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FAIR GAME
So Many Foreclosures, So Little LogicBy GRETCHEN MORGENSONPublished: July 4, 2009
LAST week, the stock market tumbled on news that housingforeclosures and delinquencies rose again in the first quarter. TheOffice of the Comptroller of the Currency said that among the 34million loans it tracks, foreclosures in progress rose 22 percent, to844,389. That figure was 73 percent higher than in the same periodlast year.
But the comptroller’s office also saidthat amid the gloom, there waspromising data about loanmodifications: they rose 55 percent inthe quarter. That growth came on a
very low base, of course, but the move encouraged John C. Dugan, head of thecomptroller’s office.
“As the administration’s ‘Making Home Affordable’ program gains traction and helpsoffset the impact of this very difficult economic cycle,” he said in a statement, “we shouldcontinue to see progress in future reports.”
A glimpse of second-quarter mortgage data, however, indicates that the progress Mr.Dugan and his colleagues in Washington are hoping for may take longer to emerge —raising questions about whether policymakers and banks are moving quickly orintelligently enough on the foreclosure problem.
Foreclosures remain one of the great financial ills for the economy. The Bushadministration largely overlooked foreclosures affecting average homeowners, focusinginstead on propping up elite, troubled financial institutions with taxpayer funds. TheObama administration has said it wants to wrestle the foreclosure issue to the ground byencouraging mortgage loan modifications, but its efforts have gotten little traction.
Loan modifications occur when a lender agrees to change terms of a troubled borrower’smortgage; the most common approach is to reduce the loan’s interest rate. Cutting theamount of principal owed — an option that could be of more help to a borrower — is rarebecause it means homeowners pay less money back to the bank over time.
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Lenders and their representatives, however, don’t like to modify loans through interestrate cuts or principal reductions because, of course, it reduces the income they receivefrom borrowers. No surprise, then, that loan modifications have been a trickle amid therecent foreclosure flood.
Enter the government, with the program it announced in March to encouragemodifications. It offers incentives to loan servicers to change mortgage terms, providing$1,000 for each loan they modify. The program focuses on making payments moreaffordable through lower interest rates, but delinquent amounts and late fees aretypically tacked onto the mortgage balance. “Making Home Affordable” does not compellenders to reduce mortgage balances.
Servicers signed on to the program in April. The program’s early months were notcovered by the O.C.C.’s first-quarter report. But other figures on modifications conductedin April, May and June are available. And they show a decline in modifications, not anincrease as the government hoped.
Alan M. White, an assistant professor at the Valparaiso University law school in Indiana,analyzed data on 3.5 million subprime and alt-A mortgages in securitization poolsoverseen by Wells Fargo. The loans were written in 2005 through 2007; data on theirperformance is provided to the trusts’ investors. Mortgages handled by five of thenation’s largest loan servicing companies — Bank of America, Chase Home Finance andLitton Loan Servicing among them — are contained in the Wells Fargo data.
Mr. White found that mortgage modifications peaked in February and have declined inall but one month since. While servicers modified 23,749 loans in these trusts inFebruary, they changed only 19,041 in May and 18,179 in June. This is exactly whenservicers were supposed to be responding to the government’s loan modification urgings.
Foreclosures, meanwhile, keep rising. In June, 281,560 were in process, slightly abovethe 277,847 in May. Last January, there were about 242,000 foreclosures in the pipelineamong the Wells Fargo trusts.
“I was hoping we would see some impact in June of the government’s program,” Mr.White said. “Is ‘Home Affordable’ working? My short answer is no.”
To be sure, the government’s data differs from that which Mr. White analyzed, and itsloan modification figures for the second quarter may look better as a result. The O.C.C.includes prime loans as well as subprime, for example, while the Wells Fargo datacontains no prime loans.
Nevertheless, Mr. White has collected the figures since November 2008, and he said thatin the months since, the performance of the 3.5 million mortgages that he analyzestracked the O.C.C. data pretty closely.
THE Wells Fargo data is illuminating. It shows that in June, 58 percent of modificationscut the payments that the borrower has to pay, a slightly smaller percentage than in Aprilor May. The average reduction in June was $173 a month.
But the most fascinating, and frightening, figures in the data detail how much money islost when foreclosed homes are sold. In June, the data show almost 32,000 liquidationsales; the average loss on those was 64.7 percent of the original loan balance.
Here are the numbers: the average loan balance began at almost $223,000. But in theliquidation sale, the property sold for $144,000 less, on average. Perhaps no other singlefigure shows how wildly the mortgage mania pumped up home prices. It also bodespoorly for the quality of the mortgage-related assets lurking in banks’ books.
Loss severities, like foreclosures, are rising. In November, losses averaged 56.1 percent ofthe original loan balance; in February, 63.3 percent.
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Given losses like these, Mr. White said he was perplexed that lenders and theirrepresentatives were resisting reducing principal when they modify loans. His data showshow rare it is for lenders to reduce principal. In June, for example, 3,135 loans — just 17.2percent of the total modified — involved write-downs of principal, interest or fees. Thetotal loss from these write-downs was just $45 million in June.
And yet, the losses incurred in foreclosure sales involving loans in the securitizationtrusts were a staggering $4.59 billion in June. “There is 100 times as much money lost inforeclosure sales as there was in writing down balances in modifications,” Mr. White said.“That is not rational economic behavior.”
If banks have written down the value of these loans to the 40 cents on the dollar that theyare fetching on foreclosures — the only true value for these homes right now — then whydon’t they bite the bullet and reduce the loan amount outstanding for the troubledborrowers? That type of modification would be far more likely to succeed than larding aborrower who is hopelessly underwater with yet more arrears.
“You can reduce payments with a lot of gimmicks similar to those built into subprimeloans — temporary rate reductions that defer a lot of principal, balloon payments,” Mr.White said. “To me that leads to a situation where American homeowners are paying 50to 60 percent of their incomes for mortgages which reset in 2011 and 2012. That is notsolving the problem.”
Certainly not for borrowers, that is. And because many of these losses will ultimately bepassed on to taxpayers, it’s not solving our problem, either.
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