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Is Redefault Risk Preventing Mortgage Loan Mods?

posted by Adam Levitin

There's a very interesting new study on mortgage loan modifications out from the Boston Federal Reserve staff.  This sort of study is long-overdue and from an academic standpoint, there's a lot I really like about this study.  But the study is going to get a lot of policy attention, and I think it's important to point out some of the problems with the study that limit its ability to serve as a policy guide.  


The study has two big claims.  First is that the reason we aren't seeing many mods is because of high redefault and self-cure rates for borrowers in general, basically type I and type II errors respectively.  If a mortgagee modifies a loan and it redefaults in a declining real estate market, the mortgagee's recovery from the foreclosure or REO sale will be diminished.  Thus, there is a danger of modification actually reducing value for mortgagees.  Conversely, some the defaults on some loans that are modified would have been cured without modification.  The modification is thus a give-away from the mortgagee's perspective.  Mortgagees are scared of both of these possibilities (or maybe rationally recognize that they are quite likely) and therefore aren't doing mods.  

The other claim, based on an empirical analysis of a sample from the LoanPerformance database, is that there is no statistically significant difference in the percentage of portfolio and securitized loans being modified.  From this the study concludes that securitization is not an important factor in the paucity of loan modifications.  Instead, the authors' identify the common factors of redefault and self-cure as limiting mods.  

From this, the study reaches two conclusions.  First, that there are far fewer preventable foreclosures than assumed.  Second, that servicer safe-harbor provisions to allow servicers to modify loans without fear of litigation are unimportant.  

So what's wrong with this picture?  Regarding the claim that redefault risk and self-cure risk are limiting loan mods, I think that as a pure matter of theory, it makes a lot of sense.  But when the claim is tested against the actual numbers produced in the study, it doesn't hold up--there's still plenty of room to do value-maximizing modifications. 

One of the very strange things about this study is that it has some empirical data and a model, but it never puts the two together.  Instead, the study assumes that the empirical data and the model support the interpretation advanced simply because the model indicates that high levels of redefaults and self-cures would make modifications no longer worthwhile, and the numbers of redefaults and self-cures look really large.  But just because a number looks large doesn't mean that it necessarily shifts the modification calculus.  I've tried putting the numbers together with a model.  Bear with me on the math--it's entirely possible that I've overlooked something in my calculations, and if I have please comment to let me know--but if my math is right, then redefault/self-cure risk just isn't what's limiting mods.  

The question a rational mortgagee with no outside interests should ask when faced witha  defaulted loan is whether the net present value (NPV) of a modified loan is greater than the NPV of a unmodified loan.  If so, a modification would be value maximizing for the mortgagee.  My NPV modeling is somewhat crude, not least because it tries to avoid discount rate and refinancing horizon issues by treating UPB and NPV as equivalent, which they are not, but I think it captures the essential point.  

Let's use some very conservative assumptions--that there will be high redefault and self-cure rates, and that foreclosure losses will be high, and much higher for redefaults.  For a modified loan, lets assume a 30% chance of self-cure (from the study), a 40% chance of redefault (conservative from the study), resulting in a 75% loss severity (quite conservative), and a 35% chance the modified loan will perform as modified.  For an unmodified loan, there is a 30% chance of self-cure and a 70% chance of foreclosure, with a 55% loss severity (conservative--it's more like 60% now).  Let's assume a mortgage with a $200,000 NPV if it performs unmodified, and that M is the maximum NPV of a modified loan such that it will be greater than the NPV of the loan unmodified.  Thus:

[Value if modified, but would have self-cured] + [value if performs as modified] + [foreclosure value if redefault]≥ [value if self-cured without mod] + [value if foreclosed without mod] 


To put the numbers on it: 

.3M + .3M + .4*.25*$200,000 ≥ .3*$200,000 + .7 * .45 * $200,000

.6M + $20000 ≥ $123,000

.6M ≥ $103,000

M≥ $171,666.67

This means that even using the Boston Fed's most conservative assumptions, the principal and/or interest could be written down such that the NPV of the loan would go to $171,666.67 and the modification would still maximize net present value for the mortgagee.  To put this in slightly different terms, a modification would still be value maximizing, even with a 15% write-down in NPV.  And that's with some very conservative assumptions.  Loosen these assumptions (e.g., FDIC's 15% mod-in-the-box self-cure rate or a 30% redefault rate), and there are even more generous modifications possible.  

