In a story about all the former subprime mortgage brokers who are now in the business of “helping” people get loan modifications, the NYT details the unsavory—and, according to the FTC, illegal—practices of a California outfit called the Federal Loan Modification Law Center. In the words of one ex-sales agent: “They basically told us, ‘Do whatever you need to do. It’s a sales floor. You’re here to sell.’ People would quote success rates and just pull them out of thin air.”
It’s a great piece, definitely worth a read, although the thing it doesn’t address is the reason so many people turn to these sorts of companies in the first place. Trying to negotiate a loan modification—or a short sale—is a gruelling process that can easily leave a person emotionally battered. A few thousand bucks, even for a person already financially overwhelmed, can seem like a perfectly reasonable price.
Why are these negotiations so difficult to maneuver? Conventional wisdom tells us that a big part of the problem is the distributed ownership of the mortgages being considered for overhaul. Our old friend securitization. But is that actually true?
A new paper by researchers at the Boston and Atlanta Feds and MIT would have us believe that it’s not. Manuel Adelino, Kristopher Gerardi and Paul Willen plumb a data set from Lender Processing Services covering about 60% of the mortgages originated in the United States between 2005 and 2007. They take a look at renegotiation rates for loans held in private-label securitizations and loans held on lenders’ books and find no significant difference. This, they conclude, is because, despite popular thinking, the legal framework of mortgage securities isn’t a hang-up. It’s simply not in the typical mortgage owner’s economic interest to mass modify:
At face value, this assertion may seem implausible, since there are many estimates that suggest the average loss given foreclosure is much greater than the loss in value of a modified loan. However, we point out that renegotiation exposes lenders to two types of risks that are often overlooked by market observers and that can dramatically increase its cost. The first is “self-cure risk,” which refers to the situation in which a lender renegotiates with a delinquent borrower who does not need assistance. This group of borrowers is non-trivial according to our data, as we find that approximately 30 percent of seriously delinquent borrowers “cure” in our data without receiving a modification. The second cost comes from borrowers who default again after receiving a loan modification. We refer to this group as “redefaulters,” and our results show that a large fraction (between 30 and 45 percent) of borrowers who receive modifications, end up back in serious delinquency within six months. For this group, the lender has simply postponed foreclosure, and, if the housing market continues to decline, the lender will recover even less in foreclosure in the future.
There’s been plenty of talk about redefault, but that notion of self-cure is a fairly new one. And valid, I would think.
Although Alan White, a law professor at Valparaiso University who has one of the best data sets on loan mods (having tracked a particular set of securitizations for the better part of two years), disagrees. A couple of weeks ago, in Congressional testimony, he found fault in the Boston Fed paper, arguing that the model used was open to a wide range of possible outcomes, depending, as it did, on certain assumptions about redefault, cure and loss severity rates. He also pointed out that there is often a reason to modify that goes beyond the particular property in question: foreclosures reduce the value of neighboring houses, as well.
The thing White and the Fed/MIT economists do agree about is the low rate at which modifications are being made. In the Fed study, only 8% of seriously delinquent homeowners received a modification in the year following the first serious delinquency, and just 3% received a modification that was “concessionary”—i.e., reduced a borrower’s monthly payments.
Which explains why, for better or for worse, homeowners are turning to outfits like the one detailed in the NYT.