Oops, they did it again.
Mortgage Daily News reports Fannie and Freddie spent $600K in Oct., 2011 at the MBA’s annual convention. In 2010 they spent $640K on the same conference and Congress went ballistic. Apparently Fannie, Freddie, and the FHFA thought the outrage of our elected officials warranted a change, so they responded by reducing spending by a whole 6.25%.
I shouldn’t be writing. I’m backed up with arguably the most complicated and important data aggregation project I’ve ever been involved in. When finished I’ll be pushing out chart’s that make CR’s chart fascination look benign.
But I can’t help but to take a few minutes and digitally ink a few words about this.
Fannie Mae and Freddie Mac just stuck up the middle-finger to you, Congress, and to the American’s that you’re supposed to represent. Will you finally do something meaningful about it?
Unlike many I don’t think that Ed DeMarco is evil incarnate. I think that he’s doing his best given the constraints of HERA but he’s dealing with two unruly, entitled, dishonest beasts who hold themselves above the law, who have shown that they can’t be regulated, and who need to be unwound.
Let’s finally change HERA, the law that funds these monsters. Let’s admit we can’t mend it, and finally end it.
It’s time for Congress members to stand, Reagan-style, in front of their headquarters and scream “Fellow members of Congress, tear down these organizations.”
This isn’t a Democrat nor Republican problem: Fannie and Freddie have become the vision of an equal-opportunity contemptuous monster. They’re like the child of parents who bitterly divorced and who later realizes he can play them off one another, listening to neither, while repeatedly spending wildly on their credit-cards then sneering when called out.
Speaking of children, my own son is in a public charter-school math and science program where three years of honors high-school math are required before starting high-school. His class is the first where Hon. Algebra II wasn’t offered in summer-school because of budget cuts, so they took the class online. Teachers confirm that the whole group has struggled substantially more in pre-calc and now calc classes than their predecessors who had a real teacher for what is, for eighth graders, a tough class.
Congress, why don’t we have enough money to fund honors math classes for our brightest kids — the one’s who have proven by working their asses off that they’re the future one-percent types that pay all those taxes — but we do have $180 billion to fund these reckless, worthless, market-destroying organizations.
Here’s a blueprint to burn down Fannie Mae and Freddie Mac:
1. Over 3-6 months auction the portfolio, the loans they own, at whatever the private market is willing to pay. Allow people to “buy” their houses out of the pool at auction value plus a small administrative fee, and the rest go to private investors. Leave the guarantees intact since they’re contractual obligations. If people scream this is “illegal,” that it’s some type of taking, then just stop funding them, call Fannie and Freddie’s own loans when they miss a payment, and allow a bankruptcy judge to do what the Constitution contemplates should be done to bankrupt organizations. Since Fannie and Freddie executives advocate for fast foreclosures I’m sure they’ll be enthusiastic at their own organizations quick liquidation; they can quickly pack and leave, with no severance.
2. Create a new organization to continue the guarantees, albeit on a ramp-down period of 5-8 years until the private market can find it’s footing. That is, for the first 48 months the guarantee program will continue as-is, though with first-loss provisions for originators, then over the next 36 months the maximum volume of guarantees would be reduced by 1/36th of the volume from the first 48 months. Then .. they’re gone; nothing but a bad memory of failed social experiment that caused immeasurable suffering.
That’s it. Loans will be held by private organizations who have shown they have a substantially lower 12-month re-default rate, who are willing to write down principal when they realize it is in their bests interests, and who — while they’re far from perfect — are a lot better than the GSE’s.
Don’t leave them around to “create standards” for new technical infrastructure, their latest gambit. That’s best left to a consortia of private businesses. Plenty of people, myself included, would love to compete for this work by creating private businesses that will do this more competently and even more transparently than the GSE’s, since we’re not exempt from disclosure laws and have to answer to market forces.
With this latest move the GSE’s have set the stage for their own well-deserved execution. Now the question is whether our legislators will have the backbone to do what’s needed. Any legislator, from either party, that won’t cooperate deserves to lose their jobs this fall.
Housing Wire published an article, Nightmare continues for Florida foreclosure system, that meant to blame foreclosure defense lawyers for slow foreclosure processing times. However, the article inadvertently highlighted a different but more genuine cause for the slowdown in the swamp.