There's also another way to test the explanatory power of redefault and self-cure risk.  Presumably redefault risk and cure rates also vary with other mortgage characteristics.  For example, it stands to reason that an underwater investor property mortgage is less likely to be cured than an above-water owner-occupied one.  The question, then is whether modification rates track the variations in redefault and cure rates by mortgage characteristic.  If they do, then the study's conclusion would be much stronger; if they don't then either these factors don't matter or mortgagees only care about them in the very rough aggregate (which seems both unlikely and unfortunate).  Hopefully this is something the authors will investigate in later versions of their study.  

Regarding the second claim, that securitization doesn't matter in terms of mods, there's first a data question and then, regardless of how that is answered, a factual and a logical problem.  I don't know the LoanPerformance data set in great detail.  You can see some of its characteristics listed here.  I don't know if LP includes data on loans held in portfolio by credit unions and community banks.  If it doesn't, that might be distorting the results as the portfolio loans for large banks might well be serviced by the same servicers as securitized loans.  If so, the study wouldn't be comparing securitized vs. portfolio, as much as self-serviced vs. serviced-by-others.  

Irrespective, there is a major factual issue overlooked by the study:   there is a difference in how a securitization servicer and a portfolio lender view redefaults and self-cures.  A portfolio lender is fully sensitive to both; a servicer, in contrast, does not care what the property brings in at a foreclosure or REO sale because the servicer is paid off the top.  As long as there is just some land value left, the servicer will get paid.  The servicer might have to make additional months of servicing advances on a redefault, but those are reimburseable too, off the top.  The only cost to a servicer from redefault is some time value.  That means servicers are less sensitive to redefault than portfolio lenders.  Self-cure is also less of an issue for servicers because most of their mods involve interest rate reductions, and rate reductions have only a small affect on servicer compensation, unlike a principal reduction.  In short, redefault and self-cure risk is not an equally applicable factor, so it cannot alone explain the similar rate of mods for securitized and portfolio loans.

So what is the explanation?  There are two possibilities.  First is that it is simply coincidence. The paper recognizes this as a possibility, although it quickly dismisses this.  The second, possibility is that there is another common factor (or factors).  I think servicer capacity is a major concern that applies across the board.  To start with the bulk of servicer personnel at most companies aren't even in the US; they've been outsourced.  Doing a mod is like underwriting a new loan in a distressed situation.  That's a skill, and I don't think it's what servicers were looking for over the past decade when they moved operations to India. Instead, they were looking for low-cost labor for their routine ministerial tasks, and it will take a long time for the industry to acquire the workout talent it needs.  

In any case, even if there is a common factor, that hardly means securitization doesn't create serious concerns.  Even if issues like capacity can be addressed, there are layers of problems preventing modifications, all of which must be addressed, but the study dismisses this possibility a little too quickly, and based on a questionable analysis of the other literature on securitization.  For example, the study claims based on a single empirical study of PSA provisions (which has its own limitations), that "suggests a small role for contract frictions in the context of renegotiation."  This is a very strange statement, as it assumes that contract frictions are just a matter of formal contract provisions.  My article with Anna Gelpern shows that in PSAs there are a variety of frictions to renegotiation, some formal, some functional, and some structural.  Our article is cited elsewhere in the study, but doesn't seem to have informed the Boston Fed staff's study on this point.  The study also claims that the Congressional Oversight Panel's foreclosure report states that "none of the [contractual] restrictions [on loan modification in PSAs] were binding."  The Oversight Panel said no such thing.  The Panel merely observed that in some pools where there was a 5% cap on the number of loans that could be modified, that that cap was not yet limiting modifications.  

In short, there is no reason to assume that contractual frictions don't matter.  That said, I agree with the study's claim that servicer safeharbors are unlikely to do much good, but that is because there are contractual frictions that safeharbors don't address as well agency problems.   

