Loan Mod Catastrophe Can Be Avoided

Is the glass half full or half empty?  Or is it the wrong glass?  On October 8, Treasury Secretary Geitner announced that the Administration’s loan modification program was on target to help 500,000 households avoid foreclosure.  On October 9, a Congressional TARP Oversight Panel released a crtical report that predicted the Administration’s program would, “in the best case,” prevent “fewer than half of the predicted foreclosures.” (NY Times 10/10/2009).  Who’s right?

The problem, of course, is that no one really knows.  The program, which requires completion of a three-month “trial” period for a homeowner to qualify for a “permanent” loan modification, is still in the infancy of the implementation period to provide any meaningful statistics.  According to the NY Times article, as of September 1st, only 1.26% of trial modifications had become permanent, and the plan had produced only 1,711 “permanent” loan modifications.   Many of these so-called modifications involve only a short-term reduction in rate with no reduction in principal, and leave the homeowner upside down with no hope of qualifying for a refinance.  With many Option ARM loans due to reset, and thousands of new homeowners who just entered the market to take advantage of the 3.5% FHA down payment and the $8,000 tax credit, the stage is set for a new wave of delinquencies if the job market continues its current trends.

Another problem is the so-called “shadow inventory” – the homes that should be on the market at a trustee or foreclosure sale, but are not.  The evidence is empirical but not necessarily reliable.  Stories abound of homeowners who have not made their mortgage payments for months, but who have yet to receive a Notice of Default fromt their lender.  Perhaps some lenders are waiting to see how their first round of “trial” modifications play out.  In some cases, the sheer volume of applications has overwhelmed the loan servicers, forcing delays stretching into months while the applications are “under review.”

Bruce Norris recently attempted to calculate more precisely the extent of this phenomenon, noting that the number of Trustee Sales had dropped despite the ever-increasing number of delinquencies.  In July, 2009, he reported the number of Trustee Sales in California had dropped to slightly more than 17,000, compared to almost 29,000 in July of 2008.  Based on the number of deficiencies, the number of Trustee Sales should have been almost threetimes as many – 52,700!  Running the numbers over the past year, comparing delinquencies vs. trustee sales, Bruce Norris calculates that there are approximately 306,329 additionalhomes that should have gone to trustee sale in California.  If the rumors about delinquent homeowners who haven’t even been added to the list are even partially true, the discrepancy would be even higher.  And if the best the Administration’s Plan can hope to achieve is “less than half” of the predicted foreclosures, the prospects for success are indeed dismal.  Any grade less than 50% would not be considered acceptable under any circumstances.

Rising unemployment, overwhelmed and untrained loan servicing agencies, and a continuing refusal to provide adjustment for actual market value, are all ingredients for failure.  Add a few scoops of Option ARM resets, continuing chaos in the appraisal system, and a whole new crop of FHA-backed minimum-down mortgages to the mix, and you have the classic recipe for a catastrophe.  On the national level, the conflicting statistics only generate fuel for debate over policies and programs.  But at street level, families and neighborhoods continue to suffer from the collapse of a complicated securitized mortgage marketing scheme that should not have been allowed to take over and replace a more fundamental but functioning system.

What most homeowners facing default fail to grasp is that the investors who hold or control their mortgage have absolutely no incentive or interest in “saving” the homeowner from default.  All that matters is the value of the Note, and in any particular situation involving a portfolio consisting of hundreds or thousands of individual Notes, which in turn comprise security for an investment held by shareholders, the decisions whether or not to modify the terms are made — not for the benefit of the individual homeowner — but purely and simply on the basis of the impact on the value of the portfolio overall.  Complicating this process are multiple layers of IRS, SEC and similar regulations and restrictions that limit the extent to which the portfolio managers can make adjustments without putting the shareholders — or themselves — at risk.  As it is, the best a lender can tell a homeowner in distress is that they will do a “charge off,” effectively shifting the financial burden for the loss from the lender to the borrower.  While it sounds like a huge break if the lender “forgives” a $100,000 Note, the lender gets to write off the loss against other gains, while the homeowner faces the prospect of a $40,000 tax bill via a Form 1099.

There are solutions out there.  Modifying the tax codes and restructuring the securitized mortgage market dynamics would take too long and would offer little in the form of timely relief.  I like Bruce Norris’ concept of returning to the days when an investor could buy a property by assuming the existing loan.  It would be a simple transaction, and return control of the housing market to people willing to work to make it succeed, instead of faceless institutional speculators amassing unmanageable volumes of security instruments that bear little relation to the properties they represent.  Investors would be permitted to manage their risk more directly, and more importantly, homeowners would have the opportunity and the incentive to participate in the process for a successful outcome.  It provides the opportunity for a classic “win-win” that would save families, preserve neighborhoods, and restore communities.