Two lawyers are cited, David Rodstein of the Rodstein Law Group, and Jane Bond of McCalla Raymer. McCalla Raymer is large foreclosure filer in other states, though they’re a relatively recent entrant to Florida. The Rodstein Law Group is definitely a new firm, as I’ll explain later.
“It’s not as bad as it seems,” the article quotes Rodstein, speaking about the backlog of Florida foreclosures. ”It’s much, much worse.”
Rodstein explains his reasoning: “Borrowers can hire these (foreclosure defense) attorneys for a small monthly payment — much less than the mortgage — and the attorney can come in and easily delay the case for a year plus.”
Bond notes the problem escalated after the firm run by disgraced lawyer David J. Stern blew up. One bank went from having six lawyers in FL to 26, she adds.
Since I don’t know which servicer she is referring to I can’t check my database to see who these new firms might be. I strongly suspect two of these new firms include McCalla Raymer and the Rodstein Law Group.
“The judges are frustrated,” Bond notes. “The attorneys are frustrated. The servicers are frustrated. Everyone is frustrated.”
I’m frustrated too because, you see, Rodstein worked for disgraced and shuttered law firm Ben-Ezra Katz, and whined about the pace that his former employer was forced to turn over files to government-owned Fannie Mae. It was this slow, disorganized turnover — and the reckless lawyering that led to it — which sent our court system reeling and have caused massively higher loss severities to MBS investors.
“I really wish there was more time to do this in a more orderly manner,” said then Ben-Ezra & Katz attorney David Rodstein to the Palm Beach Post on Feb. 25, 2011, Fannie Mae wants files back from fired firm.
Let’s repeat that: the Mortgage Bankers Association asked a lawyer who worked for a firm that was shuttered based on ethical issues — and who then worked to delay handing files back to banks — to chair a committee and lie that it is foreclosure defense lawyers who slowed down foreclosures.
After almost exactly one year Rodstein apparently forgot that he actively worked to slow the transfer of files back to Fannie Mae, which as the Housing Wire article correctly notes, ground the entire FL foreclosure system to a halt. Now a lawyer directly responsible for that slowdown blames the dysfunction on foreclosure defense lawyers rather than accepting any form of personal responsibility.
As for Bond she surely knows that the General Counsel of her new employer is former Fannie Mae lawyer Susan Reid, who had something to do with attorney supervision in Florida. I’d like to be more specific on Reid’s responsibilities but the FHFA, the government agency overseeing Reid’s former employer Fannie Mae, refuses to answer Freedom Of Information Act requests. Fannie argues that they’re a “private” company, albeit one who’s soaked up $180 billion in taxpayer dollars along with cousin company Freddie Mac, and not subject to FOIA disclosure.
I’m sure readers will be shocked — shocked! — to learn that Reid left Fannie Mae after just under 19 years there, in Sept., 2010, right after Stern’s firm was exposed as a fraud-factory and exploded Death Star style. Reid worked for Fannie when they blew off a report from Nye Lavelle that decisively proved Stern was a crook.
It’s telling that these are the two lawyers the MBA chooses to chair a panel on the subject about why foreclosures linger in Florida. But it’s even more insightful that neither Rodstein nor Bond told reporter Jon Prior about the role they or their firms played in the meltdown.
Bond is right about judges being frustrated. Just today I heard a judge literally screaming at a foreclosure lawyer about her inability to “responsibly” handle these cases as she argued to delay a case. As for the other two “frustrated” groups, foreclosure lawyers and servicers, they can find the source of their frustration in any mirror.
There are two groups notably missing in Rodstein and Bond’s list: investors, who actually funded the loans, and borrowers trying to bring their cases to resolution. I realize that to Rodstein and Bond borrowers and lenders exist just to feed them fees but you’d think they’d throw them a crumb of sympathy, especially investors who’s losses continue to climb.
Bond investors, the organizations that wrote the checks, are entirely missing in their narrative.
Maybe Bond, Rodstein, and the MBA reason that both borrowers and lenders were dumb enough to trust servicers, so Rodstein, Bond, and the misnamed MBA — which doesn’t seem to hold any regard for bond investors whatsoever — believe neither has any rights. Bond holders and borrowers, in their world, are supposed to pay endless fees to the irresponsible, dishonest, and reckless agents and their attorneys that have mangled the borrower-lender relationship beyond recognition.