  

Explaining the failure of modification efforts will be an unresolved question for some time, but at this point I think it's really just academic to try and pinpoint why the mods aren't being done.  Instead, we have to look for a method that we know will produce loan modifications.  I hate to sound like a broken record, but there's a solution that cuts to the chase--bankruptcy modification cuts through all of the mess.  And when even a conservative scholar like Stan Leibowitz can write a piece in the WSJ arguing that negative equity is the driving problem, it's time to take another look at cramdown.  

Finally, I wonder whether the goal of maximizing NPV for investors is the right metric.  A foreclosure might maximize value for investors, but be socially detrimental.  If the policy goal is improving social welfare, then we might want to discourage foreclosures that by themselves might be economical. 

Comments

Funny thing, Professor... I've been discussing this particular paper with several people in the last 24 hours. A few excerpts from my own discussions:

When I got into the paper, the first red flag that I saw was that they used datasets from LPS - the Fidelity spinoff.

I suggested that, purely from an anecdotal standpoint, the dataset(s) they used may be, at minimum, skewed and at most fraudulent. Then I asked if anyone had bothered to look into whether or not LPS or Fidelity was involved in any significant litigation anywhere.

While this paper may ultimately help paint a clearer picture on some level, it's findings may very well be based on fraudulent data.

The best way I can demonstrate these issues is simply to direct you to Home Equity Theft so you can view this info for yourself. Unfortunately, I've learned over the years that allowing someone to see the evidence with their own eyes is sometimes the simplest and best way to allow them to understand . A search for "Lender Processing Services" returns this. http://homeequitytheft.blogspot.com/search?q=Lender+Processing+Services+Inc

Likewise, a search of HET for " Fidelity National Information " pulls this: http://homeequitytheft.blogspot.com/search?q=Fidelity+National+Information

And " Fidelity National " this: http://homeequitytheft.blogspot.com/search?q=Fidelity+National

Similarly, the same searches can be conducted at dockets.justia.com where you can run a national search at the federal level for litigation involving Fidelity National Information (Fidelity has at least 3 or 4 business names that are incorporated under the "Fidelity National" umbrella) and/or Lender Processing Services. Currently, 109 federal cases pop on a search of " Fidelity National Information " and not all of those cases involve a "Fidelity National" subsidiary, etc. Only one pops for " Lender Processing Services " but as LPS was spun off from Fidelity National little more than 12 months ago, one simply must look at the age of the data sets being used. It was indicated somewhere that the data sets were 12-18 months old if I remember correctly. Additionally, when the lead-off story from the Home Equity Theft search of LPS involves an investigation from the Connecticut AG's office into LPS there's enough there to make one perk up a tad.

Anecdotally, I've called the building management for Fidelity's 1270 Northland Dr, Mendota Heights, MN address in the past. At the time of the call, they confirmed that there was no office space for Select Portfolio Servicing. When I called a phone number for Fidelity and asked to speak to someone from SPS I was told that there was no one from SPS at that number OR location. Yet, if I remember correctly, the CSFB Asset-Backed Securities Trust Series 2003 HE-2 trust, cited within this thread ( http://ssgoldstar.websitetoolbox.com/post?id=2443140 ) states SPS (or more likely Fairbanks Capital given the time frame) as the servicer of the trust and a business address of 1270 Northland Dr, Mendota Heights, MN. I'll have to try to dig up the 424b5 again to confirm this.

There is also discussion of Fidelity here:
http://ssgoldstar.websitetoolbox.com/post?id=2474008

While this paper may very well help shine light on issues, how/does the information that I've outlined above affect the overall broader picture ?

And please note that any statements made above are purely my own opinion formed while digesting the aforementioned information in hyperlink...

Adam,

This is a great post. I probably differ from you on a few details, but overall it seems you've tried to honestly arrive at an estimate and reason for why there are seemingly so few modifications. A few points that I'd add:

1) In my opinion, your last point is really the heart of the issue. NPV is what most servicers are using to calculate the modification benefits/costs. In many cases, the positive NPV calculation leads to foreclosure. However, if everyone foreclosed on everything right now, that would further the downward spiral in prices and subject the country to a lot more pain in housing and unemployment, so this is clearly not the best idea for the country as a whole. As you suggest, what's economic in the individual case is detrimental on the whole.

