For as long as there have been mortgages the big stick assuring repayment has been the threat of foreclosure. Now some of the nation’s largest lenders have begun to re-think the value of foreclosing and the result is a sudden and bizarre battle between two groups: lending traditionalists who want to keep longtime foreclosure practices pretty much in place and lending progressives who believe the old approaches are actually making the foreclosure situation worse and that new options are needed.
Who cares? You do and I do. For the first time since the start of the mortgage meltdown a realistic strategy has begun to emerge that could actually lower foreclosure numbers and thus the pressure to reduce local home values. For those with an interest in buying foreclosures, new lender policies could make such purchases significantly more attractive.
For months Sheila Bair, chair of the Federal Deposit Insurance Corporation, has argued that toxic mortgages are so bad that lenders should essentially engage in a product re-call: Forget about re-doing loans one by one and instead modify thousands of loans at once.
When the FDIC took over IndyMac in July, says Bair, they found that the huge west coast lender had 60,000 mortgages that were more than 60 days past due, in bankruptcy, in foreclosure or otherwise not current. Bair says that 40,000 borrowers were potentially eligible for the FDIC’s IndyMac loan modification program, meaning that as many as 40,000 borrowers could potentially avoid foreclosure.
Under the FDIC modification plan the idea is to convert toxic loans into sustainable mortgages. Loans would be revamped where possible so that borrowers would pay no more than 38 percent of their gross income for principal, interest, taxes and insurance (PITI). Loans would be modified with interest rate reductions, extended loan terms and all unpaid late charges would be waived.
At first it might seem that any program that could reduce foreclosure levels should be wildly cheered, but borrowers are not the only people involved with mortgages.
Investors, for example, bought loans and mortgage-backed securities on the basis of assumed rates of return. If rates and terms changed then so did the value of those investments. Companies that provided credit-default swaps — essentially insurance policies for Wall Street investors — could now face huge claims because mortgage-backed investments were not performing as promised. And lurking in the background were an assortment of derivatives, massive bets made on the basis of presumed mortgage values — values which changed under the Bair program.
In addition, the lending industry has been vehemently opposed to massive loan modifications — those systemic changes favored by Bair.
“Forbearance is certainly an effective tool in some cases, but it is not a sustainable long term solution,” said John Robbins, the 2007 chairman of the Mortgage Bankers Association. “If we have learned one thing coming out of the Katrina and Rita disasters, it is that blanket policies rarely have the desired blanket effects. Each loan is an individual transaction and situation, one which needs to be addressed individually between the lender and the borrower.”
Modifications at IndyMac might have remained quietly on the sidelines had the general foreclosure situation not gotten progressively worse.
Lender-backed HOPE NOW, for example, reported that “the mortgage lending industry helped 212,000 homeowners avoid foreclosure in September. This is the first time since HOPE NOW began compiling data in July 2007 that the number of foreclosures prevented in one month exceeded 200,000. It is also 30,000 (15.6%) more than the previous record of 192,000 foreclosure preventions set in August 2008.”
More than 200,000 foreclosure preventions sure seems like a good thing, but a closer look at the numbers raises a question: If the foreclosure situation is improving then why are preventions at record numbers? Does that not suggest more people in need of help?
In fact, there is substantial evidence that foreclosure numbers are not just rising, they are about to get much worse.
Figures from RealtyTrac.com show that foreclosure filings in September — default notices, auction sale notices and bank repossessions — were reported for 265,968 properties. That’s up 21 percent from a year earlier, but most importantly it understates the problem. Why? Because unlike a year ago many states have recently instituted foreclosure moratoriums, thus large numbers of foreclosure actions have been suspended.
Current foreclosure numbers are a lagging indicator — they follow job losses, plant closings and downsizing. The current foreclosure numbers do not reflect the recent rash of job losses. Tellingly, Standard and Poors now says it expects that losses at Fannie Mae will double in 2009 — and Fannie Mae is the nation’s largest mortgage buyer.
The Private Sector
The grim news for lenders is that traditional approaches to foreclosure simply have not worked. It doesn’t make any sense to clamp down on massive numbers of borrowers if the end result is huge and continuing losses, bulging foreclosure numbers and woeful reports to shareholders.
The result is that some of the country’s largest lenders have begun to re-think their foreclosure policies:
- Citigroup has announced that it will “preemptively reach out to a select group of 500,000 homeowners whose mortgages Citi holds; these homeowners are not currently behind on their mortgage payments, but some may require help to remain current on their mortgages. This effort is expected to result in workouts of approximately $20 billion in underlying mortgage balances.” Citi also says it will“systematically implement its practice of not initiating a foreclosure or completing a foreclosure sale on any eligible borrower where Citi owns the mortgage.” In other words, a foreclosure moratorium for most borrowers.
