The National Debate Over Loan Modification Re-defaults is Stupid

It is apparently time for yet another national debate on whether loan modifications are an effective way to prevent foreclosures, and so far this one promises to be every bit as stupid as the last.

TransUnion recently reported that after their loans were modified, only 40 percent of homeowners remained current on their mortgage payments 18 months later.  The study made headlines by reporting that after 18 months, 59.1 percent of modified loans had re-defaulted, meaning they went 60 or more days past due, and within 12 months, 42 percent had gone 60 or more days past due.

Building on this report’s results, some have said that were we to look at re-defaults in 36 months, the percentage re-defaulting would be even higher.  I don’t have any way of knowing for sure whether that’s true or not, but I’d be willing to accept it as being the case.

Adding to the headlines, a report by the Office of the Special Inspector General for TARP, more commonly known as “SIGTARP,” showed almost equally dismal performance for HAMP loan modifications.  In its April 24, 2013 Report to Congress, SIGTARP stated, among other things, “Of the 1.2 million HAMP participants, 306,000 have re-defaulted on their mortgages,” and went on to say that an additional “88,000 homeowners have missed payments and are at risk of re-default.”  

The report puts the cost to taxpayers for the re-defaults to-date at an intended-to-be-infuriating, $815 million.

Seemingly, ‘tis the season, so Fannie and Freddie also recently released a report tooting their GSE horn.  The FHFA, which is the agency that regulates Fannie and Freddie, reported that since the federal government forced them into conservatorship in September of 2008, they’ve provided nearly 2.3 million “foreclosure prevention actions” that, as of March 2012, have succeeded in helping 1.9 million borrowers avoid foreclosure, including 1.1 million permanent loan modifications.

Of course, the FHFA has prohibited Fannie and Freddie from offering principal reductions on the loans they hold.  Fannie and Freddie do modify loans under HAMP, but only by reducing interest rates and offering forbearance agreements.  FHFA’s report showed that that half of the loan modifications granted by Fannie and Freddie during the first quarter of 2012, reduced monthly payments by over 30 percent, with nearly one-third receiving principal forbearance.

The FHFA also claims that modified loan performance, without forgiving principal, “remains strong.”  According to the agency’s report, as of nine months after modification, less than 15 percent of the loans that were modified in the second quarter of 2011, had missed two or more payments… and if you can figure out how to compare that statistic to any other, I’ll bake you a cake and then jump out of it in my birthday suit.

Not surprisingly, the combined effect of the three high-profile reports on borrower performance after having their loans modified, made headlines that have sparked a national debate… yet again.  And unquestionably, it would have to be considered an important topic when you consider that not only have roughly 5.5 million Americans had mortgages modified since 2006… but according to the MBA National Delinquency Survey, as reported by Calculated Risk, there were another 4.8 million considered to be literally “teetering on the edge of default,” as of February 2011… and today, according to Lender Processing Services (“LPS”), there are still 4,785,000 loans over 30 days delinquent… with 2.8 million of those loans already over 90 days past due.

From the Left and the Right…

For conservatives and the mortgage banking lobby, these reports are “red meat,” proof that Obama’s loan modification program is a waste of taxpayer money and is only delaying the inevitable.  For example, John H.P. Hudson, area manager for San Antonio, Texas-based Premier Nationwide Lending, was recently quoted by National Mortgage Professional Magazine as saying…

“Unfortunately, the real tragedy is that many borrowers probably could not afford the house at the time the loan was consummated. Sometimes a foreclosure is the only real outcome.”

The solidly conservative, Townhall.com, ran the headline, “The Stunning Failures of Obama’s Mortgage Program,” leading with the statistic, “1.2 milllion people participated in the (HAMP) program at a cost to taxpayers of $4.4 billion,” before quoting from the SIGTARP report on re-defaults.

For those more on the left side of the aisle, the reports only prove that borrowers need principal reductions to make modifications sustainable, and that banks and servicers have incentives that drive them to create foreclosures over the alternatives.

At the Huffington Post, the story began with the understatement of the century, “For many homeowners that have fallen behind on their mortgages, a loan modification doesn’t prove to be a cure-all.”  The HuffPo article then went on to reference a recent study conducted by a broker-dealer that specializes in mortgage-backed securities, Amherst Securities Group, which found that principal reductions are a much more effective way to prevent foreclosures than modifications that only reduce interest rates.

According to the Amherst study, only 12 percent of borrowers who were granted principal reductions re-defaulted in 2011, compared with 23 percent of borrowers whose interest rates were reduced, and 30 percent who only received a forbearance.  According to the U.S. Treasury Department, “the typical amount of debt forgiveness in a principal-reduction modification is approximately $60,000.”