Rodstein’s former employer has slowed down more foreclosure cases than any Florida foreclosure defense lawyer, and maybe more than all of them put together. If Reid was overseeing FL attorney compliance during her time with Fannie Mae then the GC of Bond’s firm is responsible for slowing down even more cases than Rodstein. Except for Stern and Ben-Ezra themselves it is difficult to think of a worse choice of mouthpieces to whine about the pathetic pace of Florida foreclosures than these two
“Fool me once, shame on you; fool me twice, shame on me,” is an ancient saying. By hiring the same people who caused the mess, rearranged at new law firms, who refuse to take any responsibility for the mess they caused, servicers are setting the system up for another meltdown.
I’d be happy to use my database to pull the Bar ID’s of any lawyer involved in the “old” system and deliver a list of lawyers — let’s call it a reputational background check .. OK, or maybe a blacklist — to investors who can and should insist servicers ban them from working on new cases. Pursuant to 2008 HERA’s mandate to minimize taxpayer losses the FHFA is obligated to ban the GSE’s from hiring these reckless, irresponsible, and dishonest attorneys and any firm that would hire them.
The Florida Bar has obviously decided not to take any disciplinary measures against these lawyers. Indeed, Stern himself still has a license in good standing to practice law; there has been no disciplinary action taken against him. The FL Bar even threw out an ethics referral from an appellate court.
However, self-regulation can and should deliver a simple solution: fire foreclosures lawyers that had anything to do with creating the current mess, as well as any firm that hired them. That alone will send a message for new firms, with new lawyers, to responsibly and respectfully respond to the judges frustration, a feeling which — despite being non-existent to mill lawyers — I can attest is shared by bond bond investors and borrowers.
Over the weekend I had a conversation with Alan Boyce, a seasoned bond trader and mortgage expert, who persuasively argued that computer programs inadvertently helped trigger the housing crisis and continue to substantively depress the market.
Alan’s hypothesis is that banks programmed their mortgage pricing systems to be either market leaders — “competitive” is the term he used — or second-tier more conservative followers.
You can see those systems work in real-time to this day. Log onto a myriad of websites for mortgage pricing information, enter some basic information or even your social security number, and computers will instantly and accurately churn out their best quotes. Mortgage brokers use essentially those same systems.
As the “competitive” mortgage companies — many who engaged in both prime and sub-prime lending — began to fail, he argues, systems at other banks automatically responded by ratcheting up their own prices. This cycle continued on a slower but just as deadly trajectory as the 1987 quant market meltdown, where the S&P shed 20% of its value in one day.
Volumes declined, leading to the end of an ever-decreasing number of sub-prime players, which led to higher prices from fewer competitors.
Finally the fiercely competitive players were wiped out, leaving nothing but the more conservative banks. However, these banks had programmed their systems to come in second; they did not want to be market leaders.
As each system tried to push behind the pricing of the others pricing increased dramatically, becoming almost entirely divorced from the underlying cost of capital.
Rates rose and volume dropped in a self-sustaining cycle that eventually crashed the market and, unlike the 1987 crash, has been neither noticed nor corrected to this day.
There are many side-effects, some that the public has noticed and some that we haven’t.
One of the worst is a dramatic increase in mortgage profitability, at the expense of both borrowers, the housing market, and the overall economy.
Boyce notes that mortgage profitability has increased about 600% since the height of the bubble. He convincingly argues originators and the GSE’s enjoy an essential monopoly and the inevitable pricing power that comes from being king.
I’ve never heard much discussion about whether banks and the GSE’s are behaving like Enron energy traders who didn’t flinch at flipping off electricity to entire neighborhoods when their pricing demands weren’t met, but the notion doesn’t seem far-fetched.
On one hand, the GSE’s have a mandate under the 2008 HERA law to minimize losses. On the other, that doesn’t mean that they’re allowed to fix prices. I don’t know if any of their myriad of exemptions includes immunity from price-collusion, but seeing that the government created two GSE’s on purpose that seems unlikely.
Indeed, the GSE’s absolutely used to compete fiercely. Competition is what led Fannie to adopt a “strategic relationship” with Countrywide in 1999, and served as the partial impetus for Freddie to purchase the doubly-pledged Taylor, Bean, and Whitaker loans throughout the bubble years.
Boyce didn’t raise the question but I will: now that the private secondary market has all but evaporated is there either inadvertent or overt price gauging between the GSE’s under the guise of risk management?