2) In terms of your calculation, estimates can vary pretty wildly. Each serivcer is using different numbers based on their own portfoio experience. I believe it would change a lot if you use, for example, a 10% or 15% discount rate (essentially where mortgage bonds are trading in the market right now) and if you use the OTS figures. A recent report cited 70% of loans modified in Q1 '08 are now delinquent(and that's only one year later, let alone two years later). Also, many '06 and '07 subprime mortgages have 80% severities. In that case, it's going to be the very small minority of cases where it makes sense to modify a loan.

3) Overall, I'd say capacity is a huge issue. Servicers I've talked to have doubled their staff the past two years running and are still understaffed. Even if you have the right number people in place, getting everyone immediatly trained on doing a good analysis is going to be impossible.

4) Regarding securitization, there are 5% caps on mods in the PSAs, but they have been surpassed on many deals. It was a constraint originally, but it's an easy hurdle for servicers to get over. The harder constraint is the principal forgiveness. I do think some servicers are reluctant to do a partial writedown. Although there are also some who are going full steam ahead as well, so this depends on who your servicer is.

5) Regarding the prior post, I think Mike is confusing First American Loan Performance with Lender Processing Servicers. Different companies. Loan Performance is extremely credible in terms of data accuracy. They are the industrry standard.

I'm not sure what the conclusion is here really. Just that it's not clear cut what the overall answer is. There are definitely conflicts between the micro answer and the macro answer.

Great post. I think you've correctly identified the real issue is servicer capacity - the system is swamped (see link below). Also, I think there is an availability bias at work - self cures are directly observable by the people working on the modifications, while foreclosure costs are not.

http://residentialpropertyanalytics.blogspot.com/2009/07/mortgage-modification-blues.html

By the way, I was wrong on the LPS comment. I just assumed they were using Loan Performance and not LPS. Loan Performance is kind of the standard for individual loan data. I'm actually surprised they didn't use that dataset. In any case, my bad on that one.

(whew) ...Thanks for coming back and confirming that for me, Nick. Thought I had completely lost my mind there for a second...:)

I do try to be as thorough as I can, as a consumer, when I make statements like this...

Kevin, I would go so far as to say that the system, in addition to being "swamped" is also greedy or I believe I would prefer to use the phrase "inherently corrupt" - but that's me. Try running your favorite servicer's name through dockets.justia.com sometime and see how much litigation pops - just at the federal level.

***WARNING: I rode this one right off the rails here. Upon further examination, Kevin, correct me if I'm wrong here but I believe you were intending "foreclosure costs" as a data set not readily available to the world as opposed to individual application to each loan. That said, I'll post the thought anyway as it continues to lurk in my head.

************************
With regard to foreclosure costs, why is that even an issue? Does not the note insurance that covers the individual tranches cover the overall cost of the individual loan? Even if it "only" covers the outstanding principle balance, once a property is auctioned any outstanding fees should easily be covered by the auction price - unless the fees are so obviously inflated and/or egregious as to be considered ridiculous. And if such is the case, it should be easy enough for a forensic account to step in at that time and follow each and every penny and it's eventual resting place on the balance sheets.
************************

Another interesting, and somewhat disturbing (at least to me), point was brought to my attention recently. In addition to MIT, this paper has the Federal Reserve Bank of both Boston and Atlanta's names on it - despite not expressing the thoughts of any of the institutions. Why the heck didn't any of THEM think to do any background on the source(s)?

And since I'm on the subject:

http://www.mortgageorb.com/e107_plugins/content/content.php?content.3769
Florida Court Selects LPS Case Management Software

The Clerk & Comptroller in Palm Beach County, Fla., has selected the ShowCase integrated case management software offered by Lender Processing Services' (LPS) Aptitude Solutions division, the company says.

