Until this past week, policy makers had pinned their hopes for a solution to the burgeoning home mortgage crisis on mortgage service companies, which are the only point of contact for delinquent and soon-to-be delinquent borrowers seeking modifications to mortgages purchased by investors in the form of mortgage-backed securities. Problem was, mortgage servicers had modified only 1 percent of the adjustable interest rate loans that reset in January, April, and July of this year.
In light of that sobering fact, U.S. Treasury Secretary Henry Paulson deserves credit for recognizing that something had to give if borrowers in trouble were ever going to catch a break. And Sen. Charles Schumer (D-NY) should be applauded for proposed legislation to allow government-supported Fannie Mae and Freddie Mac to purchase additional mortgages from subprime borrowers who seek to refinance on the secondary market to resell as mortgage-backed securities. Rep. Barney Frank (D-MA) is expected to introduce similar legislation in the House in the near future.
But first, kudos to Paulson for bringing the largest mortgage servicers together with state and local agencies and housing counselors to participate in the new HOPE NOW partnership. Paulson displayed seriousness and pragmatism in this response to the subprime mortgage crisis, and we expect to see him holding servicers to their words and tracking their efforts to help as many homeowners as possible.
Among the voluntary steps the members of the HOPE NOW partnership have agreed to take are contacting at-risk borrowers, albeit through direct mail rather than the far more effective step of making phone calls; adopting standards and processes to strengthen communications between servicers and counselors; expanding the capacity of the existing network of counselors to connect borrowers to their servicers; and creating technological solutions to link counselors and servicers, which they believe can streamline the process and allow them to help as many borrowers as possible.
Ultimately, the HOPE NOW partnership emphasizes outreach to borrowers as the way to help homeowners stay in their homes. Secretary Paulson reiterated this perspective in his introductory remarks saying, “Only through better integration of their efforts can mortgage counselors and mortgage servicers reach the greatest number of borrowers facing payments they can’t meet and only with increased coordination can they be more effective in finding solutions for those homeowners.”
When the secretary next meets with the servicers, he needs to follow up with them to find out how many new people they have trained to make loan modifications, how many loans have been modified, and under what circumstances. These efforts to expand outreach to borrowers and potentially increase the numbers of loans modified will be helpful, when coupled with the expanded ability of subprime borrowers to refinance their loans into prime, fixed rate loans under yesterday’s proposals by Schumer and Frank that would temporarily lift the portfolio limits on Fannie Mae and Freddie Mac—with $125 billion of the expanded portfolios required to be used to fund refinancing subprime loans.
But much more needs to be done. In the case of HOPE NOW, even if servicers were to rapidly increase the numbers of loans they modified, it would not prevent enough foreclosures to protect our communities and economy from serious harm. Not all troubled loans can reasonably be expected to be modified, particularly in communities where significant declines in housing prices have left many borrowers owing more than their homes are worth. Similarly, lifting the portfolio caps will not help someone who is looking to refinance a loan worth more than the house is worth. Given that stark reality, congressional leaders must demonstrate that they also understand the seriousness of this crisis by pressing the secretary to join them in yet bolder responses.
Indeed, we can only hope that as the HOPE NOW partnership moves forward, it develops more robust outreach capacity than is currently demonstrated on its website, which is bereft of any meaningful content and web design fundamentals. Still, Paulson’s productive jawboning also yielded yesterday’s statement from the American Securitization Forum, which clarified that mortgage servicers can be reimbursed for the costs of counseling from a mortgage pool’s cash flows when “the related counseling service has had or is likely to have the effect of mitigating losses or maximizing recoveries on the particular loan.”
The ASF statement seems to make clear that investors in mortgage-backed securities are willing to forgo some returns in the form of counseling costs with the expectation of greater returns down the road created by lower default rates. This should, theoretically, give servicers greater latitude not only to make changes to loan terms that they believe will reduce defaults, but also to pass on the costs that they incur in revitalizing moribund loss mitigation departments. From the perspective of the servicers, bringing counselors into the potentially fraught relationship with the borrowers can serve a mediating purpose, with the expectation that professionally trained counselors can help lower default rates.
Four months ago, the ASF issued a similar directive indicating that loan restructuring should not jeopardize the tax treatment of the sales of the mortgages into the secondary markets. The ASF’s position was supported by similar opinions from the Mortgage Bankers Association, a tax Q&A issued by Deloitte and Touche, the Financial Services Roundtable, and, ultimately, the Securities and Exchange Commission. Even earlier, the Federal Reserve Board of Governors issued statements encouraging lenders and servicers to work with borrowers “to consider prudent workout arrangements that avoid unnecessary foreclosures.”
There is now ample evidence from both the public and private sectors that mortgage servicers are empowered to make changes to loans in order to keep borrowers in their homes while still protecting investors’ interests. Now we must watch the servicers carefully to make sure their deeds match their rhetoric.
The HOPE NOW partnership, which has promised to measure and report their progress on their “action plan,” wants to see “common communications guidelines that will be used to respond to at-risk borrowers in order to offer them the best possible solutions, customized for each borrower.” But it remains to be seen whether the servicers will simply develop highly customized ways of saying “no” or if the responses result in actual loan modifications.
Real action would range from minor changes, such as temporary adjustments to monthly payments and extending payment periods, to more comprehensive restructuring of loan terms by converting loans from adjustable rates to fixed rates, reducing interest rates, or writing off part of the principal balance. Those steps would actually benefit borrowers.
