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: Bair's Mortgage Miracle -- The FDIC has a loan modification for you. |
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| | From:  tc101 (Original Message) | Sent: 12/4/2008 3:59 AM |
WSJ DECEMBER 3, 2008
Sheila Bair's Mortgage Miracle -- The FDIC has a loan modification for you.
What do you do if you've spent your career encouraging mortgage loans to people who can't repay them? Barney Frank's answer is to grill federal officials on why they aren't preventing foreclosures. Infuriated at the difficulty of modifying mortgages, the Beltway crowd doesn't understand that such contracts weren't designed to let people live in houses they can't afford.
Still, at a recent hearing of his Financial Services Committee, Mr. Frank received encouraging words from FDIC Chair Sheila Bair. She outlined her ballyhooed plan to prevent an estimated 1.5 million foreclosures by the end of 2009. She plans to accomplish this feat by modifying more than two million loans at what she estimates would be a taxpayer cost of $24 billion. This may be wonderful politics, but the real-world evidence suggests it will be far more difficult and expensive.
The live-fire test has been going on at failed lender IndyMac Bank since August. Readers will recall that IndyMac wounded itself with sloppy underwriting and then was wounded further when Senator Charles Schumer released letters warning that "the bank could face a failure." A subsequent wave of withdrawals killed IndyMac, and the FDIC took over. The FDIC soon launched a program to modify IndyMac's troubled mortgages, and this is now the basis for what Ms. Bair would like to do nationwide.
Our colleagues at Marketwatch.com recently reported on the FDIC's experience at IndyMac as well as industry-wide data from Lender Processing Services, which manages payments for much of the banking industry. Turns out that the FDIC is moving very slowly in modifying loans, but perhaps not slowly enough, because of the likelihood of further defaults.
Three months into the IndyMac experiment, the FDIC has modified all of 5,400 delinquent loans. It's too early to tell how many of these borrowers will default again, but since even the modified monthly payments consume 38% of borrowers' pretax income, expect a lot of failures. The FDIC uses a re-default rate of 40% in its models but believes the actual rate will be lower. LPS says more than 50% of loans typically go delinquent again after modification.
To roll out its plan nationwide, the FDIC wants to offer private loan servicers a new incentive to modify troubled loans. The private firms would do the same thing the feds have been doing at IndyMac, except they would move the monthly payment down to 31% of pretax income, instead of 38%. The FDIC would pay servicers $1,000 for every loan they modify, and taxpayers will share the losses if loans re-default.
To get to 31%, lenders could offer borrowers lower rates, longer terms or even "principal forbearance." This means that part of the original loan would be converted to an interest rate of zero, and it would not have to be repaid until the home is sold or refinanced -- or the loan matures. In other words, the borrower gets lower payments now but may have a problem again later if home values don't rise and he needs to sell. Other modifications might create a lower interest rate now that rises over time, again squeezing borrowers at some future date. Sound anything like "subprime" loans?
Under the FDIC plan, a borrower would have to stay current for at least six months under the modified terms to make sure that lenders aren't just dumping their losers on taxpayers. Well, not all of their losers anyway. The FDIC is still assuming a 33% re-default rate, even at the lower debt-to-income ratio. All of this is why the White House estimates Ms. Bair's plan could cost as much as $70 billion next year -- not $24 billion.
Many readers probably also tripped over the idea that moving monthly payments to 31% of pretax income is sound finance. Some may ask why anybody who borrowed or lent above that threshold should receive assistance from taxpayers, most of whom are still paying the rent or mortgage on time. Others might wonder how lenders will know what a borrowers' income is in order to set the new ratio. False or undocumented income is the reason many of these loans failed the first time. At IndyMac, the feds are checking reported incomes against IRS data, but private lenders who participate in the new program will have more flexibility in "verifying" income. Sound familiar again?
What we have here is another uncharted voyage into the land of taxpayer risk, and for little economic gain. We can only hope that news of the FDIC program doesn't encourage more people to stop paying their mortgages as they await rescue from Sheila Bair.
More broadly, our politicians need to realize that our economic challenges now go far beyond housing. Rather than further delaying the moment when real estate markets clear, Washington should be sending positive signals to all markets. A pro-growth tax cut or a "regulatory stimulus" plan to encourage new business creation is the answer to rising unemployment, slowing sales across industries, and capital markets that are virtually closed to many debt and equity issuers. A growing economy is also the best way to create more solvent homeowners.
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