Thanks Mike Dillon for doing a nice job revealing Lender Processing Services as a totally unreliable source for data set utilized, which in my view makes this a seriously flawed study, particularly since LPS "has been known to fabricate loan data" as noted by a Florida Consumer Law Attorney.
Other aspects of this report are equally troubling. While it is made patently clear that "The views expressed in this paper are solely those of the authors and not necessarily those of the Federal Reserve Bank of Boston, the Federal Reserve bank of Atlanta, or the Federal Reserve System.", its authors believe that their "analysis has some important implications for policy." It is disconcerting that a report which fails to present so much of the picture on such a vital issue it purports to have researched to be even remotely considered as a tool for policy making.

This all leaves me seriously questioning intent of this report.

Granted it does make some passing allusions to underlying issue of servicer incentive but these are not expanded upon at all and they are very easy to miss.
" In addition, the rules by which servicers are reimbursed for expenses may provide a perverse incentive to foreclose rather than modify."
"because servicers do not internalize the losses on a securitized loan, they may not behave optimally." and Congressional Oversight Panel's observation that “The specific dynamics of servicer incentives are not well understood.”

Professor Levitin, you said it best in your paper on MBS Modification Issues. "Foreclosure is frequently more profitable to servicers than loan modification. Therefore servicers are incentivized to foreclose rather than modify loans, even if modification is in the best interest of the MBS holders and the homeowners."

Bottom line is, until services adopt 'best practices' as set forth in a now very well known FTC settlement, Curry v. Fairbanks, Select Portfolio Servicing - http://www.ftc.gov:80/os/caselist/0323014.shtm , modifications will continue to redefault or they just won't happen significantly as has pretty much been the case all along. Funny how the report fails to note servicers have now received 18+ Billion in TARP funds toward Home Affordable Modification Program (HAMP). Lot of good that did.

http://web.mit.edu/madelino/www/cvManuel_Adelino.pdf

Interesting that Mr. Adelino, a former business analyst from GOLDMAN SACHS and McKinsey & Co., shows up working for the Federal Reserve Bank of Boston and authors a paper like this.

The only McKinsey & Co. that I am aware of is the one that revamped Allstate Insurance's internal policies which, in turn, helped spawn "From Good Hands To Boxing Gloves". http://www.injurytriallawyer.com/blog/from-good-hands-to-boxing-gloves-how-allstate-has-earned-billions-by-shortchanging-policyholders.cfm

You are debating the source of data and ignoring the 70 trillion pound gorilla. The reason lenders do not renegotiate is because they get paid much more when a property goes into default - not just the paltry amounts the authors talk about; cure rates and redefaults are meaningless.

The investors are getting twice the original loan amount paid out in Credit Default Swap claims payments. Credit Default Swaps are like insurance for mortgage backed securities. AIG paid massive claims since last September.

On a typical $200k loan, the investors gets a CDS payoff of around of around $425k to $550k; they don't care about redefault or cure rates; they don't care if the REO sale brings in $80k or $120k.

Eliminate CDS payouts and you will eliminate the vast majority of foreclosures; the banks will beg to modify and reduce principal. CDS encourages foreclosure and discourages modification.

If you do not wrap your brain around this one you will remain as clueless as the authors of the FRBB paper.

Banko, if I could have an intelligent discussion regarding CDSs I would. Unfortunately, I haven't been able to concentrate on the topic long enough to grasp it much beyond the point that I know that CDS payout is one of several critical points to the entire Mortgage Servicing Fraud and loan mod refusal issues. Fortunately, I do know several others who CAN discuss this extremely important concern with more intelligence than I.

To date, though, I believe that you are the first that I have seen throw around actual numbers to illustrate the problem from a "single note effect" standpoint. So far, all I've been able to gather has been more abstract"entire pool" figures. I'm all ears... Educate away, either here or privately. I'd LOVE to be able to digest more info on this topic - especially from a "single note" perspective. Suggetions?


If I default on my $300,000 mortgage Bank of America will collect approximately $550,000 to $650,000. If my friend defaults on their $500,000 mortgage Goldman Sachs will collect $900,000 to $1.2 million (depending on interest rates, term of the mortgages, and credit ratings).

