Don’t expect loan modifications to solve the foreclosure mess!
On average the 1st lender loses $58,000 for every home that goes through foreclosure. You’d think they’d do everything possible to keep homeowners in their homes. Well, it’s a lot harder than it seems. It didn’t even work for Hitler!
President-elect Obama, congressional leaders and various regulators, lenders and community groups are proposing more aggressive measures to try to stop the rising pace of home foreclosures. No matter what measures are enacted, these programs will likely encounter the same financial and legal hurdles that have slowed public and private foreclosure preventions for the past year.
Here are some of the roadblocks lenders and homeowners have faced as they try to work out more affordable loans that will slow the foreclosure rate and keep more people in their homes:
At the heart of the problem is the financial alchemy lenders used to stretch borrowers into mortgages beyond their means. Hundreds of mortgages – and sometimes other loans – were bundled and placed in separate trusts. Wall Street then sold investors bonds backed by that mortgage pool. The monthly payments from homeowners are used to pay back the holders of those bonds.
Wall Street bankers believed they had minimized the risk to any one investor that an individual loan would go bad. The problem is that no single lender owns a specific mortgage. So there’s no one party for a homeowner to negotiate with when it comes time to modify a loan. Their loan could be owned by thousands of investors.
“It may just be hard to contact all these folks,” said Adam Levitin, a Georgetown University law professor who recently wrote a paper on the problems servicers are having modifying loans. “They can be spread all over the world, and getting approval can be very difficult. This is Humpty Dumpty, and all of Paulson’s horses and Bernanke’s men can’t put this one together.”
Recent programs announced by private lenders like Bank of America and government regulators like Fannie Mae only apply to whole loans that are owned directly by a lender.
Most mortgages written during the peak of the lending bubble were bundled into pools of loans whose monthly payments are paid to the holders of a series of mortgage-backed bonds. The original lender no longer has an interest in the mortgage.
Payments from homeowners are collected by “servicers” and paid to investors holding the bonds backed by that mortgage. So it has fallen to these loan servicers to try to modify mortgage terms for homeowners whose loans were sold into these pools. So far, that process has involved a painstakingly slow review of each loan, something most servicers weren’t originally set up to do.
Each mortgage pool comes with different guidelines for how to deal with bad loans. Some don’t spell out clearly who has the authority to make changes in individual loans. Some trusts are managed by two layers that include both a ’servicer’ and a ‘master servicer.’ If a servicer decides to modify a loan, it still faces a potential legal challenge from investors.
”That is not a resolved issue and potentially subject to litigation,” said William Longbrake, who recently retired as vice chairman of Washington Mutual. “And that makes servicers more conservative about how aggressive they’re willing to be.”
The securitization of home mortgages has complicated public and private efforts to modify loans because mortgages bundled into pools are backed by many different classes – or ‘tranches’ - of bonds. Each tranche comes with different rules that govern which investors get paid first if some mortgages default. One set of investors may benefit from a foreclosure, for example, even as other investors would profit from avoiding it. Some mortgage pools are backed by dozens of different tranches.
Now, as the companies charged with managing these mortgage pools try to modify terms on individual loans, they’re finding it difficult to get these multiple classes of bondholders to agree. Industry insiders have dubbed this process ‘tranche warfare.’
During the height of the lending boom, many lenders accepted a second mortgage in place of a down payment. After all, the thinking went, home prices never fall, so how could they lose?
Now, homeowners with second mortgages face a tough time getting a loan modified. In many cases, there isn’t enough home equity to cover both mortgages. So the investor holding the second mortgage, who takes the biggest hit, has no incentive to agree to new terms.
Without that approval, the holder of the first mortgage can’t modify its terms.
Since the tidal wave of failed home mortgages swamped the credit markets this year, falling home prices have created a major roadblock for millions of homeowners trying to modify loans that are now bigger than their house is worth. Some loans – based on inflated appraisals – were ‘underwater’ from the day the deal closed.
Now, with one in five mortgage holders in the same boat, public and private foreclosure prevention programs and proposals have run into the same critical question: Who should bear the loss when the principal balance of a loan is reduced to reflect the loss of the home’s value?
Some lenders have voluntarily agreed to take this “haircut.” But many investors holding bonds backed by mortgages have refused to go along. When a mortgage is part of a pool of bundled loans, all of the investors have to agree to reduce the principal.
The issue has been at the heart of the political debate over the government’s response to the crisis. Opponents of aggressive housing relief involving taxpayer funds have balked at the idea of bailing out borrowers who took on more debt than they can afford. Some foreclosure relief proposals would split the loss. Lenders and investors who agree to give up principal would share any future gains from the sale of the home.
Because the process of creating mortgage-backed securities was loosely regulated, there are no standard terms governing how these mortgage pools were bundled or how mortgage defaults would be handled.
The complex terms and financial structures of these mortgage pools vary from one offering to the next. In some cases, bonds from multiple mortgage pools were mixed together in yet another trust - which created yet another series of bonds twice-removed from the original mortgage.
As a result, there are no widely agreed-upon rules for modifying a mortgage owned by these pools.
Companies servicing these loan pools - originally tasked with managing payments to investors from a stream of monthly mortgage payments - now find themselves caught in the middle of a monumental mess as they try to balance the interests of individual mortgage holders at risk of default and the hundreds of investors who may hold a piece of that loan.
When a mortgage is modified to make it more affordable, that means lowering the interest rate or cutting the total loan amount – or both. And that means the investor who bought bonds backed by a mortgage pool will have to agree to accept a lower return on their investment.
Companies that service these mortgage-backed investments fear they may get sued if the investors later claim the borrower could have afforded the loan after all.
The legal structures of the trusts used to bundle mortgages can present further roadblocks. In some cases, efforts to modify the terms of a single loan may run afoul of a Depression-era law designed to prevent issuers of bonds from changing the terms after a bond offering is first issued. Changing the terms of even one loan in a pool could also remove favorable tax treatment for the entire pool.
The decision to modify mortgage terms is also clouded by the goal of limiting loan modification to only those borrowers who will eventually default – a prediction that’s extremely difficult to make in many cases. Loan servicers use complex formulas to judge both a borrower’s risk of default and the financial impact on investors who bought that loan.
Those calculations typically involve crunching historical data on home prices, credit risk and economic forces like unemployment. But those historical statistics turn out to be inadequate when trying to model the worst housing market in 75 years.
That’s why two homeowners with similar financial situations may get two very different responses when they try to modify their mortgage terms.
“There are a zillion and one assumptions you have to make and the calculation depends on how you do the math,” said Mark Zandi, chief econmist at Moody’s Economy.com. “One of the problems is that each servicer has their own math and each one uses their own set of assumptions. And to some degree, they’re not sure which assumptions to use and how to do the math.”
For a significant number of homeowners, no amount of loan modification will make them viable. During the peak of the credit bubble, lenders approved mortgages that were only sustainable in a rising housing market. As those mortgages reset to reflect the true cost of the loan, borrowers are simply swamped with too much debt.
“Many people were qualified for these loans with the expectation they would refinance based on home appreciation,” said William Longbrake, retired vice chairman of Washington Mutual. “That hasn’t happened. So they can’t refinance and they can’t make the higher payment.”
–Adapted from The Mortgage Modification Mess from MSNBC, www.msnbc.msn.com/id/28147389/