And keep a close eye on the actual number of restructured loans. Case in point: Of the 450,000 delinquent loans serviced by HOPE NOW partner Countrywide Financial Corporation, only about 1,000 loans are set for interest rate reductions.
The HOPE NOW partnership pins great hopes on the ability of counselors to help borrowers navigate the often difficult path to loan modification, and counselors have indicated that some servicers in the partnership have been open to making modifications in the past. It is not at all certain, however, that housing counselors will be able to convince servicers to make many of the most urgently needed modifications.
By most accounts, the chances of getting a modification are high in cases where an individual payment is missed, such as when an unexpected medical bill means a family faces the stark choice of paying the doctor or the mortgage. With a counselor’s assistance, a servicer may be more willing to work out an arrangement to make up the missed payment at a later date. But it is far from clear that servicers are willing at this point to make major changes to loan terms when the default is a function of an adjustable rate mortgage whose monthly payment has jumped 42 percent, which is the average payment increase for loans made between 2004 and 2006.
It is even harder to see how borrowers, counselors, and servicers, who must negotiate the terms of each loan modification one at a time, will be able to help the growing number of borrowers who need help. Voluntary loan modification, which is ultimately the goal of HOPE NOW, is not a magic bullet that can save all of the estimated 2.2 million households that are expected to enter foreclosure in the coming years.
Loan modification is particularly hard to come by for borrowers in falling housing markets who have loan balances in excess of the value of their homes. These borrowers also face similar challenges when trying to refinance into Federal Housing Administration loans or conforming loans backed by Fannie Mae or Freddie Mac, even with the expanded caps as proposed by Sen. Schumer and Rep. Frank. Failure to help these families will have a much broader economic impact as their homes enter foreclosure, yet the existing partnerships, policies, and programs are incapable of addressing this growing need.
Thus, while HOPE NOW is a testament to Secretary Paulson’s appreciation for the seriousness of the current mortgage crisis, he needs partners on Capitol Hill who will push him and the Bush administration further to address some of those defaulting loans that private servicers will not be cajoled into modifying on their own. Targeting funds for refinancing subprime loans under Fannie Mae and Freddie Mac’s portfolio expansion is also part of a broader solution that can help some, but by no means all, troubled borrowers.
Overall, an appropriate public response must not provide an unnecessary bailout of lenders who made unconscionable loans or homeowners who knowingly bet the farm and lost. Similarly, we do not pretend we can or should prevent every foreclosure. With those caveats in mind, we must do our utmost to address the legitimate needs of the broad sweep of middle class homeowners whose only form of wealth has been in homeownership, most of whom never took out a subprime loan, and whose wealth could deteriorate quickly with falling house prices—especially in heavily affected communities.
There is an unquestionable need to prevent the continuing foreclosure wave from being a contagion to the larger economy with consequences for middle class wealth, job creation and wages, the effects of which we may only be beginning to see now. And there is far more to be done before this crisis passes.
We can expect that the pain of skyrocketing monthly payments on resetting adjustable rate mortgages may continue to be felt through the middle of 2010 on loans that were originated as late as this summer. For loans issued from 2004 through 2006, First American Core Logic, a mortgage risk analysis firm, projects that 12 percent of subprime loans and 7 percent of market-rate ARMs will default because of rate resets. They also projected that each 1 percent decline in national house prices would lead to an additional 70,000 foreclosures due to resets. Using a similar dataset, the Center for Responsible Lending projects nearly 20 percent of subprime loans will fail.
That’s why greater outreach and a few modified loans are clearly insufficient to address the scope of the problem. We need to see the Senate move more quickly on FHA reform and approve the expansion of the portfolios of Government-Sponsored Enterprises Fannie Mae and Freddie Mac to help subprime borrowers, even if it delays taking up GSE legislation that Treasury Secretary Paulson indicates must be moved before he will support the GSEs taking a broader role. And there are no signs indicating concern that the budget battle with the President will ultimately slow the process of getting needed counseling money out the door.
In addition to the leadership demonstrated in the Senate by Sen. Schumer, Sen. Jack Reed (D-RI) successfully included language to expand eligibility for Housing and Urban Development-financed housing counseling to all low- and moderate-income homeowners as part of FHA reform. And Sen. Dick Durbin (D-IL) raised prospects of allowing bankrutpcy judges to modify in bankruptcy the portion of a home mortgage that is no longer effectively secured and is negotiating, with Sen. Arlen Specter (R-PA) joining him on a bipartisan bill that could move through the Judiciary Committee.
Most importantly, no one is seriously considering proposals that could make the most difference to borrowers unable to obtain loan modifications or to find a new loan that could be bought by the GSEs, such as directing funds to state housing finance agencies already equipped to safely refinance borrowers in default, or by re-establishing an entity like the Depression-era Home Owners’ Loan Corporation and giving it short-term authority to directly issue troubled borrowers fully amortizing, fixed-rate first mortgages while buying out the existing lien holders at a discount.
If our nation is going to prevent a wider contagion from the subprime mortgage crisis, Secretary Paulson, the Bush Administration, and leaders in Congress need to get serious about the full range of actions that it will take to achieve that goal. Increased outreach and loan modifications are a good start and, like GSE portfolio expansion targeted at subprime borrowers, are necessary components of an overall solution. But there are still far to many families who will be unable to get relief under any of the existing programs.