Economics

No Hope For Bad Debtors?

Why nobody's cramming for the great mortgage test

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Have the banks bailed out any mortgage deadbeats? When a Wells Fargo Home Mortgage consultant told me last month that the bank had done absolutely no modifications of troubled mortgage loans since receiving its $25 billion from the U.S. Treasury in October, I thought he was crazy. Now I'm not so sure.

More in a moment about why a low rate of mortgage modifications is a piece of good news disguised as an outrage. I must stress at the outset that I do believe Wells Fargo has modified at least three troubled mortgages since October, and not only because the bank's director of investor relations Bob Strickland said Wednesday that "more than 143,000 solutions" were provided to customers through "repayment plans, modifications and other loss mitigation options."

What are those 143,000 solutions, and how many of them are actual changes to loan terms? There is no way to tell from Strickland's explanation:

Through our active communication programs, Wells Fargo home mortgage has reached 94% of its customers who are two or more payments past due.

For every 10 of these customers we have worked with seven on a solution, two declined help and one could not be reached. Of those who received a loan modification, one year later approximately 7 of every 10 were either current or less than 90 days past due.

Since Strickland uses a base unit of 10, we'll assume that Wells Fargo had at least 10 customers who were two or more payments late. Therefore, Wells Fargo worked with at least seven customers in default.

It is unclear from Strickland's narrative how much of that work resulted in actual loan modifications. (There are three generally recognized types of loan modifications: change of interest rate; lengthening of the maturity date; and reduction of principal, or "cramming.") But presumably some number between one and seven of the people Wells Fargo worked with got to an actual modification. To be sporting we'll call that number five.

Of those five, 70 percent are "either current or less than 90 days past due." Please note that "less than 90 days past due" means "in the same situation they were in before the modification." In any event, that means at least three people have actually received loan modifications from Wells Fargo.

This estimate is more generous than the estimate given to me by a consultant in Wells Fargo's Minneapolis Center, who described himself as having 12 years of experience with the nation's second largest bank, and posed to me the rhetorical question and answer: "Sir, do you know how many loans Wells Fargo has modified? None."

I tried to check that claim with a Wells Fargo representative, who said, "I state emphatically that we are indeed modifying loans and providing other workout options to our customers who are facing financial difficulty," and said "the mortgage consultant you apparently talked to would have no access to that type of data." He was unable to provide any actual evidence, however: no ballpark figure, no sample loan modification, not even a statement from a satisfied customer.

In fact, nobody has access to the type of data we'd need either to refute or to confirm any claims about how many loans have been modified—by Wells Fargo or any other bank—since funds from the $350 billion Troubled Asset Relief Program were delivered. The Office of the Controller of Currency (OCC) issues quarterly reports [pdf] on loan modifications, and more recently has been tracking the number of loan workouts that end up back in default. The OCC's next report is due at the end of March, and will cover the fourth quarter of 2008.

In the meantime, Hope Now, a coalition of big lenders, counselors, and community activists, says 122,000 modifications were performed in December, but its figures have the same vagueness—as to what types of modifications they were and how the dollars were rearranged in each case—as the Wells Fargo numbers above.

And lawyers for Countrywide Home Loans have said in court that Countrywide's claims about working out loans were "mere commercial puffery" and "only Countrywide's vague advertisements."

The bottom line is that while Rep. Barney Frank (D-Mass.) and others may be wrong about the wisdom of helping deadbeats stay in their homes, they are right to be outraged at the banks' lousy loan-modification performance. The Emergency Economic Stabilization Act of 2008 did not specify how TARP funds would be spent, but the salesmanship for the bill certainly implied that this money would allow lenders to keep more people in their mortgaged homes. Financial institutions—in advertising, congressional testimony, marketing, and statements like Strickland's above—have been voluble about their efforts to help troubled borrowers.

"In general, the level of modifications has been disappointing," says Paul Leonard, California director for the Center for Responsible Lending. "Here in California, they have been increasing, but not quickly enough to match the growth in defaults and foreclosures. We are deeply disappointed that TARP activities have not focused on foreclosure prevention."

It's an unexamined truism that loan modifications are "win-win" solutions: The lender gets to keep getting paid, albeit on slightly different terms; the borrower gets to keep his or her home. All parties avoid foreclosure, which, we're told, is in nobody's interest.