Forecast: 100% Chance of Uncertainty

In a recent article published on September 18 in Forbes Magazine, “Where Home Prices are Hitting Bottom,” author Francesca Levy attempts to make sense out of recently compiled housing price data produced by a Mountain View research firm, Altosresearch.com, in effect trying to explain where and how different Metropolitan Statistical Areas (MSA) would be hitting “bottom.”  The data focused on whether the number of homes selling at a discount had declined or held steady.  Presumably, if the number of homes selling at a discount was declining, the argument could be made that the housing market in that specific MSA was close to the “bottom” — and a signal to investors to buy.

Four days previously, Ms. Levy had authored another article in Forbes, entitled “Where Home Prices are Likely to Rise.”   In that article, Ms. Levy reported on a housing price forecast produced by Moody’s Economy.com.  As reported, Moody’s calculations were based on long-term demographic and economic fundamentals, changes in income and population, and supply and demand.  Overall, the prediction was for a nationwide 16.08% decrease in prices by the end of the year, but by 2014, prices “will have nearly reverted to their pre-2009 state.”

For San Jose, the article says that the five-year forecast calls for a 23.04% jump in prices; however, that will follow another 25.14% decrease within the next year!  Housing markets in Texas will not see much of a climb, but then they also won’t experience much of a decrease.

As I’ve fondly quoted Yogi Berra:  “Making predictions is difficult, especially about the future.”  The Forbes articles make for interesting reading, and the online graphics are impressive.  But the “small print” caveats continue to provide the harsh reality check.  No one knows the full extent of the number of homes that will go into foreclosure, whether Congress will extend (or increase) the first-time homebuyer’s tax credit, scheduled to expire on November 30 of this year, and certainly no one knows if the banks will relax credit and start making loans again.  FHA, which has been providing a substantial number of loans, recently announced it has to tighten credit due to low reserves.

All of this makes for interesting reading, but one has to question where it takes us.  There are a number of unprecedented anomalies that makes me wonder if the forecast models are valid.  At least one real estate expert noted recently that there were over 2 million excess housing units in California — a shocking number given the number of programs designed to address housing shortages in this State.  California recently hit 12.2% unemployment.  Add to this a “shadow” inventory of properties that have not yet been foreclosed, due either to voluntary moratoriums or deliberate efforts to control inventory.   The Wall St. Journal reports there are approximately 1.2 million homes where the foreclosure process has not begun, even though the mortgages are more than 90 days past due.    The repercussions on local governments across the country have yet to be fully felt, let alone measured, yet are causing unprecedented cutbacks in services.   Ultimately, the entire process will come down to buyers’ ability to purchase homes, whether as first-time buyers taking advantage of tax credits and other incentives, or property owners selling their existing property and moving up.  Without jobs, this simply will not happen.

Therefore, I question what it means to say that housing prices in any specific MSA will rise or fall over any projected time period, given the current turmoil in the market, particularly the inability of the typical person to borrow money.  At the special Norris Group event held on September 11, 2009, “I Survived Real Estate 2009,” the various speakers were remarkably eloquent if not cautious.  David Kittle, 2009 Chairman of the Mortgage Banker’s Association, and John Young, Vice President of the California Builders Industry Association, along with other panelists, were quick to point out that for every new home purchase would result in anadditional expenditure of $7,500 for furnishings and supplies, and noted that Congress is considering a $15,000 tax credit.  They claim that if enacted, this would result in over 400,000 home purchases, significantly reducing the backlog of troubled inventory.  Interesting concepts, and worthy of consideration as a means to jump start the economy.  But such a move by Congress, if enacted, would definitely throw another wrench in to the forecasting models.

It’s easy to be a skeptic, and I won’t claim to know of a better methodology or model.  But I would caution investors to adopt a healthy dose of skepticism when reviewing the ubiquitous “Top Ten Cities” lists as a basis for making an investment decision.  Concentrate on cash flow, a strong and diverse job market, and local conditions.  A good cash flow investment in a bad market will be a better investment than a negative cash flow investment in a good market.  An outdoor enthusiast once told me, “there’s no such thing as bad weather – only bad clothing.”  A corollary maxim would probably be that “there’s no such thing as a bad market — only a bad deal.”  Good gear can get you through the worst of storms.  A good deal will beat a bad market.

