worst possible thing, which is to lean against the collapsing wall and pray that it will somehow miraculously stabilize – that prices will ‘normalize’ – before it all falls over.
That eyes-squeezed-shut hope keeps our banks alive via an accounting fiction – worse, via an accounting lacuna where we simply agree not to look. It keeps homeowners over the edge in a constant state of false hope, and it freezes the spending and hopes of homeowners near the edge.
So what can we do that’s better?
Do we step aside and simply let it collapse and spend our money and energy picking up the pieces??
I toyed with an idea a few months ago – it never gelled, but I felt like I was onto something. It was that homeowners could take a written-down low-interest mortgage, but would lose some of the appreciation and their tax deduction.
Getting rid of – or aggressively clamping down on – the homeowners tax deduction is something we really ought to do. We subsidize overconsumption of housing by the middle and upper-middle class. We simply escalate the prices of all housing stock, and so hurt the working poor who are trying to achieve homeownership – the very people we ought to focusing our assistance on.
But it’s dumb to suggest – as I did – that workout homeowners should lose it – it simply makes the house that much less affordable.
But the idea of having them get rid of (some or all of) their appreciation isn’t dumb. It begins to separate house-as-shelter from house-as-investment, and offer to those who want to keep their house as a home – rather than a piggy bank – some options.
What if we simply agreed that people who are underwater can apply to have their mortgage reset to 100% of the current value of the house, at current low rates, but they accept a participating second from Fannie or Freddie, the terms of which are such that if they sell the house in the next seven or ten years, they get no appreciation, and thereafter they get some measure of the appreciation.
These loans have _some_ value, and can be held or sold – giving a better return to the lenders than simply foreclosing (nominal value of the participating debt plus the new mortgage, plus the ‘foreclosure hit’ that’s avoided). Communities are better off, because the ‘good’ homeowners – the ones who want to stay and keep their roots – can. I’m not jealous of them, because I can sell my house in five years and maybe make a few bucks (or not) which they can’t.
What’s the downside??
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The note would have to be carefully written so that it’s guaranteed to be senior to any refi’s, helocs, or other claims on the house. Also, there’s an incentive to sell the house at the bottom of the market and buy a house across the street, although there wouldn’t be too much of an incentive since these people would have wrecked credit.
Also, what if the “2nd chance” fails? What happens to this secondary note if the first note forecloses? I guess it would be just like any other secondary note and would be settled after the first note if there’s anything left.
I’ve heard ideas that are variations on this approach: “shared-appreciation mortgages”, etc, although I like this one best since it minimizes moral hazard (so there’s be less incentive for people to game their way into the program).
I’d want to run run this by some people in the field and see if they can find a way to game it, but from here, it looks like a very solid idea.
Regarding AL’s idea of writing down underwater mortgages to current market value, in exchange for giving up future appreciation:
1. I don’t think there is anything that would prevent a mortgage holder and homeowner to agree to that now. It’s an interesting proposal that might make sense to a particular bank and homeowner.
2. Are you suggesting some legislation? What would this look like: a directive that banks must refinance on those terms? I assume at the election of homeowners? Setting the terms in such legislation would be tricky. The banks, for example should not be entitled to a windfall–one could limit their priority to future appreciation to the difference between the payments under the old loan and the renegotiated loan, perhaps with a little kicker to the banks for their trouble?
A few thoughts:
1. Drum’s alternatives are somewhat mutually exclusive. If one isn’t sure who hold one’s mortgage, hearing that Acme Mortgage Services will reduce principle shouldn’t encourage anybody that’s never heard of Acme. OTOH, my mortgage is with a local bank that for the most part keeps the mortgages local. If someone got a big break from them, the information would flow fast in the area and would certainly encourage unwanted copy-cats.
2. I think part of the bank’s problem is that they don’t have good information absent a legal process. They are not sure how much your house is worth, or more importantly, how much you can afford. Putting your house up on the block is a good way to achieve certainty.
3. I’ve read a number of credible comments from lawyers that serve homeowners to believe that the banks will at the point of foreclosure negotiate. (Though see next comment) These lawyers have complaints about the banks, but I wonder how many homeowners know how to propose something to the banks. Should the government buy up some of those unemployed law grads to provide homeowner assistance?
4. I’ve also seen credible indications that the banks are being strategic on which properties they advance through foreclosure and public auction. It appears they are targeting houses they think they can get a good return on, holding them for no more than two months from sale. IOW, if the banks are sitting there thinking they’ve got to move some properties and your underwater house has favorable demographics and zip code, the banks might just be inclined to foreclose.
5. On the fees, I wonder if there is a big difference btw/ recourse and non-recourse states.
6. The politics of legislation are evil. I live in an area where the median home price briefly dropped below $100k, if the federal government starts talking about bailing out people with $400k mortgages, the Democrats can probably kiss off the Midwest for a generation. I appreciate that A.L. is not jealous because it might act as a price support for his house, but this is going to look like a wealth transfer to housing speculators in 3 or 4 states.
What is so terrible of making the best of a bad bargain. Banks don’t like owning houses. It is in their interest to keep people in the houses they now occupy because more foreclosures will put more more mortgages underwater.
Writing down mortgage principal is no different than a fabric mill writing down bad debts to a fashion design house. Once it gets more complicated, I think you are asking for trouble.
The problem, at this point,that should be investigated is not how to build another financial Rube Goldberg machines to prop up banks, but is why has the write-down route not been taken.
