There’s general agreement that home foreclosures are a major problem and that the Obama administration is right in deciding to attack the problem.
“If they’re going to spend money at all, this is useful because it resolves both an economic and a political problem.” says the Cato Institute’s William Niskanen, reflecting something of a consensus view.
But the severity of the problem, the mechanics of tackling it and the amount of money needed are very much under debate.
The Obama administration last week said it would “commit substantial resources of $50-$100 billion to a sweeping effort to address the foreclosure crisis,” through a variety of initiatives, including the TARP program, whose funding thus far has gone entirely to propping up banks.
Depending on whom you ask, that’s either way too much money or far too little.
“I think it’s too much. What would you do with it?” says Christopher Mayer, a real estate expert and vice dean at Columbia University’s business school, who recently testified before the House Financial Services Committee’s hearing on using TARP funding for foreclosure relief.
“A $100 billion is not a lot, given what the federal government is on the hook for,” says Edward Pinto, who was chief credit officer at Fannie Mae and now runs a consultancy. “The meter is running and it is going to increase.”
Pinto estimates foreclosure losses could be as high as $800 billion over the next 4-5 years.
There are currently 55 million mortgages in circulation. About 35 million are the responsibility of Fannie Mae, Freddie Mac and the FHA. About 8 million have been bundled and turned into securitized debt. The rest are held in the portfolios of various private lenders, such as banks.
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Pinto is forecasting 8.8 million foreclosures in the next few years. That’s roughly consistent with the FDIC’s estimate of 4-5 million in the 2009-2010 period and what’s likely to be two and a quarter million in 2008.
If that sounds like the result of something more than a garden-variety recession, you are right.
“The problem is we're in a much, much weaker position in this real estate crisis because the traditional underpinnings of underwriting have all been compromised,” says Pinto.
He estimates that one out of two loans made in the late years of the housing boom (2005-2006) were fundamentally dubious and essentially destined for foreclosure, because of exceedingly high loan-to-value and/or debt-to-income levels.
At the same time, the deepening recession is predictably adding to the pool of foreclosures as more qualified and resourceful borrowers fail to keep up with payments.
One Problem, Many Ideas
Though foreclosure prevention has been high on the Washington for a year and a half, the success rate has been low.
“Mortgage loan modifications have been an area of intense interest and discussion for more than a year now,” FDIC COO John F. Bovenzi recently told Congress. “Meanwhile, despite the many programs introduced to address the problem, it continues to get worse."
The FDIC knows as much about home foreclosures as any government agency, so statements like that don’t bode well.
The Hope for Homeowners program launched in October with an $18 billion budget is widely recognized as a failure and is in the process of being redesigned.
In addition there is no shortage of new proposals, from government loan guarantees or outright purchases of mortgages to dramatic changes in bankruptcy laws to incorporate home foreclosure.
Rep. Maxine Waters (D. Calif) recently introduced legislation based on a plan championed by Sheila Bair, chairwoman of the FDIC, which was launched in late August at IndyMac, the failed California thrift the agency has been running in conservatorship.
The “Systematic Foreclosure Prevention and Mortgage Modification Act of 2009” would seek to modify 2.2 million mortgages, about half of the non-GSE loans expected to become a problem in 2009. Under the plan, the government would share up to 50-percent of the loss, if the loan redefaults.
Under the IndyMac program, the bank has made some 47,000 streamlined remodification offers to qualified borrowers since September. About 9,000 have been complete and another 1,700 in progress. The average unpaid loan balance is $269,000. The average monthly reduction in payment is $428,000, according to IndyMac's Evan Wagner. The FDIC says remodification efforts have saved $423 million
That may all sound promising, but neither the company nor the government are releasing redefault data. "It's still too early in the game," says IndyMac spokesman Evan Wagner. "As the numbers become a bit more mature that is something we'll be more willing to talk about publicly."
“Out model is something we still stand behind,” says David Barr of the FDIC, which recently agreed to sell IndyMac banking operations to a limited partnership. Barr says preliminary data shows about 1 percent or less are not current, on a 30-past due basis.
The Mortgage Bankers Association "supports the Bair plan in concept," says its senior VP of government affairs, Steven O'Connor, but is "still waiting to see some of the details."
"We don’t see there being one single solution to help borrowers," adds O'Connor.
The private sector has been trying—and struggling—as well.
The Hope Now program, which includes 70 percent of the nation's major lenders, has modified some 2.2 mortgages since its launch in 2008 and is now helping about 200,000 borrowers a month, including those who have redefaulted.
The group is in the process of trying to calculate a default rate, but its consortium structure makes that "tough", says Scott Talbott, senior VP of The Financial Services Roundtable, the lenders' trade group.
A joint federal agency report in December paints a more detailed and deteriorating picture. According to the Offfice of Thrift Supervision and the Office of the Comptroller of the Currency The number of loans modified in the first quarter that were 30 or more days delinquent was 37 percent after three months and 55 percent after six months
"One very troubling point is that...re-default rates increased each month and showed no signs of leveling off after six months and even eight months," the report said.
“Bankers are doing traditional workouts,” says Pinto, offering an explanation for the unusually high redefault rates.
By contrast, the Depression-era Homeowners Loan Corporation—which many foreclosure relief advocates would have as a model for today’s problem – had an 80-percent success rate with the one million loans in modified. The average loan-to-value ratio was 80-percent, which is much lower than the bulk of today’s cases.
Details And Fine Print
There are other crucial differences between now and then. The number of underwater borrowers—meaning the loan is greater than the market value of the home – is increasing by the day, as home prices continue to sink amid rising inventories.
According to the National Association of Realtors, there are now some 10 million homeowners in that category.
The group’s chief economist, Lawrence Yun, says government subsidized rates to modify loans need to include that group otherwise “some will lose the incentive to make payments” and avoid foreclosure.
Another conundrum is the role of the companies paid to service the loans. It’s generally agreed that they need a financial incentive to agree to modification, which is already the case with foreclosure.
Columbia’s Mayer and others say servicers also need legal protection from the government to act without having to get approval from a variety of partners and thus protect them from lawsuits.
JPMorgan Chase, however, is pushing forward. The bank, which says it has prevented about 330,000 foreclosures since early 2007, just announced it is extending its mortgage modification efforts to some $1.1 trillion of investor-owned loans it services.
Chase believes "it can legally modify the vast majority of mortgages owned by investors consistent with the relevant investor agreements and the best interests of investors," according to a statement.
Mayer and fellow Columbia professors Edward Morrison and Tomasz Piskorski are pushing a plan that both compensates and protects loan servicers, which they estimate would prevent a million foreclosures at a cost of $10.7 billion.
Mayer also wants the government to continue efforts to reduce interest rates because “lower mortgage rates represent the single best way to reduce foreclosures by stabilizing house prices.”
Dean Baker, co-director of the Center for Economic And Policy Research, has been pushing a fairly simple plan, which he says give banks more incentive to negotiate with borrowers. It would give homeowners legal rights to stay in the property after foreclosure, paying rent at market rates, even if a property was resold.
Baker is among those who oppose any significant government spending on foreclosure relief, partly because too much money “goes to bankers" and the money could be spent else where on such things as health care and education.
"How much money are we willing to spend to keep people in their homes," asks Baker. "How far are we going to go?"
Based on the current political momentum, taxpayers may soon find out.