Investors need to look deeper into the background information provided by these articles, and REALLY understand the dynamics and demongraphics.  Communities with diverse economies and industries will fare better than those without.

Foreclosure Crisis: More Info but Less Knowledge

Yet another study — this one released last month by the Federal Reserve Bank of Boston — serves only to reinforce what we already know:  lenders were reluctant to modify existing loans during 2007 and 2008.  (Wash Post, 7/27/2009).  Although some 1.5 million borrowers were subject to some form of foreclosure filings during the first half of this year (2009), only around 200,000 loan modifications have been issued since March, when the Administration launched the new Making Home Affordable Guidelines.   Part of the difficulty in evaluating the data is that many lenders have only very recently begun to apply the new Guidelines, while study after study focuses on statistics from 2007 and 2008.  Part of the reason for the sweeping new Guidelines was to remedy the shortcomines of the previous programs.

The Washington Post reports that “Modification makes economic sense … only if the borrower can’t sustain payments without it” and the modified terms will allow the borrower to keep up.  Duh.  Another brilliant conclusion:  Borrowers who are likely to fall behind even if the loan is modified are not a good candidate for loan modification.   Double-Duh.  And this:  Lenders have little financial incentive to help delinquent borrowers, who with extra effort and a little luck, can catch up without a modification.  Well, you get the gist of it.  I hope they didn’t spend a lot of money on that study!  If we only had solid information like this back in 2006, we might have been able to avoid the whole problem, don’t you think?

Compounding the issue is a fundamental lack of critical knowledge:  is it more economically advantageous for lenders to foreclose or modify?  Even the Washington Post can’t make up its mind:  the headline says “Foreclosures are Often in Lender’s Best Interest.”  Then, they quote Laurie Goodman, senior managing director at Amherst Securities, saying “In some cases, lenders lose twice as much foreclosing on a home as they did two years ago.”  Apparently, falling housing prices — often a direct consequence of foreclosures — cause lenders to lose money in foreclosure sales.  Go figure.

So, did we learn anything from the Boston Fed study?  Well, we learned that only a small percentage of loan mod applications are actually being approved, as lenders are only just now starting to apply the new Guidelines.  The study seems to confirm what we suspected — lenders are focused on their bottom line, not the borrower’s.  Lenders are working on finding the right balance of when would be the most optimum time to proceed to foreclosure based on the projected price bid they can get.  If the loan mod will only delay foreclosure and housing prices continue to drop, it only makes sense to deny the loan mod and proceed to foreclosure.

Sadly, this often comes as a bitter blow to the hard working borrower who is just trying to get a temporary reduction in their monthly mortgage payment, either through a rate adjustment or an extended term, so they can meet expenses and catch up.  Where home values have dropped significantly below the amount of the loan, and the lender refuses to make a meaningful modification, the borrower has little incentive to keep the house.  The result — absent any intervening factors — will be more foreclosures, further reducing prices, and causing lenders to prematurely panic and sell before the prices drop further.

Obviously, this will not work.  The Treasury and HUD have summoned industry executives to a meeting to discuss how increase the pace of loan relief.  It would seem that if more loans could be modified, even if only temporarily, there would be fewer foreclosures and less downward pressure on housing prices overall, not just for foreclosure properties.  Achieving stability would be a good objective, but we still have not seen any studies of the application of the new Guidelines.  Maybe if we had some relevant information, we might gain some relevant knowledge.

New Loan Mod Regulations Attack the Wrong Problem

A bad situation is about to get much worse.  Two bills pending before the California Legislature, AB 764 and SB 94, will apply criminal penalties and fines to real estate brokers and attorneys who charge advance fees or take retainer fees to handle loan modifications.  The primary basis for this approach appears to be the continuing assumption that homeowners can get these services for free from the lenders themselves, or from HUD authorized nonprofit loan counselors.  Any broker who wishes to charge for these services must first obtain approval from the Real Estate Commissioner and comply with the new provisions of the law.   Violation of these provisions by an attorney would constitute grounds for disciplinary action.  Unfortuately, this legislation — like many other recent regulatory actions — attacks the wrong problem.

