Here Be Chickens (And They're Roosting!)

Here Be Chickens (And They're Roosting!)
We got a little problem here.....

A progress report released last week by the Treasury Department showed that only 11 percent (about 95,000) of Bank of America's delinquent borrowers who were potentially eligible for the program had been given a loan modification. That compares with 27 percent, or 117,000, for J.P. Morgan Chase, and 33 percent, or 68,000, at Citigroup, the Treasury reported. The figure for Saxon Mortgage Services, which is owned by Morgan Stanley, is 41 percent, or 32,000.

There are too many conflicting currents here, which is what will ultimately doom this program, as has doomed all the previous ones.

First among them is the simple question: How many of these people who allegedly "qualify" for a modification will wind up with a sustainable mortgage if they get one?

This is a key question, yet one that hasn't been asked in public, nor have there been public answers tendered. The truth is pretty ugly - without significant principal forgiveness (not "forbearance") a huge, perhaps even majority percentage of these loans are not sustainable even if modified.

The problem is simply that on any reasonable set of assumptions the income of the household does not support the principal balance. "HAMP" calls for modifications to reduce principal and interest for all outstanding mortgage liens (firsts and seconds, if any) to 31%.

Here's the "waterfall" process, as shown by MGIC (one of the mortgage insurers who has been hammered severely by this mess)

The problem here is that several of these steps don't do much. If you "capitalize" arrears all you're doing is adding them to the principal balance of the loan. This "cures" the instant default but does nothing to solve the underlying problem that caused it in the first place (unaffordable payments.)

Reducing the interest rate helps only if the owner started with a "reasonable" rate up front. If their original loan was an "OptionARM" with a teaser, and they qualified on that teaser, they're unlikely to get to sustainable payments even with a reduced interest rate.

The third step, extending terms, does little as well. A $200,000 loan @ 5% over 30 years has a P&I of $1,069.19. The same loan over 40 years (the maximum extension) has a P&I of $960.39. $100 matters (it's about a 10% payment reduction) but if the difference of $100 makes it possible for you to pay then you're still one unscheduled calamity (e.g. your car needs a new alternator) away from being delinquent again.

The fourth step, "forbearing" principal, is not principal forgiveness. It is simply deferment, turning your note into what amounts to a balloon. This last step is particularly nasty for homeowners in that it will preclude you from being able to move for a decade or more, making it impossible for the workforce to follow job opportunities, as you would have to pay off the balloon in order to sell the house.

Then you have attitude:
Even as the administration urges lenders to do more to help homeowners, some Bank of America employees continue to express skepticism about whether all of those seeking assistance really need it. "There's a difference between hardship and entitlement," said Jerry Durham, Bank of America's vice president of home retention.

Oh really? Let us remember that Bank of America "acquired" Countrywide Financial, the king of making unsustainable and outrageously risky loans that were pushed like a drug junkie shoves his smack under the nose of debt addicts. Never mind that Bank of America seemed to think it was "entitled" to tens of billions of taxpayer dollars. Now the bank suddenly thinks that other people being "entitled" is such a bad thing? Who set the example?

The article also cites a disturbing trend:
On a recent morning, Tiffany Palmer was on the line with a frustrated borrower looking for help with his mortgage. He was $6,000 behind in his payments.
"Do you have a 401(k) or savings -- liquid assets that can be quickly converted into cash?" she asked him. He was going to have to come up with money for the mortgage. Because his monthly mortgage payments represented less than 31 percent of his income, he made too much to qualify for a modified mortgage under the federal initiative. "You will not be eligible for the program," she said.
This sort of "advice" should be barred under Federal Law and result in criminal sanction, especially for banks that have received taxpayer funds (of which BAC is particularly exposed.) Why? Because 401k and IRA money is protected in the event of a bankruptcy, with few exceptions. As such it is outrageously irresponsible to suggest that a debtor in trouble liquidate retirement accounts to come current, especially when nothing is being done to make the loan sustainable in the long term. Better to file bankruptcy and shove that loan up the bank's behind!

Never mind this sort of advice:
Could she skip her credit card payments, about $400 a month?
Oh, so that's nice - screw someone else so we get ours? Uh huh.