But the continuing deflation of real estate prices means real money has to be lost by somebody. If the goal is to keep large numbers of people in houses they can't afford, then the only type of loan modification that will really work is the cramdown, in which the outstanding principal is reduced to reflect the current market.

This of course is a form of theft. You borrow a bunch of money from a bank and then you don't have to pay it all back. Banks naturally don't like this option, and even the generous modification guidelines offered by the Federal Housing Authority build in heavy conditions (such as a requirement that the borrower split proceeds from any future sale of the property) to minimize the loss. It's understandable that few if any principal-reduction modifications are being done.

Yet the OCC's finding that nearly 50 percent of modified loans end up back in default demonstrates that distressed borrowers can't be helped merely by fiddling with the interest rate or changing the length of the mortgage. This has been clear for at least the last 18 months. At the bitter end of his presidential campaign, John McCain brought out a plan to have the government directly compensate lenders in exchange for haircutting bad mortgages. The plan went nowhere. Even the Federal Deposit Insurance Corporation's conservatorship of IndyMac aims to get monthly payments into balance with the borrower's income (which is mostly wasted effort, as nearly half of defaults are the result of job losses), not to reduce principal.

So should anybody have expected that TARP funds would encourage banks to reduce principal, or do other forms of loan modifications? Christopher Thornberg, co-founder of Los Angeles-based Beacon Economics, believes that was a pipe dream.

"The purpose of the TARP funds was not to allow banks to do loan modifications," Thornberg says. "They're being used to keep the credit system moving as banks fail. The problem is that you're still looking at $1.5 to $2 trillion in losses on all kinds of loans, not just mortgages. The good news is that TARP funds were not used according to the original plan, which was to buy inflated assets. The Treasury instead is giving this money to certain banks to allow them to continue lending as other banks fail."

Perhaps it's time to state publicly what the market has already decided: Helping out distressed mortgagees is not good business, at least not on any large scale. You don't have to agree in full with the consultant Ramsey Su, who wrote in The Wall Street Journal this weekend that loan modifications are not only dumb but evil and immoral. But one bright spot about the economic slump is that it has yet to produce its Dorothea Lange, that there has been a fairly general lack of sympathy for irresponsible lenders and borrowers who got themselves (and the rest of us) into trouble.

Nor is there any realistic prospect for stemming the macro decline in asset value by potchkying with some loan terms. Using the Federal Reserve's flow-of-funds data, Thornberg estimates the entire U.S. asset base was overvalued by $15 trillion or $16 trillion in 2007. "As of Q3 2008, households are out $6.6 trillion already. So with Q4 being so brutal we may be half way [to the bottom] or more."

That still leaves a lot of room to fall, and little reason to believe the landing will be any softer the more the nation strives to keep bad debtors in their current houses. The good news is that loan modification in its current form doesn't seem to be making much difference one way or another. I don't believe my Wells Fargo consultant was right with his zero-modification claim. But I kind of hope he is.

Contributing Editor Tim Cavanaugh writes from Los Angeles.

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  1. There are 4 million mortgages in this country considered “at risk”.

    http://www.chron.com/disp/story.mpl/business/realestate/5985260.html

    The government has spent in excess of two trillion dollars on bank bailouts and now the “stimulus”.

    For two trillion dollars, they could have paid off and average of 500K per mortgage for every bad mortgage in the America. That would have paid off most of them and left the others so small that the collateral would have more than covered them.

    Now of course that is a cock-eyed scheme full of unfairness and moral hazzard. But honestly, would have been any worse than what we are doing? More importantly, it would have been a one time check instead of a perminant rise in the size of government. I guess for some people that would be bug not a feature.

  2. Looking for a picture of Admiral Ackbar yelling “It’s a TARP!”, thanks.

  3. It’s “principal.”

    Jesus.

  4. We’re so sorry Uncle Ackbar
    But we haven’t done a bloody thing all day.

  5. I really want to laugh. So Congress agrees to give the Treasury all kinds of money with no strings attached except a measly implication about its purpose, and that implication isn’t adhered to…

    then they get made because Treasury gives the banks all kinds of money with no strings attached except a measly implication about its purpose, and that implication isn’t adhered to…

  6. Daschle’s out.

    As if making him wear those glasses wasn’t punishment enough!

  7. and reduction of principle, or “cramming.”