On the surface, this consumer-protection legislation appears to address a serious problem:  the rash of scam artists seeking to profit from the thousands of homeowners facing hardship and possible foreclosure.  It is too early to predict whether these bills will pass, but the trend is clear.  Authorities are clamping down on the widespread abuses and scams that have plagued distressed homeowners for the past couple of years.  One company recently shut down by the FTC in Southern California had 400 employees, seven attorneys, and claimed a 98% success rate at “modifying” loans.  In one of these, the lender increased the mortgage payment by over $300 per month — even though the homeowner was current on their payments!  The “loan mod” company charged the homeowner $3,600 for this “modification.”  This was not an isolated case — approximately 60% of all “loan mods” approved by lenders in the first three Quarters of 2008 resulted in either no change or an increase in the borrower’s mortgage payments!  To no one’s surprise, a majority of these “modifications” failed and the properties went back into foreclosure, prompting renewed efforts by the Federal government to offer incentives to lenders to actually lower monthly payments.  (These Guidelines were released on March 4, 2009).

Nonetheless, thousands of homeowners, facing foreclosure and fearful of losing their homes, were scammed into paying money to unscrupulous individuals and companies who promised to “stop foreclosure” and “save your home.”  Responding to the problem, the California Department of Real Estate (DRE) issued a “Consumer Alert” and established a program which would allow real estate brokers to submit their Advanced Fee Agreements for review and the opportunity to be listed on the DRE web site if the DRE issued a “no objection” letter.  The DRE now lists hundreds of brokers on their web site who have been “approved” to charge advanced fees.  The DRE also list over 240 individuals and companies against whom the DRE has filed a “Desist & Refrain” Order and/or Accusation for loan modification activities.

On June 1, 2009, the California Attorney General issued a press release directing anyone who acted as a “foreclosure consultant” to register with his office and post a $100,000 bond by July 1, 2009.  The press release also lists several enforcement actions taken by the AG in relation to prosecuting loan modification scam artists.

Earlier, in February, 2009, the California State Bar had released an “Ethics Alert” that contained a fairly comprehensive discussion of the background leading to the current foreclosure crisis, and warned that attorneys who offered their names to non-attorney companies in order to allow those companies to collect advance fees were in violation of the Rules of Professional Conduct, which prohibit licensed attorneys from assisting non-attorneys in the practice of law, and prohibit attorneys from splitting fees with non-attorneys.  Also, the Ethics Alert reminded attorneys that it was a violation to file lawsuits to delay a foreclosure sale without good cause.

These and similar measures are designed to protect consumers and homeowners, ostensibly from the potential scams of companies seeking to profit from the chaos in the housing crisis.  However, as distasteful and outrageous as these practices may be, they are not thereal problem.  A blanket attack on real estate agents and attorneys will invariably sweep up many professionals who, by virtue of their expertise and training, are in the best position to actually provide much-needed assistance for these distressed homeowners.  At the same time, this regulatory approach does nothing to make the task easier for the homeowner to handle the task themselves — the legislation directs them to go to a local HUD office or to their website at  www.HUD.gov to get a list of approved nonprofit housing counseling agencies.

The real problem is two-fold.  First, the process whereby these loans were securitized, fractionalized, sold, and resold means that in any given instance, the “lender” is merely a loan servicer for an investor two, three or four times removed from the original institution that originally approved the loan.  Each investor has specific restrictions and requirements beyond which the “lender” may not modify the terms of the loan.  There is no ability to negotiate directly with the investor, and the process for reviewing each application in light of these requirements takes anywhere from a month to 90 days or more.  The second aspect of the real problem is there is no real incentive to provide meaningful relief in the form of principal reduction, or otherwise offer modifications that will make a difference.  “Loan Mods” that simply shift the debt load to the back end of the loan, or offer insignificant adjustments (i.e., a 27-cent monthly reduction), as an alternative to foreclosure, really do not accomplish anything.  Forcing a distressed homeowner who has suffered a sudden loss in wages or other genuine hardship to endure three to four months of back-and-forth with an unnamed and undisclosed “investor” just to receive an unacceptable or meaningless proposal is bad enough.  Limiting — if not eliminating — their range of options to seek competent assistance merely adds insult to injury.  Making it virtually impossible for competent professionals to charge for legitimate services will only force them to refuse to participate, and do little to address the real problems.

There is no question but that there have been outrageous abuses by scam artists seeking to profit from the crisis.  Existing regulations govern the conduct of licensed real estate and legal professionals, and if properly applied and enforced, would address most of these types of problems.  What is needed even more is meaningful and effective regulations to allow lenders the ability to modify existing loans without the hidden restrictions imposed by silent investors lurking in the background.   Focus on the real problem — don’t attack the lifeguards and ignore the sharks!