David Dayen, writing for Firedog Lake, also pointed to the Amherst study, but summed up his view of the situation succinctly…  “When it comes to homeowners keeping their homes, principal reduction works, and crappy HAMP-style loan modifications do not.”

“However, when it comes to banks and servicers, principal reductions do not work, as they eat into profits. What’s more, crappy HAMP-style loan mods work decently, because they often forbear principal or capitalize late fees in ways that increase profits. What often works best is foreclosure, because the servicer gets first in line to recoup its costs in a post-foreclosure sale. So that’s why we get the policies we get.”

But, David also admitted that… “Principal reduction as a percentage of overall modifications are up this year at the big banks, though overall modifications are down. However banks cannot reduce principal on loans owned or backed by Fannie and Freddie, and at this point that’s most loans.”

Rick Sharga of Carrington Mortgage Holdings, also chimed in from the center, telling CBS News that the 40 percent of American homeowners who have avoided foreclosure through a loan modification is still a very good thing.  According to Sharga…

“That is about 2.2 million people who didn’t go into foreclosure, whose homes didn’t contribute to housing market depreciation overall and whose loans didn’t have to be written off the books by the lenders. That is an enormous impact.”

CBS closes out their story by echoing the point that, “Some 5.5 million Americans have modified their mortgages since 2006. But 4.8 million more Americans are in danger of losing their homes.”

Seems to me I’ve heard that song before…

These sorts of reports and the debates they inspire are nothing new.

Back in 2009, a paper titled: “Loan Modifications and Re-default Risk,” written by Roberto G. Quercia, of the University of North Carolina at Chapel Hill and Lei Ding, of Wayne State University, stated that, “a primary concern with loan modification efforts is the seemingly high rates of recidivism.”  The paper quoted data published by federal banking regulators (the OCC and OTS), which showed that, “within six months, more than one-half of all modified loans were 30 days or more delinquent and more than one-third were 60 days or more delinquent.”

Quercia and Ding posed the same question in their 2009 paper that is being posed today as a result of the SIGTARP and TransUnion studies: “Do these high rates of re-default imply that loan modifications are failing?”

It was a stupid debate back in 2009, and it’s an even stupider one now.  There’s no question about whether or not loan modifications work to prevent foreclosures… of course they do.  It’s just like asking whether step ladders work to help people slam dunk basketballs.  The answer is… yes, of course they do.

Now, if it’s only a two-foot step ladder, and the person is only five feet tall, then it might not work… but you wouldn’t describe that situation as, “step ladders don’t work to help people dunk basketballs,” right?  Of course a step ladder helps someone slam dunk a basketball… but it has to be a high enough step ladder.

The term loan modification today is just a synonym for, “reducing the amount of someone’s mortgage payments.”  I know there are some who don’t agree with that, but they are simply not thinking people.

Bank in 2009, I had a conversation with a banker-type from Credit Suisse about this issue and he was making the point that in some instances, loan modifications result in the borrower’s payment increasing, as opposed to decreasing.  I replied that those instances should not be considered “loan modifications,” and he asked, “Well, what should we call them?”  

And I said, “I don’t know… how about ‘payment increases?’”

Do you want to know why I’m so sure that that the term “loan modification” means reducing someone’s mortgage payment?  It’s simple.  Because if I were to line up a million people in this country and ask each one whether “loan modifications” make one’s mortgage payments go up or down, every single one of them… or damn close… would say, “down.”  If we’re going to have to start debating the meaning of words in the English language, then we’re really a lot farther away from finding a solution to foreclosures than anyone thinks.

So, now here we are, it’s 2013… and we’re apparently still having the same debate based on the same type of vague and ambiguous data being reported by government agencies and large data-driven companies that ends up in a debate over the question: If more than half the loans modified re-default in 18 months or less, does that mean loan modifications don’t work?

I can’t be the only person who sees how stupid this debate is, can I?  Loan modifications absolutely work… if you design them to work.  Just modify payments to $1 a month and I guarantee no re-defaults.

So, why can’t we know the specifics behind the reports of modified loans re-defaulting?  It’s been five years of this, doesn’t anyone know which ones re-defaulted exactly?  

We’re they the ones with modifications that resulted in higher monthly payment amounts?  We’re they the ones that still left the borrower underwater by 50 percent, living all alone on a street in the middle of the Nevada desert, 40 miles outside Las Vegas where no one should have ever built homes in the first place?  We’re they the ones that were technically modified but only ended up saving the borrower $40 a month?  Why can’t we know specifically what is going on?