    This is incorrect. It’s “principle forgiveness” when a lender does it on their own (it’s counted as income to the borrower so it NEVER happens); it’s “principal forebearance” if the lender decides to make a portion of the principal an interest-free lump-sum payment at the end of the term (what the FDIC did with a handful of IndyMac bank mortgages).

    It’s only a “cramdown” if a bankruptcy judge does it – and the portion crammed merely goes into the unsecured portion of the borrower’s debt, the rest is still secured by the collateral (house). Less than 10% of borrowers getting crammed down would be able to handle the payment plan set up by the court, so the house almost always gets foreclosed anyway.

    The only reason any of this crap is being floated is because Fannie Mae, Freddie Mac, the FDIC, government pension funds, and a few other banks and government agencies are all dangerously insolvent.

    It’ll take $4 trillion just to get them slightly insolvent. That means your taxes are going to triple, unless the “government bubble” pops. We’ll wind up with asset forefieture for driving 5 mph over the limit before the government bubble pops.

  8. Sweet fuck, joe. Did he beat up someone’s kooky spinster aunt for those?

  9. What’s the over/under on total unpaid taxes by Obama appointees?

  10. “It’s only a “cramdown” if a bankruptcy judge does it – and the portion crammed merely goes into the unsecured portion of the borrower’s debt, the rest is still secured by the collateral (house). Less than 10% of borrowers getting crammed down would be able to handle the payment plan set up by the court, so the house almost always gets foreclosed anyway.”

    One of the things that popped the bubble was the Bankruptcy reform. Under the old system, people would reaffirm their house and right off their unsecured debt in Chapter 7. With the reform, a lot fewer people qualified for Chapter 7 and were forced into Chapter 13. This greatly reduced the incentive to keep your house since under 13 you have to have a payment plan on your unsecured debt. This caused a lot of people who would have otherwise stayed in their homes and made mortgage payments to say fuck it and walk away from their loans.

    The banks were so fucking greedy, they screwed themselves. But really they didn’t screw themselves since they were able to go to Uncle Sam to cover their losses in the bailout.

  11. Sally Daschle Rafael.

  12. Uh, joe. The horrors you find googling. Funny and nightmarish.

  13. Was TARP really supposed to finance mortgage write-downs? I thought it was supposed to underwrite revaluation of MBSs, a very different project.

    If TARP was supposed to be used to clean up the balance sheets of banks, I guess it could go to mortgage write-downs, where doing so would move the mortgage from a non-performing asset to a performing asset. But I vaguely recall something here on H & R from a few months ago showing that many/most “renegotiated” mortgages go right back into default.

  14. LOL.

    You’re…directing traffic?

    No. I’m in a fucking box. That’s it.

  15. “This is not Earl Grey!”

  16. Think about the amount of research it’s going to take to consider a lender’s options on a distressed mortgage, figure out the right parameters for a forgiveness or forebearance arrangement and weigh that against a forclosure … That’s going to be, what, 5 hours of research? One analyst could do a few dozen of those decisions a month? Workout people have to be a lot smarter than the folks on the originations side. Who is staffed for that?

  17. The real political problem here is that an individual’s ability to repay a mortgage has nothing to do with solvency of the lending institution but we’re acting as if the two were connected somehow.

    If a bank lends me money and then goes bankrupt, that does not effect my ability to make my mortgage payments. Instead, my ability to pay my mortgage depends solely on my income. It’s completely a one way street once I have my mortgage. Money goes from me to the bank not the other way around.

    Yet, we keep acting as if the solvency of banks somehow effects the ability of people to earn money to repay their mortgages. Why should we subsidize these people’s foolish decisions? We haven’t even seen any major job loses yet. If so many people can’t pay now when they have jobs, how will they pay down the road when they don’t? Do we just keep shoveling good money after bad in the hope that all these people will eventually make enough money to pay for their extravagant housing choices?

    This is all a big con to enslave the responsible to the irresponsible. People who saved and lived within their means must subsidize the spend thrifts.

  18. With all the talk about mortgage relief, why no talk about the second-biggest homeownership expense: property taxes?

    I hereby propose a Property Tax Holiday until the housing crisis ends.

  19. I hereby propose a Property Tax Holiday until the housing crisis ends.

    Wow, you really want to hear the cries and lamentations of local politicians, don’t you, Daze?

  20. Isaac,
    you really want to hear the cries and lamentations of local politicians

    I would be willing to put them out of their misery.