Boyce cites some compelling figures from September, 2011. He examines a hypothetical borrower with a 739 FICO score and a 75.01 loan-to-value (LTV) ratio: reasonably strong credit and just over 25% equity in their house.
That intuitively sounds like a strong borrower to me but apparently they will pay a .25 points “Adverse Market Delivery Condition” (AMDC) charge, a .5 points “Loan Level Pricing Adjustment” (LLPA), and another .5 points penalty in the bond market. After all the pricing math this person, with reasonably strong credit and a sizable equity cushion, will be offered a loan at 4.5% for money so cheap that the government is essentially paid to lend it.
Leave the same equity cushion but drop that borrowers score to 699, which is still high given our economic climate, and the costs skyrocket. The market hasn’t changed so the AMDC remains at .25 points but the LLPAs jumps to 1.75 points and the bond pricing to 5.5%. For paying a credit-card payment late, once, months before, that same borrower now faces a 6% mortgage rate.
On a $300,000 30-year fixed mortgage for $300,000 the 739 FICO score borrower will have a $1,520.06 P&I payment; the borrower with the 699 FICO score will pay $1,798.65 per month. Those forty FICO points will cost the borrower an extra $278.60 per month, $100 thousand more — a third of the initial loan amount — over the life of the loan.
Charging an extra $6.96 per month per FICO point does seem like an unreasonably steep pricing premium.
Boyce served a stint as a senior executive on the secondary market desk at perennial bad-boy Countrywide. On one hand that obviously serves as a taint on anybody’s reputation, but on the other hand almost anybody who knows what they’re talking about in the mortgage field was involved to some extent with one or more of the sub-prime lenders.
While it’s reasonable to contextualize the motivations of those who were involved in the market during those days it can also become counterproductive because so much institutional knowledge is tied up in their collective conscience.
In any event, Boyce’s figures speak for themselves, and those figures paint an ugly portrait for the ongoing health of the housing market as well as the overall economy that inevitably follows this vital market.
Returning to those automated pricing systems, the government should explore whether bankers accidentally discovered they can jack up mortgage prices to rates that might be as unreasonably high now as they were unreasonably low during the bubble.
As we approach what seems like the tenth final deadline for the AG settlement we can continue playing the blame game endlessly while families are thrown to the street and our economy sits rotting like unpicked fruit on a tree. But at some point — and I suspect we’re past that point — this becomes counterproductive if not outright harmful.
Let’s figure out first what went wrong, what we can do about it now, which elements are blocking the way to a stable market and how to quickly but responsibly repair them, and what’s most likely to restart the private market. Financially responsible American’s deserve to obtain or refinance their mortgages and it’s up to our government and banking system to make that happen.
In two stories Pro Publica follows up on their Monday non-story about Freddie Mac’s decision to increase retention rates of the interest-only (IO) arm of pools they bundled in 2010.
Yesterday Pro Public released two more stories on the subject. Rather than admit any problem with the original they doubled down, or more accurately, tripled down.
The first of the two stories, Why Fannie and Freddie Are Hesitating to Help Homeowners, was released at 4:10pm. After a few hours initial authors Jesse Eisinger and Chris Arnold released Frddie Mac’s Regulator Says Trades Were Shut Down Because They Were “Risky.”
Both stories contain the same theme. Senators from both parties are shocked — shocked! — that Freddie Mac decided to keep the IO arm, putting itself in a position where the GSE stood to lose money if borrowers refi’d into lower interest mortgages.
Quoting Pro Publica’s “why they’re hesitating to help homeowners” story: “Sen. Barbara Boxer, D-Calif., told NPR she was shocked by a recent meeting with DeMarco. ’It was the worst meeting I’ve ever had in my life,’ said Boxer. ‘His interest is making sure Fannie and Freddie do well financially.’”
I can’t imagine why DeMarco would think such a thing: maybe it’s because by law he’s obligated to? Specifically, the Housing and Economic Recovery Act of 2008 (HERA) mandates that the GSE’s attempt to make a profit to pay back the US for the damage their pre-meltdown recklessness caused. Boxer voted in favor of the legislation, along with 84 of her Senatorial colleagues including Sen. Robert Casey, D-Penn., who also criticized Freddie’s behavior.
As I’ve already written it’s far from clear that Freddie’s decision to retain the IO coupons can be construed as harmful to American borrowers for a number of reasons, the most compelling being that by owning the paper Freddie can more easily modify mortgage rates downward without investor liability or interference.