Welcome to Loan Mod Purgatory — please take a number.

According to an article that appeared in CNNMoney on Monday, May 18, lenders are overwhelmed by a flood of applications; mortgage investors are threatening to sue loan servicers for modifying loans, and unemployment is the newest threat to stabilizing the housing market.  This article comes on the heels of an announcement on Friday, May 15 by the Obama administration, announcing a new, standardized process and incentives for short sales and “deed-in-lieu” transfers of ownership.   The newest initiative is aimed at homeowners who cannot get loan modifications. These newest actions follow by two weeks the Government’s announcement that it would provide incentives to lenders holding second liens to reduce interest rates and/or release second mortgages.

Anyone involved in the loan mod process would have to acknowledge that the entire process is bogged down.  CNNMoney noted that even though it has been three months (to the day) since President Obama announced the Housing Affordability and Stability Plan (February 18, 2009), and Guidelines were issued on March 4, many (if not most) loan servicers have been slow to get up to speed to respond to the requests.  Borrowers frustrated by the lack of clear guidance and inconsistent advice are tempted by robo-call operations offering to “help” homeowners for hefty fees.  Ironically, it turns out that investor contracts arising from the securitization and sale of the loans, which was part of the problem in the first place, are restricting which loans can be modified and how.   Congress is working on a bill to provide a “safe harbor” to allow loan servicers to use the Federal mortgage relief programs, but some investor groups are lobbying hard against passage.  It is no secret that many loan servicers are using the “investor contracts” as excuses not to make prompt and effective modifications.  Unfortunately, the borrower has no way of knowing whether or not the excuse is valid.  One gets the same feeling one gets when the car salesman returns from the back room to report the General Manager’s “last, best and final” offer, but you never even see the guy behind the curtain.

Compounding the problem and undercutting efforts to stabilize the mortgage crisis, many lenders have yet to sign up for the Federal program.  According to CNNMOney, 14 of the mortgage service companies, including Bank of America, Citgroup, J.P.Morgan Chase & Co., and Wells Fargo.  Others claim to be implementing their own versions, and still others are evaluating the program.  At the application level, each lender and loan servicer appears to have their own processing requirements.  Some permit the borrower to send the required documentation electronically, while others insist the documents be sent by fax.  One loan agent told me their fax room was a complete mess, with different applications getting mixed up with others like a crazy game of 52-card pickup.  Another loan agent told me they had no way to confirm receipt of the electronic transmission of the application documents.  Still another e-mailed me within 24 hours to confirm receipt, followed up 5 days later with a request for a missing piece of information, and provided an estimated time of review and affirmed that the foreclosure status was being suspended pending review of the loan mod application.  Simply stated, there is no uniformity or standarization.

As I’ve reported before, the fact that some of the lenders and loan servicers are only now just beginning to implement the Guidelines first released on March 4, and others are still “evaluating” the program, calls into serious question any claims or reports of successful loan modifications.  Sixty percent (60%) of all reported “loan mods” approved in the first three Quarters of 2008 resulted in mortgage payments that were the same or higher than prior to the modification.   I saw one “approved” loan modification that reduced the monthly payment by 27 cents!  And that lender insisted the borrower was foolish to reject it!  This type of chaos and confusion will only serve to further destabilize the process; create additional opportunities for fraud; and worst of all, erode any sense of confidence that the Federal program might otherwise have a chance to work.

In addition to the impact of rising unemployment cited by the CNNMoney article, there is another growing threat to the Federal effort to stabilize the situation — credit card debt.  Broke, facing unemployment, and no longer able to tap their home equity for relatively inexpensive funds to make up the difference, many homeowners have tapped the most costly source of revenue remaining — their credit cards.  Unfortunately, the card companies, who reset the loan rates faster than you can say “charge it,” have started charging cardholders the highest possible default rates of 29.99%.  Behind the wave of home foreclosures working their way through the so-called “trial periods” and voluntary moratoriums is a second wave of crushing credit card debt.

Sadly, the situation is bound to get worse before it gets better.  Unless and until the loan servicers get clearance from the investors, or simply clear directions from their managment, and free up the backlog of applications, the confusion and frustrations will continue to mount.  One problem is that no one knows what will work, and therefore everything is approached with the same level of risk aversion.  It would be a great service if the U.S. Department of the Treasury could simply select a statistically significant cross-section of different types of loans, fund the modificaion, and see what would really work to increase the probability of success.  Hindsight, of course, will teach us all many lessons.  The question is whether we can wait long enough.