  21. That’s what’s best in life: cut taxes, see revenues driven before you, and hear the lamentations of the politicians.

  22. Wow, you really want to hear the cries and lamentations of local politicians, don’t you, Daze?

    Their salty, salty tears are paradoxically so very, very sweet.

  23. Joe McDermott: Ouch. Thanks for the fix.

    Russ 2000: I was using what Wiki calls the increasingly popular “informal” use of the term “cram down.” (The only word I use in its strict dictionary sense is “deadbeat”.) I thank you for the clarification.

    Paul: What do you mean by “reaffirm” your house?

    Shannon: Here’s a math experiment somebody should do: How much less than $700 billion would it have cost just to let the major banks fail and have FDIC cover the $100,000 on lost deposits? (Leaving aside that it wouldn’t have had to cover nearly that much in almost all cases.)

    Daze: To be fair to local govts, in most places you can get your property taxes reduced based on a decline in the appraised value. You can even do that in California under Prop 13 (Which I don’t like just on sportsmanship grounds: if you’re going to get the benefit of a tax assessment that doesn’t reflect substantial increases in property values, why should you get the benefit of a substantial decrease?)

  24. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

  25. Well said Tim. Why am I not surprised that so called “sub-prime” loans given to “less than prime” debtors have gone bad 🙂

  26. Here’s a math experiment somebody should do: How much less than $700 billion would it have cost just to let the major banks fail and have FDIC cover the $100,000 on lost deposits?

    I did that math about a month ago. It’s about 4 Trillion.

    Take the top 100 banks by deposits. Add up the deposits (about 5 trillion). Consider 80% are insolvent (I’m assuming the level 3 assets are worth no better than 20 cents on the dollar). Look at the top 10 – Citicorp, JMPC, Bank Of America, WellsFargo – they wouldn’t be shoving TARP money at them if the FDIC could cover the deposits. FDIC didn’t have enough to cover WaMu and National City and Wachovia. They’re too big to find buyers; the TARP essentially was the method used to “buy” those banks. Smaller, healthier banks don’t want to take those deposits because there’s no assets to back them.

    Also, the FDIC would be stuck with a few million mortgages in default – the court system can’t handle that many foreclosures so an RTC-type of institution would have to be set up if/when FDIC takes them over.

  27. Russ2k,

    Wasnt BoA one of the Banks that initially refused TARP money are only took it after the come to Jesus meeting with the feds? If so, I dont think they needed the money to stay solvent, so they shouldnt be included in the calculation. Ditto BB&T. I dont know about any others, but I know a number only took the money after the meeting.

  28. Add up the deposits (about 5 trillion).

    But wait: You wouldn’t actually be replacing that 5 trillion, or even 80% of it, would you? I mean, the FDIC only insures up to $250,000 per person per bank.

    Or is that 5 trillion in 50 million different accounts, so the FDIC would be on the hook for all of it?

    Is there any cutoff? If a single person has got a billion dollars in $250,000 accounts at 4,000 different banks, would the FDIC insure all of it?

  29. robc, Wells Fargo also reportedly refused TARP funds, and even made a show of wanting to say no at the meeting of the heads of the five families.

  30. By the way, a bunch of state attorneys general (in the “State Foreclosure Prevention Working Group”) say the OCC’s redefault estimate is way too high. Meat of their letter yesterday to the comptroller:

    The 13 reporting non-bank subprime servicers in our group reported a much lower redefault rate. Of the 401,027 loan modifications made between October 2007 and September 2008 (the same ending date as the OCC/OTS Report), only 25.8% (103,561 loans) were at any stage of delinquency.

    We have spoken with several major subprime servicers subsequent to the release of your report. Most of them are indicating to us a redefault rate of loan modifications much lower than the OCC/OTS Report. In particular, subprime servicers that are pursuing aggressive loan modification strategies are demonstrating much lower redefault rates.

    They’re critical of the OCC, and have a range of (very attractive) data they want collected. If you email me or contact me on Livre du Visage, I’ll send you a pdf of the letter.

  31. WARNING: Personal Opinion: The banks will use the money to recompensate themselves for the losses they have when they forclose on a property which isn’t worth the loan. As mentioned above, they got the money with almost no strings attached.