But there’s one point I missed: even if the decision to retain the coupons wasn’t in the best interests of borrowers — even if Freddie Mac was simply trying to make money at the expense of the American Homeowner — that’s exactly what they’ve been ordered to do under the law.
Under laws passed by a Democratic Congress and signed into law by a Republican President Fannie Mae and Freddie Mac must try to make money and pay back the American taxpayer.
There’s a legitimate debate about the best way to help American homeowners. For example, I strongly believe that principal reductions, while politically unpopular, would likely put a floor on the market and — assuming we can figure out a way to address the enormous amount of shadow inventory without torpedoing the market — save the GSE’s more long-term money than they’d cost. Somebody, either at Fannie, Freddie, or the FHFA obviously disagrees.
I don’t entirely understand their reasoning but at least I recognize the constraints that they’re under and, I’m hopeful, that they recognize and understand the argument in favor of principal reduction. Principal reduction is one element that has sharply reduced 12-month re-defaults in the private market, with its lousier borrowers, lowering it below the GSE 12-month re-default rate. In a report they wrote IT problems were partly to blame but I’m sure there’s something deeper than that (if that is the case here’s a short-cut: enter the principal reduction as a one-time negative “fee” in existing systems).
It wasn’t long ago that Fannie and Freddie were running around touting their “affordable housing” initiatives. In cooperation with “strategic partners” to serve as originators, the most notable being Countrywide’s Angelo Mozillo, lots of people purchased lots of houses. They achieved the “American Dream” of home-ownership .. only to see it ripped away when the bubble burst.
Private banks built and financed most of the half-million dollar Chinese drywall 3BR house that went on to rot hopes and dreams the same way they did the house’s wiring. But it was Fannie and Freddie that laid the political, legal, and moral foundation that allowed those banks to put people into homes bankers knew they could not afford.
In Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, Gretchen Morgenson and Josh Rosner spell out this argument better than I could. Their hypothesis and narrative is substantively different than the normal “Fannie and Freddie did it” oversimplification we’ve become familiar with, and a lot more compelling. Fannie and Freddie really did do it, just not in the way most people understand.
Pro Publica and certain members of Congress are veering dangerously close back to the notion that there is something positive about selling houses to people who cannot afford them, and that the GSE’s should be aiding in that goal. There isn’t, and they shouldn’t.
DeMarco has been described as steely or icy. Given his history, his mandate, and those he has to work with that’s understandable. All things considered he arguably has one of the worst jobs in government. Love him or hate him he should be commended, not condemned, for following the law. If Congress has changed their mind about that law they should revise that law rather than attacking the agency head working to enforce it.
Yesterday Pro Publica released a piece about Freddie Mac retaining the interest portion of some of their securities, Freddie Mac Bets Against American Homeowners. Their theory is that Freddie Mac has set up a hopeless conflict of interest because by retaining the interest-portion of certain securities they GSE is incentivized to disallow refinances to lower interest mortgages.
As Yves Smith points out in nakedcapitalim, Pro Publica’s Off Base Charges About Freddie Mac’s Mortgage “Bets” this story is simply incorrect.
It’s difficult to defend the behavior of either GSE, Fannie or Freddie, because — borrowing from Abba Eban — the GSE’s never miss an opportunity to miss an opportunity to do the right thing. While I don’t believe they’re anywhere close to the root cause of the housing bubble, they’re definitely the root cause of the foreclosure fraud scandal that followed it. It’s long past time they were shuttered and that we drop this myth that they’re viable independent organizations.
Still, this is one area where Freddie Mac didn’t do anything wrong and the statistics support that their decision to retain the interest portion of the securities in their portfolio is not affecting their modification decisions.
Before digging in to specifically what Freddie is accused of, and why it’s one of the few areas where they did nothing wrong, let’s jump to the end and inspect whether it’s affecting modifications. I wrote a piece of analysis just last week that dug into mortgage modification statistics that partially addressed this issue, Mortgage Modifications: Slaying Zombie Debt.
I’ll summarize key portions of that article; every quarter the Office of the Comptroller of the Currency (OCC) releases a study detailing loss mitigation options, including modifications, for mortgages. Their latest study was release for Q3, 2011. They break modification options down into several buckets, including capitalization, interest rate reduction, interest rate freeze, term extension, principal reduction, principal deferral, and “not reported” (the servicer cannot contractually explain what modification term they offered).