It feels like someone is reporting that, “4 out of 5 dentists recommend Trident for their patients that chew gum.”  Or how about… “In recent coin tossing experiments, more coins preferred heads over tails.”  What the heck does that even mean?

Back in 2009, Quercia and Ding understood the problem.  They said that “factors involved in loan modifications” made the question of whether high re-defaults meant that loan modifications were failing “less straightforward than it appears.”  They pointed out that, “modifications do not necessarily reduce mortgage payments, only some do.”  

They understood that some modifications only add the back payments and other charges to the loan balance, thus increasing the amount of the debt, and therefore, depending on how far the interest rate was lowered and to what degree the term of the loan was extended, the payment after a modification could be higher.  And in those instances, it’s not really much of a surprise that the borrower re-defaulted, right?

But does that mean that loan modifications aren’t effective at stopping foreclosures?  No, and anyone who doesn’t see this as being painfully obvious has the IQ of a potted plant.  How in the world can we still be having the same stupid debate in 2013 as was going on in 2009?  Have we learned nothing over the last four years?  Do we have some sort of national learning disability?
You don’t have to be a genius to figure out the factors that cause re-default.  The most cynical would be that people are just trying to remain in the home as long as possible without paying, and although I’m willing to concede that there are certainly some that fall into this category, I’m also quite confident that it’s a small minority.

The simple fact is that living in a home while not making mortgage payments is stressful and unpleasant.  You never know what tomorrow will bring and I can’t imagine many homeowners willing to intentionally endure that sort of uncertainty.  And that is to say nothing about the unpleasantness of applying for a loan modification.  Who would go through that wonderful experience knowing that they would re-default and find themselves back in foreclosure within a year and a half?  I’ve personally heard homeowners say that they’d rather go through chemo-therapy than apply for another loan modification.

Our country’s “Great Recession,” it would seem to me, would have to be the most obvious reason for borrowers to re-default on modified loans.  Long-term unemployment has only gotten longer in terms of its term, and under-employment, which is when someone gets a job making significantly less than their prior job, has become near endemic.  Those are the sorts of factors, along with life events like illness, injury, or divorce, that could clearly lead to re-defaults in significant number.

Re-default by Design…

Above all else, however (and I would love to be able to wager on this point), the leading contributor to re-default after a loan modification has got to be the nature of the modification itself.  And that shouldn’t be the least bit controversial or surprising.  The terms offered in a loan modification are notorious for being no better than they absolutely have to be.  The fact is, loan modifications for the most part have been a model of short-sightedness and that’s not an accident… that’s by design.

The design of the original HAMP waterfall methodology, for example, essentially guaranteed a significant number of re-defaults by working off of only gross monthly income and mostly ignoring a borrower’s back-end debt-to-income (“DTI”) ratio.  If a forbearance would fix the immediate problem, then a forbearance was often all that was offered.  The emphasis of the program from inception, was to qualify as many people as possible without any meaningful consideration of what would be sustainable for the borrower.

HAMP v. CFPB’s New “Ability to Repay” Rules…

Just contrast HAMP’s underwriting guidelines with the stringent new Ability to Repay and Qualified Mortgage Rule, designed by the Consumer Financial Protection Bureau (“CFPB”) that will go into effect on January 10, 2014.  (The preceding link will take you to a very good short summary of the new rule.)

I mean, if you want to prevent loans from defaulting… or re-defaulting… this is the sort of Draconian rule-making that is certain to accomplish the objective… although I’m afraid that it may primarily prevent defaults by preventing anyone from qualifying for a mortgage in the first place.

“The Bureau’s 2013 ATR Final Rule implemented the ability-to-repay requirements under TILA section 129C. Consistent with the statute, the Bureau’s 2013 ATR Final Rule adopted § 1026.43(a), which applies the ability-to-repay requirements to any consumer credit transaction secured by a dwelling, except an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan.”

“Under the general definition for qualified mortgages in § 1026.43(e)(2), a creditor must satisfy the statutory criteria restricting certain product features and points and fees on the loan, consider and verify certain underwriting requirements that are part of the general ability-to-repay standard, and confirm that the consumer has a total (or “back-end”) debt-to-income ratio that is less than or equal to 43 percent.”

A back-end DTI of no more than 43 percent?  That means that going forward, ALL of a borrower’s debts, meaning the mortgage’s principal, interest, taxes and insurance, but also including such financial obligations as child support, alimony, payments on second liens… for the most part, as of next year ALL debts will not be able to total more than 43 percent in order to qualify for a mortgage.