- Bank of America says that beginning Dec. 1 it began to “systematically modify troubled mortgages with up to $8.4 billion in interest rate and principal reductions for nearly 400,000 Countrywide Financial Corporation customers nationwide.””
- JPMorgan Chase, which took over Washington Mutual and its trouble loan portfolio, says it will “systematically review its entire mortgage portfolio to determine proactively which homeowners are most likely to require help — and try to provide it before they are unable to make payments.” The effort, says Chase, will “proactively reach out to homeowners to offer pre-qualified modifications such as interest-rate reductions and/or principal forbearance. The pre-qualified offers will streamline the modification process and help homeowners understand that Chase is offering a specific option to make their monthly payment more affordable.” In total, Chase says that its “enhanced program is expected to help 400,000 families — with $70 billion in loans — in the next two years.”
The scope and enormity of these private-sector efforts is remarkable. In comparison, HUD’s widely-touted FHASecure program helped just 3,794 delinquent conventional borrowers refinance with FHA loans as of Oct. 1 — a full year after the program began.
Equally remarkable: Fixing home loans one at a time is out, systemic programs are in.
Getting In Line
The changes undertaken by the three lenders above should not be underestimated: For the first time since the mortgage meltdown began it’s possible to see movement for the better on the foreclosure front and the possibility of more home price stability.
Not an end to foreclosures. Not an end to the mortgage meltdown. But something far better for borrowers and lenders than what we’ve been seeing for the past two years.
The catch is that as while Citi, Chase and BOA are enormous, they’re not the biggest players in the mortgage marketplace. To have real change you have to involve Fannie Mae and Freddie Mac, companies that federal regulators say “own or guarantee almost 31 million mortgages, about 58% of all single family mortgages.”
The New Approach
Since September both Fannie Mae and Freddie Mac have operated under the authority of the federal government. It is no longer necessary to get both companies to change their policies if you want to revamp foreclosure practices; it’s only required to have their regulator — the Federal Housing Finance Agency (FHFA) — make the decision for them.
FHFA has now determined that Fannie Mae and Freddie Mac will offer streamlined loan modifications.
“The program,” says FHFA, “targets the highest risk borrower who has missed three payments or more, owns and occupies the property as a primary residence, and has not filed for bankruptcy. To be considered for the program, a seriously delinquent borrower should contact his or her servicer and provide the requested income information. The program creates a fast-track method of getting troubled borrowers to an affordable monthly payment where ‘affordable’ is defined as a first mortgage payment, including homeowner association dues, of no more than 38 percent of the household’s monthly gross income. This affordable payment will be achieved through a mix of reducing the mortgage interest rate, extending the life of the loan or even deferring payment on part of the principal. Servicers will have flexibility in the mix used to get there, but the goal is to create a more affordable payment.”
In other words, Ms. Bair won. Lender by lender, bureaucrat by bureaucrat, the opposition to mass mortgage modifications has fallen apart.
But the question is why. Why did Ms. Bair win?
We won’t know with certainty for weeks and months, but the answer likely involves two events.
First, when hedge fund managers with Braddock Financial Corporation and Greenwich Financial Services reportedly sought to limit mortgage modifications in late October they were told by Rep. Barney Frank (D-MA) chairman of the House Financial Services Committee and other House Democrats that “for hedge funds, which have been the beneficiary of a lack of regulations and a very permissive attitude, now to put obstacles in the way of this important national policy is intolerable.”
The message from Capitol Hill: All hedge funds are being advised not to stifle loan modification efforts.
And second, of course, the Democrats won the national election with huge margins. Within a week after the votes were counted federal policy changed.
How are investors impacted by the changes now underway with loan modifications? It’s too early to cite any evidence, but logically the new lender programs are good for investors because they reduce the number of homes being foreclosed.
The idea is not that the number of foreclosures will instantly fall, but rather that they will not grow as much as would otherwise be the case without the new modification efforts. For investors fewer foreclosures are good news because they suggest a quicker return to marketplace normality — and an end to falling home values. For lenders, anything that brings investors back to the marketplace and reduces foreclosure inventories is a benefit.
“What we’ve seen for the past few years is that lender policies and practices that may have worked for a small number of foreclosures are simply impractical when foreclosure numbers jump,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the largest source of foreclosure listings and data.
“The policies just undertaken by the private sector and now by Fannie Mae and Freddie Mac create the potential to save large numbers of delinquent homeowners from foreclosure,” continues Saccacio. “While there will be debates and arguments over what’s happening and why, the important point is that practices which plainly weren’t working are being replaced with policies which might bring real relief to the marketplace.”
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.