The conflicts of interest here are huge:
The banks have "Servicing Rights" (or MSRs) that require them as servicers to advance principal and interest payments to the noteholders. There are several risks involved in such an enterprise, of course, including the risk that the debtor won't pay at all, but in addition there is "prepayment" risk - that is, anything that causes the loan to terminate early (short sale, refinance, etc) decreases the value of that loan to the bank holding the servicing rights. These "MSRs" were "written up" in a major way in the first and second quarters. Was that a fantasy? Probably.

Forbearance, interest rate reductions and similar games sound good but they decrease cash flow. Remember that the ultimate holders of these notes through securitization have to agree. When this is Fannie or Freddie this simply forces their heads further underwater, but when it is someone else they have no mandate to agree to take less than they contracted for. In most cases securitization documents permit some small percentage of modifications without investor approval (e.g. 5% of the loans in the pool) but once that threshold is crossed the story changes.

In addition, and perhaps most importantly, a loan that is modified but which re-defaults is one where the investor made a good faith change (reducing his or her cash flow) believing that it was cheaper than prosecuting a foreclosure, but then wound up with both the lower cash flow and the foreclosure! This is perhaps the most serious problem and unlike the others it is not really a conflict of interest, it is simply the expression of the fact that in nearly all cases the first loss you can take and clear your board is the best loss; the more screwing around you do the worse things are.

The bottom line is that there is no evidence that HAMP is working or can, and the Congressional Oversight Panel has seen through the ruse:

The Panel found, "The result for many homeowners could be that foreclosure is delayed, not avoided." HAMP modifications are often not permanent: For many homeowners, payments will rise after five years, and although the program is still in its early stages, only a very small proportion of trial modifications have converted into longer term modifications. The Panel is also concerned about homeowners who face negative equity or are "underwater" - that is, the value of the loan exceeds the value of their home. For many borrowers, HAMP modifications increase negative equity, a factor that appears to be associated with increased rates of re-default.

Yep.

At the time I said that these efforts would fail as there is no actual solution other than forcing those who made bad loans to eat them. HAMP, and all other programs like it, are inherently just another gimmick promulgated upon the public by our government - another form of "extend and pretend", that when boiled down to its essence is legally-sanctioned accounting fraud.

The solution to unaffordable mortgages, as I have repeatedly noted, is foreclosure and a forcing downward of housing prices whether Congress and The Administration want to admit it or not. Affordable housing requires not gimmicks but houses that are inexpensive enough for people to be able to purchase and afford on an ongoing basis. We're not there, despite the crooning of The National Association of Realtors and other associated pressure groups.
This is directly contrary to the stated policy of Congress as expressed by Barney Frank, who has said that making bad loans on purpose is A POLICY to prevent home prices from contracting to long-term sustainable values.

In other words the bankers and Realtors have effectively bought Congress and goaded them into keeping home prices unaffordable for the average American. Refusing to reverse course on this policy will guarantee that sustainable economic growth will not return to America.

We will not and cannot, mathematically, exit this crisis until the bad debt is flushed from the system. This same sort of gimmickry and game-playing was attempted in the 1930s and was directly responsible for The Depression extending for a decade, ending only when World War II began.

You would think that we would have learned from this history lesson that all the game-playing in the world will not solve a debt problem, nor will shifting debt from one hand to another (e.g. to the federal government) lead to a sustainable economic recovery.

Those institutions that made bad, unsustainable loans must be forced to recognize their losses, even if it results in business failure. Only through contraction of these asset prices to sustainable levels where people can afford to purchase them on an ongoing basis given the actual employment prospects that exist (including the consequence of offshoring all our call centers and most of our manufacturing!) will we exit this crisis.

Housing prices must come down significantly - very significantly - from here. This will bankrupt many lenders who made unsustainable loans and that must be not only allowed to occur but encouraged so as to result in truly sustainable home ownership.

An environment of excessive debt, fostered by the improper and ridiculously negligent and intentional acts of both Congress and The Federal Reserve, cannot be resolved with more debt, any more than you can solve a drunk's problems by handing him another bottle of whiskey.

To read the entire original article click here