  32. I did that math about a month ago. It’s about 4 Trillion.

    Sounds about right. don’t forget though, all those deposits have to go somewhere. Not every bank can go bust – it happens through consolidation. It’s not like the FRBNY has tellers…

    Wasnt BoA one of the Banks that initially refused TARP money are only took it after the come to Jesus meeting with the feds?

    JPM did the same. ended up with 25 bill at 4%. they’ll use it to acquire someone soon.

    But wait: You wouldn’t actually be replacing that 5 trillion, or even 80% of it, would you? I mean, the FDIC only insures up to $250,000 per person per bank.

    Or is that 5 trillion in 50 million different accounts, so the FDIC would be on the hook for all of it?

    Is there any cutoff? If a single person has got a billion dollars in $250,000 accounts at 4,000 different banks, would the FDIC insure all of it?

    Short answer is there is no cutoff. there are even services that make it easier. Overall, there might be a small amount that isn’t covered, but most deposits are. Whats more, large money market pools are usually institutionalized, and are now guaranteed separately.

  33. Of those who received a loan modification, one year later approximately 7 of every 10 were either current or less than 90 days past due.

    I think it’s pretty safe to say that these aren’t people whose loans were modified under programs initiated in October, 2008.

  34. Take the top 100 banks by deposits. Add up the deposits (about 5 trillion). Consider 80% are insolvent (I’m assuming the level 3 assets are worth no better than 20 cents on the dollar). Look at the top 10 – Citicorp, JMPC, Bank Of America, WellsFargo – they wouldn’t be shoving TARP money at them if the FDIC could cover the deposits. FDIC didn’t have enough to cover WaMu and National City and Wachovia. They’re too big to find buyers; the TARP essentially was the method used to “buy” those banks. Smaller, healthier banks don’t want to take those deposits because there’s no assets to back them.

    I don’t see why we would consider BofA less Merrill, Wells, or JPMorgan insolvency risks. Also, if we’re looking at FDIC insurance by itself, you should only include FDIC-insured core deposits, which is a lower number than many suspect (i.e. it was about 50% at Wachovia under the old $100k cap, which is why deposits left so quickly).

    To point out something about CDARS, participants are mostly small banks, and frankly outside of the worst areas those are the ones in the best condition.

    And Tim, good article, but your Wells mortgage consultant’s full of it. I work in Wells Finance/Treasury on resolving the distressed mortgage portfolio, and I can tell you the company’s been fairly aggressive on loans in or near foreclosure. I’m not sure how much I could say is public information, so I’d recommend looking for info on Bob Caruso and Lender Processing Services as they relate to Wells. To be sure, a lot of the numbers coming from the top are obnoxiously meaningless ($500 billion in new lending! 143,000 loans modified!), but I will say that as everyone on the Street’s been told there are mod programs, applications, loans in process, and their fully funded results.

    Besides, a lot of Wells’ exposure to default was through equity lines, and it’s hard to modify those like first liens. The real question is how Wells deals with legacy Wachovia’s books, and Wachovia did have fairly ambitious mod programs (the results were pretty underwhelming, though).

    Really, you need a few things before you squeeze any profit out of modifying a loan:
    * Near-certainty of eventual foreclosure
    * A high expected loss severity (i.e. you recover 50-60% or less of the outstanding loan balance after foreclosure).
    * A reasonable basis for believing that after modification the loan can “cure” (become performing again). For borrowers who have lost their jobs or can’t afford an eventual fully amortizing payment, that’s probably impossible.
    * Compliance with the Truth In Lending Act. If you have adjustable rate mortgages tied to indices that have shot down recently — LIBOR, MTA (12-month average of the 1-year Treasury), and other measures of market cost of funds — you add in legal risk if you lock someone into a loan that eventually has a rate higher than what they’re paying now.
    * A good amount of excess capital because you’re taking your losses upfront.

    And the industry standard is that at best 40-50% of modded loans re-default, so you spend the money to build huge loan mod infrastructure overnight, lock in principal forgiveness, a lower rate, and then loans default half a year later when home prices are even lower.

    So, best-case scenario, you can eek out a bit more money with mods on god-awful loans, but most still default and banks can be worse off. It’s definitely not the silver bullet discussed over Kool-Aid coolers in Washington.

  35. I refer you to the New Orleans Federal Court ruling in Jones v. Wells Fargo. In that case it became clear that they are manufacturing these defaults. they WANT this to happen.

    Give it a look.

  36. I am really enjoying reading your well written articles. thanks.

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