Freddie Mac was accused by ProPublica of making financial decisions that create a conflict of interest for lowering interest rates. This is directly refuted by the fact that Freddie regularly freezes and lowers interest rates in modifications.
Keep in mind, while reviewing the figures, that most modifications involve more than one category of relief, so results add to over 100%.
Freddie reduced interest rates in 74% of the modifications they offered and froze rates in 7.6% of their mods. In contrast Fannie reduced rates in 70.4% of their mods and froze rates in 3.6%. In contrast government-guaranteed (FHA, VHA, etc..) loans lowered rates in 93.7% of their mods, private investors lowered rate in 71.5% of their mods, and portfolio loans lowered interest in 83.6% of their mods.
That is, the facts just don’t support that Freddie is especially stingy about lowering or freeze interest rates when modifying mortgages.
Back to Pro Publica. Summarizing their article, they reported that Freddie retained the interest rate obligations of certain pools of mortgages they’d bundle, but sold off the principal portion.
So what? Pooling and selling mortgage is what the GSE’s do. Love them or hate them their job is to purchase mortgages, bundle those mortgages into pools, then sell those bundles to investors so that they have money to make more mortgages.
Freddie then hedged the interest-rate portion that they kept, so that if rates fluctuated their financial position would not be adversely affected. Not only is there nothing wrong with this, but it would be entirely irresponsible of them to do so.
Finally, it’s important to remember that the new government proposed refinancing programs are refinancing, not modifications. There is nothing Freddie can do one way or another regarding refinancing: borrowers simply take out a new loan at a lower interest rate.
That is, if this issue had any effect on Freddie’s decision-making process — which it appears not to — Pro Publica didn’t even focus on the area where it would matter, modifications, not refinancing.
Finally, because loan modifications arguably run afoul of investors — who have paid for and are contractually entitled to the terms they purchased — retaining the interest bearing portion makes modification of that same interest bearing portion considerably easier than if they sold it.
This akin to running a story that a surgeon is knocking random people unconscious then cutting them open. Technically it’s true but it’s also misleading. It’s especially bad if the surgeon is a hack who routinely botches their operations, which is a fine analogy for the GSE’s behavior.
I’m not sure why Freddie kept the interest bearing portion, but one possible reason is that nobody wanted to purchase it, or that potential buyers wanted even higher rates which Freddie would need to pass on to new borrowers.
There’s lots of reasons to criticize the GSE’s, but retaining the interest bearing portion of mortgages is one of the few areas where they’ve done nothing wrong.
Principal writedown, erasing part of a mortgage debt usually to avert foreclosures, has become a raging debate.
There is nothing new about the concept of principal writedown. In many ways it remains the core tenant of Chapter 11 and 13 bankruptcy, the former usually for businesses and the latter for individuals. Chapter 11 is oftentimes not even referred to as “bankruptcy” but by the gentler name “reorganization.” In contrast, Chapter 7 is liquidation, where the assets of an individual or a company are sold, their debt eliminated, and the business shuts its doors or the individual theoretically starts over again.
Principal writedown is a growing but still seldom-used method used to modify mortgages, typically when the value of a house is substantially worth less than the amount owed.
Let’s examine some interesting figures from the latest quarter report from the Office of the Comptroller of the Currency (OCC), entitled “OCC Mortgage Metrics.” I’ve uploaded some of the data tables in the report to a downloadable spreadsheet, here.
Principal writedown is present in 7.8% of the 137,539 Q3, 2011 mortgage modifications. Only private lenders cut principal, probably because the notion tends to leave neighbors livid even if it’s the right solution. Private bankers make rational economic decisions, whereas government officials are clearly bound by political constraints based upon what the neighbors think.
It’s in the neighbors best interest to reduce principal and avoid foreclosures, since it keeps their own property values propped up, though it irrationally leaves them livid.
Before examining principal writedown itself, let’s look at various types of loan modification the OCC reports on: capitalization, interest rate reduction, interest rate freezing, term extension, principal reduction, and principal deferral. [Note as we walk through the numbers: since mods often involve more than one aspect figures often sum up above 100%.]
