Boston Fed: No Way Out of Foreclosures

Here's a deceptive headline from the Boston Globe: "Lenders avoid redoing loans, Fed concludes." Actually, this remarkably straightforward study [pdf] from the Federal Reserve Bank of Boston begins with the (old) news that lenders have "performed payment-reducing modifications on only about 3 percent of seriously delinquent loans."

The meat of the discussion paper "Why Don't Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures, and Securitization," by Manuel Adelino, Kristopher Gerardi, and Paul S. Willen, is an exploration of why loan modifications, or renegotiations, are so rare.

Short answer: Renegotiations are a much-worse-than-advertised deal for lenders. (If you believe people stuck in losing situations should be encouraged to get on with their lives, they're a bad deal for borrowers too.) 

The study finds about 45 percent of renegotiated loans end up delinquent again, a rate that sounds high but is actually considerably lower than the redefault rate found by the Office of the Comptroller of the Currency and others. But the Boston Fed finds something more encouraging in its "self-cure" analysis: If you don't help troubled borrrowers out at all, 30 percent of them end up getting out of the jam on their own.

There are plenty of other interesting factoids:

• The difference in loan-mod rates between securitized loans and straightforward loans is "statistically insignificant." So much for the advantage of doing business with your friendly neighborhood bank, as well as the canard (treated at length in this study) that fear of bond-investor lawsuits are holding up renegotiations.

• Something that should have been obvious but (to me at least) wasn't: In "a world with rapidly falling house prices," the truism that renegotiating is a better deal for the lender is not true, because of the one-in-two chance that there will be a redefault and the lender "will now recover even less in foreclosure."

• The "self-cure" risk — the likelihood that the lender is wasting money on a modification because the unlucky borrower would have solved the problem on his or her own — makes it even harder to argue that loan modification is advantageous (or less disadvantageous) than foreclosure: "One must take into account both the redefault and the self-cure risks, something that most proponents of modification fail to do."

If you're better than I am at equations featuring Greek letters, you'll find even more red meat in the 41-page pdf. It's hard to imagine a more clear argument against the Obama Administration's $75 billion "Making Home Affordable" program — though the authors do make some noise about how the best interests of "society" might make it worth persisting in the failed loan-mod experiment. At Seeking Alpha, Matt Stichnoth dismisses as "insane" co-author Willen's suggestion that the government would be better off just giving money directly to borrowers. He's right that it's insane to expect deadbeats to stop being deadbeats, but the dirty secret of all forms of welfare is that it's almost always cheaper and more effective for the government just to give the money away rather than setting up cockamamie schemes like this one.

One housekeeping note: Though I continue to encourage wider and more pointed use of the term deadbeat, I find that 30 percent self-cure rate heartening. Even among troubled borrowers, plenty of people retain the sense of shame that helped our Olde Tyme ancestors build a great country.