Yesterday I wrote a story for Time.com about how loan modifications aren’t all they’re cracked up to be. You can read it here.
Since we like our web stories short, I didn’t have as much space as I might have liked to quote the evidence behind my conclusion—that loan modifications, at least the way they’re being done at the moment, aren’t the cure-all that politicians and economists are making them out to be. Now you get to read about that extra evidence here.
Alan White, a law professor at Valparaiso University in Indiana, looked at a pool of 4,342 subprime loan modifications reported by servicers between July 2007 and June 2008, and found that the aggregate amount of the loans actually increased from $912 million to $933 million. That’s because one of the most popular sorts of modifications is to simply spread missed payments over the remaining life of the loan. Not surprisingly, that sort of change often only works as a short-term fix; redefaults are a huge problem. Bert Ely, a banking industry consultant I talked to, was pretty negative on the whole effort. “During the S&L crisis, we had a saying: a rolling loan gather no loss,” he said to me. “All you do is roll the problem forward, and I have a feeling that’s how a lot of these loan modifications are going to turn out.”
The good news is that some servicers are moving toward more substantial interventions—reducing interest rates and, most importantly of all, docking principal balances.
It’s not a whole lot yet, but there’s evidence of growth. In White’s sample, only 1.5% of loan modifications involved principal reduction, though looking at newer numbers, from August and September, he now sees that approach in about 7% of modifications. In the story I quote a Credit Suisse study from October, and those researchers found the same thing—slow, but perceptible, progress.
Others want to go further faster. When the FDIC took over the failed bank IndyMac in July, FDIC chairman Sheila Bair suddenly had a way to try out what she had been clamoring for for months: systematic and sweeping changes to loan terms. So far, the FDIC has sent out letters to 7,5000 of IndyMac’s 60,000 delinquent borrowers, offering new mortgage payments no more than 38% of their gross income. After a legal settlement with 11 state attorneys general, Bank of America said it would do something similar with loans made by Countrywide, the mortgage lender B of A bought earlier this year. There the goal is to reduce borrowers’ payments to no more than 34% of monthly income.
I talked to Bruce Marks, who runs the Neighborhood Assistance Corporation of America, a non-profit that works with servicers to restructure loans, and he talked about “a growing consensus that traditional modifications don’t work, that the only thing that does is determining what a homeowner can afford based on documented income.”
Determining what a homeowner can afford. A wild concept, I know.
Barbara!