Let’s call that the retail end. The answer I see to that is the the horror story that has been created on the wholesale end, beginning with the Dicey MBS’s and escalating into the clouding of title and separation of the Mortgage from the note.
My guess is that these wholesale problems make the write-downs impossible.
As far as the fear that the banks have of a domino effect, I am sure they are worried about that, but how far do they want to ride this down. At some point, which I think has long past, they would be forced to write down,
but again why haven’t they. Look to the Wholesale side.
We are in a total economic fantasy land that began in earnest during W’s administration and doesn’t appear to be slowing down in the slightest. Housing is only part of it. the Financial Industry seems to have become a not very bright collection of lowlifes and a populace that feels entitled to everything immediately.
There is very little you can do with an economy and a country once it has become divided between Crooks and Crybabies.
When we find out how crooked these toxic these MBS’s had actually become we will only begin to see the economic problems we face.
And, please, no more solutions. Haven’t we had enough of unintended consequences?
I think toc3 is right about the wholesale end being the problem. Which is probably why A.L. is thinking legislation, as a way of slicing the Gordian knots and making permission solely the loaning bank’s discretion.
A.L., am I right on that one?
Wall Street would just looove a law that effectively undid securitization. Not. Which means pursuing it risks further alienation of the Democratic Party’s largest donors. Quite the political dilemma – but I generally agree with toc3’s characterization of the larger problem.
PD Shaw’s point #6 is also well worth thinking about. My sense is that if it’s seen as imposing a real financial penalty on people who take it, it will be seen as fair and not have those backlash consequences.
It failed to occur to me in 3, above, but granting discretion to either the banks or the homeowners to lower the mortgage, and to divide future appreciation legislatively would almost certainly involve an unconstitutional taking. My sense is that the proposal AL is making can only be accomplished if both parties agree to it: it can’t be accomplished legislatively.
One significant problem that is plaguing modifications is “class warfare”. Whatever bank it is that’s empowered to make modifications is supposed to act in the best interests of ALL the investors. With the investors buying tranches though, any modification reduces someone’s take – even though it may mean more total revenue on the mortgage. So, Investor A may benefit at the expense of Investor B – even though overall the investors are better off. Investor B may still want to sue.
Since there’s no guidance anywhere on how to do this properly (not in the deal documents, and not enough legal precedent), the servicers don’t like to risk liability by doing modifications. It’s not a problem of who gets to make the decision so much as what guidelines are they supposed to use?
Also don’t underestimate the lack-of-good-staff problem. The banks aren’t equipped to do lots of modifications properly any more than they are to do lots of foreclosures properly.
Good points, all. Marc, very interested to see what you come up with here.
Again, there was a “This American Life” bit on this, with a bank that was buying loans that were failing at a discount, and resetting the deal with the homeowner… and everyone was making a pretty decent profit.
But they had to completely rewrite their computer system to figure out the profit margin. And it was a small bank, that got to pick which loans they bargained with at the beginning… large banks can’t go back and change the loans they’re stuck with.
The program hinted that several big banks have come forward to ask about they’re system, but there was just too much to modify their system. It would have been difficult to completely reprogram the software of a ‘large’ bank, as well as retraining millions of staff. In the end, nobody bought rights to their system.
I think Roland and Alois both have their finger on the salient issue. Back when the excrement was hitting the fan, I spent a little time trying to understand the structure of the tranched MBS – even ground through one deal doc I found on the net just to get the real savor.
One outcome of the tranching structure is that income from a mortgage pool is allocated to the tranches (classes) differently from repayments and losses in the underlying capital structure (the mortgage principal). So impairing the capital to the benefit of income, or vice versa, is literally going to result in ‘class warfare’ (though not in the classical sense), per Alois.
Consider that most of the MBS tranches are likely held by institutions – very few individual investors ever saw one of these things. Further consider that some of these institutional holders further repackaged their tranches in some fashion, e.g., into derivative debt securities, as part of hedging structures around default insurance, and on you go.
And every swinging one of those institutional tranche holders has a fiduciary obligation to their investors – whether depositors or equity or debt holders – not to be done dirt by letting another ‘class’ benefit to their detriment. That’s where Roland’s takings analysis comes in – if the original deals are abrogated by governmental _force majeure_ in some form or another, there is 100% probability of major legal blow back, not to mention the further erosion of the rule of law in the US economy.
I’d also be willing to bet (though I haven’t done the research) that there is little standardization in the ‘exceptions’ boiler plate in the original MBS deal docs, and that many of such are at best ambiguous, given how fast they were slapped together. So trying to work out what might happen depending on some combination of voluntary or coerced workout structures is going to be non-trivial, and non-uniform. You might be able to collapse the litigation that will ensue around MBS into one ‘class’ (yet a third sense) for each packager, but the contractual facts are likely to be variable between packagers.
(All of this is a logical outcome of using the implied full faith and credit of the US to convert a rather specific asset – residential mortgages – into a non-specific asset that was literally used as cash equivalent by some of the more dodgy high yield money funds. Trying to bridge the gap between ‘good as gold’ and ‘liar loans’ has left us in a multi-trillion dollar dilemma between debasing the sovereign credit of the US or inflating its sovereign risk. Sic transit gloria Barney Frank. For those who want some of the gory details I recommend “this book”:http://www.amazon.com/gp/product/0199734151?ie=UTF8&tag=duediligence-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0199734151 )