Mortgage Lenders Do Not Want to Renogotiate Loans

[Guest Boston Fed]

We document the fact that servicers have been reluctant to renegotiate mortgages since the foreclosure crisis started in 2007, having performed payment-reducing modifications on only about 3 percent of seriously delinquent loans. We show that this reluctance does not result from securitization: servicers renegotiate similarly small fractions of loans that they hold in their portfolios. Our results are robust to different definitions of renegotiation, including the one most likely to be affected by securitization, and to different definitions of delinquency.

 

Our results are strongest in subsamples in which unobserved heterogeneity between portfolio and securitized loans is likely to be small, and for subprime loans. We use a theoretical model to show that redefault risk, the possibility that a borrower will still default despite costly renegotiation, and self-cure risk, the possibility that a seriously delinquent borrower will become current without renegotiation, make renegotiation unattractive to investors.

 

According to the Treasury-sponsored HopeNow initiative, in December of 2007 lenders were expected to prevent adjustable-rate mortgages from increasing to higher rates at the first reset of the mortgage.1 “Hope For Homeowners,” enacted by Congress in July of 2008, envisioned that lenders would write off a substantial portion of the principal balance of mortgages for financially distressed households.

 

The Obama Adminstration’s Making Home Affordable Plan, announced in February of 2009, provided financial incentives to servicers to renegotiate loans on the condition that the lenders reduce the interest rate for a significant period of time.

 

The key to the appeal of renegotiation is the belief that it can also benefit the lender, as the lender loses money only if the reduction in the value of the loan exceeds the loss the lender would sustain in a foreclosure.

 

Lenders rarely renegotiate. Fewer than 3 percent of the seriously delinquent borrowers in our sample received a concessionary modification in the year following the first serious delinquency. More borrowers received modifications under our broader definition, but the total still accounted for fewer than 8 percent of the seriously delinquent borrowers. And finally, fewer than 5 percent of all of our troubled borrowers repaid their mortgages, putting an upper bound on the number who could have repaid less than the principal balance of the loan.

 

The complex webs that securitization weaves can be a trap and leave no one, not even those who own the loans, able effectively to save borrowers from foreclosure. With the loan sliced and tranched into so many separate interests, the different claimants with their antagonistic rights may find it difficult to provide borrowers with the necessary loan modifications, whether they want to or not. In the tranche warfare of securitization, unnecessary foreclosures are the collateral damage.

 

Portfolio lenders complain about accounting rules, including the need to identify modifications, even when the borrowers are current prior to the modification, as “troubled debt restructurings”, which leads to reduction of the amount of Tier II capital and increased scrutiny from investors and cumbersome accounting requirements.

 

The shortage of qualified staff, an oft-head complaint from borrowers seeking renegotiation, affects servicers of portfolio loans and private label loans equally. Finally, the interests of the managers of a loan portfolio are not necessarily any more likely to be aligned with their investors than are the interests of the trustees of a mortgage pool; many have attributed the catastrophic failures of financial institutions like AIG in 2008 to misaligned incentives of managers and shareholders.

 

Lenders expect to recover more from foreclosure than from a modified loan. This may seem surprising, given the large losses lenders typically incur in foreclosure, which include both the difference between the value of the loan and the collateral, and the substantial legal expenses associated with the conveyance.

[Guest LAW]

Remarks by the President in a Backyard Discussion in Albuquerque, New Mexico

 

Cavalier Residence

Albuquerque, New Mexico

 

10:09 A.M. MDT

 

THE PRESIDENT: Well, the housing crisis helped to trigger the financial crisis. And it’s a complicated story, but essentially what happened was, banks started seeing money in peddling what looked like these very low-interest-rate mortgages, no money down. Started peddling these things to folks. A lot of people didn’t read the fine print, where they had adjustable-rate mortgages or balloon payments, and they ended up being in situations where they were in homes that they couldn’t necessarily afford.

 

The banks made a whole bunch of money on all these mortgages that were being generated. But what happened was -- is that when the housing market started going down, then all these financial instruments that were built on a steady stream of payments for mortgages, they all went bust, and that helped to trigger the entire crisis.

 

So the housing issue has been at the heart of the economic crisis that we’re in right now. It is a big problem because part of what happened over the last several years is, is that we built more homes than we had families to absorb them. And what’s happened now is, is that housing values have declined around the country, in some places worse than others. In Nevada, in Arizona, they’ve been very badly hit. In New Mexico, I don’t think we had the same bubble, and so prices have not been as badly affected here. But overall across the country, housing lost a lot of value.

 

Now, this is a multitrillion-dollar market, so there’s no government program where we can just make sure that whoever is losing their home that we can just pick up the tab and make sure that they can pay. And frankly there are some people who really bought more home than they could afford, and they’d be better off renting, or they’re going to have to make adjustments in terms of their house.

 

What we have tried to do, though, is to make sure that people who had been making their payments regularly, who are meeting their responsibilities, if they could have a little bit of an adjustment with the banks, if some of the principal was reduced, if some of the interest was reduced on their mortgage payment, they could keep on making payments. The bank would be better off than if the home was foreclosed on, obviously they’d be better off, and as the housing market starts picking back up again -- which it will do over time, although not in the same trajectory as it used to, right; it’s going to be more much gradual -- then potentially the bank could recoup some of the money that it had lost by making the adjustments on the mortgages.

 

So we’ve set up a number of these mortgage modification programs that are out there. But I don’t want to lie to you -- we’ve probably had hundreds of thousands of people who’ve been helped by it. I think there have been a couple of million who’ve applied. But that doesn’t meet the entire need because this is such a huge housing market.

 

And what really is probably the most important thing I can do right now to keep people in their homes is to make sure the economy is growing so that they don’t feel job insecurity. That’s probably the thing that’s going to strengthen the housing market the most over the next couple of years. If we’ve got a growing economy, unemployment is gradually being reduced, then people are going to feel more confident; they’re going to be able to make their mortgage payments; new -- homeowners, people who are potentially buyers of homes, are going to say, you know what, I don’t mind entering the market because I think things have sort of bottomed out -- that starts lifting prices and that gets us on a virtuous cycle instead of a negative cycle.

 

But it’s going to take some time. We’re working our way out of overbuilding in the housing market, a lot of not very sensible financial arrangements in the housing market. And we’ve got to get back to sort of a traditional, more commonsense way of thinking about housing which is, if you want a house you got to save for a while. You got to wait until you have 20 percent down. You should go for a mortgage that you know you can afford. You’ve got to -- there shouldn’t be any surprises out there, right? That kind of traditional thinking about saving and thinking about the house not as something that is always going up 20 percent every year and you’re going to flip and take out home equity loans and all that -- we’ve got to have a different attitude, which reflects what you talked about, more of an attitude that this is your home. This is not just a way to make quick money.