Capitalization is, by far, the most common loan modification method used in 88.5% of all mods in Q3, 2011. Capitalization is troubling in that it takes a borrower who is already in trouble and puts them in worse trouble by adding missed payments and fees to their already unaffordable balance.
Increasing zombie-debt sounds like exactly the wrong thing to do for both bank and borrower, but thanks especially to Fannie Mae, Freddie Mac, and other government-guaranteed loan modifications capitalization is the most common element of all modifications.
Capitalization was used in 86.6% of Q3, 2011 modifications for prime loans, 89.5% of Alt-A mods, 88.3% of subprime mods, and 93.4% of the large but nebulously named “Other” loan type. In contrast, principal reduction was used in 5.5% of prime mods, 8.7% of Alt-A mods, 12.3% of Subprime mods, and 4.6% of “Other” loan types.
Private investors are more willing to modify a loan to see if it will perform, probably on the notion that if restructuring will not work the debt should be written off. That is, they’re more likely to encourage either positive or negative resolution. Private banks appear wary of zombies.
In contrast, government-backed loans appear more likely to favor measures to keep the loan “alive,” without reducing principal. We’ve heard of zombie-like bureaucrats in DC; it stands to reason that they’re comfortable with their financial equivalents. Fannie, Freddie, and government guaranteed (FHA, VHA, etc..) mods included capitalization at 96.8%, 99.1%, and 98.3% respectively. In contrast, 85.3% of loans held by private investors and 67.4% of loans held in portfolios involved capitalizations.
Jammed-up government-backed borrowers are more likely to receive term extensions. Fannie, Freddie, and government-backed term extensions exist in 68.1%, 69.5%, and 84.4% of their respective mods. In contrast, just 24.2% and 36.5% of portfolio loans involve term extensions. This suggests the private market prefers their loans either alive or dead; they’re trying to move beyond extend and pretend.
None of the government-backed loans agree to reduce principal whereas 15.3% of loans by private investors and 18.4% of portfolio loans involve principal reduction. Similarly, principal deferral — the process of moving principal later in the life of a loan when the house might have more value — is present in 25.6% of Fannie’s mods, 18.2% of Freddie’s, and .1% of those guaranteed by the government (that’s not a typo). However, this more borrower-friendly method for making loans affordable is present in 23% of loans held by private investors and 29.2% of portfolio loans.
Modification success is broken into two series of reports, one towards the top of the report that summarizes success over all time periods lumped together and a more useful series, buried further down, that breaks down success using more granular time-based reporting.
Even with lousier borrowers, it’s clear the private market does a better job making mods.
For 2008-2010 modifications the success rate — the rate where borrowers did not re-default after a year — was 61.6% , 46.8%, and 26.4% for GSE and government-backed loans. In contrast, private and portfolio loan 12-month re-default rates were 50.6%, 38.6%, and 23.7%.
The summary report, lumping together all times, paints a rosier picture for the government for 12-month re-default rates. Fannie and Freddie both report a 28.2% re-default rate, government-guaranteed loans had a 50.8% re-default rate, private portfolio loans come in at 48.3% re-default rate, and portfolio loans suffer a 25.2% rate.
However, those all-time modifications statistics include the much higher private loan 12-month re-default rates for the 2008 modifications, at 61.2%. Given that these loans were often to substantially riskier borrowers — think corner-stores where mortgage brokers purchased “Wite-Out” by the case — it’s amazing they lowered their 12-month re-defaults to 29% for the 2010-era mods.
Although private lenders do offer principal reduction, they do so comparatively low rates making it difficult to adequately quantify what effect principal reduction has on modified loans. [Note: remember again that that most modifications offer some combination of terms, meaning the percentages of loan modified by type of modification exceeds 100% of all modification types.]
In Q3, 2011, lenders offered principal reduction in 10,722 modifications. In contrast, 121,716 modifications included capitalization, 112,819 included a rate freeze, 79,536 contained a term extension, and 28,133 included principal deferral.
Overall, there were 137,539 loan modifications in Q3, 2011, according to the OCC, so 7.8% contained an element of principal reduction. That figure is low enough, and the OCC data coarse enough, that it is impossible to draw a definitive conclusion.
Around the web we find colorful depictions of how to slay zombies, or bring them back to life. It’s apparent that the private market has a good track record of making the right long-term decision when forced to shoulder the downside risk of its own decisions. Being a basic tenant of capitalism, this shouldn’t be a surprise but it’s still happening all too seldom.