(There are certain exemptions in limited instances, but they are extremely limited, and “higher priced loans,” now their own category, also have new restrictions pertaining to Qualified Mortgages.)

My point is that if the federal government wanted to prevent re-defaults on loan modifications, they could have designed HAMP to do that.  They could have offered incentives for principal reductions or at least principal forbearances in order to qualify a borrower for a truly sustainable loan modification… they could have, but they didn’t.

Fannie and Freddie still refuse to reduce the principal on a mortgage, claiming that dong so will cost taxpayers too much, but it’s impossible for me to imagine any number of principal reductions that would cost taxpayers more than the foreclosure crisis already has… and we’re just running in place, for God’s sake.  Go back a page or two… in 2011 we had 4.8 million about to fall into foreclosure… and today that number is still basically unchanged at 4.8 million.

Christy Romero, Special Inspector General of SIGTARP, after releasing her report to Congress was quoted as saying…

“The Treasury needs to research why so many borrowers are dropping out of the program.”

Really Christy?  You guys had time to put that entire report together… all 358 pages of it… and I’m supposed to believe that five years into this mess, no one brought up the idea of trying to find out more specifically what was going on until it was done?  Like, it was some sort of afterthought?  That’s just super, don’t you know.

“Hey, you know what would be cool… if we checked to see why people are re-defaulting?”  Well, thanks Beevis, that’s one heck of an idea.  Too late for this report, but maybe next time.  There’s no rush… it’s only costing taxpayers a billion here and a billion there, to say nothing about the hundreds of thousands still losing homes unnecessarily and due to our government’s collective incompetence.  Take your time, by all means.

National Mortgage Professional Magazine reported that some of the concepts being “kicked around by SIGTARP” in their report include:

• Conducting further research into the causes of re-default.
• Requiring servicers to develop and use an “early warning system” to actively reach out to homeowners who may be at risk of re-defaulting.
• Providing help and information to homeowners who have re-defaulted.

Good Lord.  And that’s what was “kicked around” after authoring a 358 page report for the United States Congress?  You mean to say that if I were to have read all 358 pages, that would be your ideas for the future… that’s your big finish?  Well, thank heavens that I had the good sense not to read your 358 page report, because if I had… and those ideas were the pay-off… I think I would have found myself unable to speak for at least a year.

“What’s wrong with Martin.”  
“I don’t know, he just sits there in his bathrobe and stares out the window all day long.”

The solution is painfully obvious…

What this country has needed from the beginning is simply a loan modification program that doesn’t treat homeowners like social pariahs… one that doesn’t treat information about the process like it’s a matter of national security… and one that doesn’t allow for the possibility of someone losing a home that shouldn’t have, just so it can sit empty until it’s torn down or sold to some wannabe slum lord for a fraction of what its owner would have gladly paid to keep it.

You know… a program that makes sense… something that one could have a shot at explaining to someone else… one that didn’t leave every American homeowner’s future in the hands of some low level manager with a headset, a name badge, and the communications skills of a ferret.  Or even worse… to someone answering the phone in India who knows about as much about what this country’s homeowners are going through as I do about what went on in “Slumdog Millionaire.”

Look, I’m about as reasonable as one could be about this.  I understand that in 2009 the brand new Obama Administration was under a huge amount of pressure to do something about an unprecedented tsunami of foreclosures… and I understand that servicers were about as ready to handle loan modifications in such numbers as General Motors.  But, it’s 2013.  And these are no longer acceptable excuses for a program and a process that were it not so tragic, would make this administration the laughing stock of all time.

Just the other day I read that Bank of America and Wells Fargo received $200 million for modifying mortgages that re-defaulted.  I assume that Chase and GMAC and all the rest received their share of that catastrophic waste of taxpayer cash as well.

Well, good for them.  Make no mistake about it… I’m not mad at the banks for taking the money that was given to them… it’s not their fault… it’s my government’s unbridled incompetence and profound irresponsibility that allowed that to happen.  Those in this administration should be forever barred from using the word, “irresponsible” to describe homeowners no matter what they did in 2005.

And, now… like a broken record from days gone by, some have the unmitigated gaul to imply that the high percentage of modified loans that are re-defaulting should be blamed on borrowers… as if the re-defaults are some sort of proof that the loans should never have been modified… that modifying them was just delaying the inevitable.

Well, fine… if that’s the case then show us what is specifically causing modifications to re-default, because without that detail, I don’t believe it’s the fault of “loan modifications not working,” or that borrowers are delaying the inevitable by modifying their loans… and any sort of national debate on this issue without that information is just more of the same stupidity that brought us here.

Mandelman out.