Why do they collect such a big payout? Because they have insurance on the Mortgage-Backed Securities that hold the mortgages. When an MBS goes into default, the insurance pays. Why do they collect so much more than the face value of the mortgage? Because, over the life of the loan the mortgage would have generated 2 ½ to 3 times the face amount in cash flow, minus discounts; the insurance covers that anticipated cash flow, not the nominal value of the original mortgage.

What is this insurance? Credit Default Swaps are essentially insurance for Mortgage-Backed Securities. If a certain percentage of mortgages held in the MBS go into default then the MBS defaults and the insurance is paid. AIG Financial Products was the largest writer/issuer of CDS contracts. With the government’s backing AIG has paid out tens of billions in claims on CDS contracts.

CDS is not typical insurance; it is almost completely unregulated; an investor can purchase a CDS contract/insurance policy even though they have no insurable interest in the underlying mortgage or even the underlying MBS; if CDS insurance is purchased that covers my mortgage, I do not receive any notification. The homeowner has been unilaterally stripped of their mitigation rights as a party to the contract by the purchase of CDS contract. This, in effect, modifies the original contract without consideration to the homeowner for that modification.

We do not allow doctors to purchase life insurance policies on their patient's lives without the patient’s knowledge and then be in charge of making life and death decisions for the patient’s treatment. I trust my doctor but we all recognize that it is reckless and foolhardy to subject that trust to excessive temptation. We do allow mortgages investors to purchase default insurance policies without the homeowners’ knowledge and, if delinquency occurs, we recklessly tempt these investors to make the decisions on whether the loan will be modified or go into default.
CDS insurance offers a clear incentive for the investors or holders of pooling and servicing agreements (PSAs) to force a "default" either through foreclosure, short sales, short payoffs, or deed in lieu transactions. PSAs place limits on the number of modifications a mortgage servicer can perform.

According to a research paper for the Federal Reserve Bank of Boston, less than 3% of seriously delinquent borrowers receive concessionary modification in the first year following the first serious delinquency; concessionary modifications may be reductions in the principal balance or interest rate or extension of the term, or all three. Less than 5% of serious delinquencies receive non-concessionary modifications; their payments actually increase (half of these redefault within 6 months). Approximately 30% of serious delinquencies go the route of short sale or deed in lieu transactions; essentially, the borrower loses their home. Approximately 50% of serious delinquencies result in foreclosure proceedings and 30% of seriously delinquent borrowers lose their home through foreclosure in the 12 months following the initial delinquency. To recap: approximately 80% of serious delinquent borrowers lose their homes, 5% get a bad modification, 3% get a good modification, and the others are stuck in modification limbo.

In the first 6 months of the Hope for Homeowners Program only 25 homeowners were able to get refinancing under the plan, despite a nationwide appeal by President Bush. Federal programs have improved in the past few months but show no sign of making major inroads to solve the problem of foreclosure.

There are frequent anecdotal examples of investors/PSAs/servicers not really trying to help homeowners. I personally know a real estate attorney who offered a $350,000 settlement on a $510,000 mortgage; that offer was turned down and the property was offered at $200,000 in an REO sale. I know one man who has been attempting modification for 16 months. I know another woman who has been attempting modification for 8 months but Bank of America has lost her application 5 times. Bank of America shows remarkable efficiency in tracking billions of daily check and charge transactions to the penny, yet they show stupefying incompetence in tracking a modification application. The lack of competence is a direct result of a lack of incentive to modify. These examples are the norm, not the exception.

It would be easy to suggest that most foreclosures cannot be prevented, yet there are some excellent proposals to keep homeowners in their homes and stabilize house prices; the Milken Institute has proposed a plan “How to Rebuild US Home Prices and Fix the Economy” that could eliminate negative equity and lower monthly mortgage payments, and the price for this plan is less than what has already been spent on the AIG bailout. Regrettably, we may never see this plan put in place unless we can remove the incentive for investors and holders of PSAs to force default, unless we can stop the big CDS insurance payout for defaults.

Have the investors/PSAs/servicers actually been forcing defaults? We know CDS contracts offer the temptation of the largest possible compensation when claims are paid. We know investors/PSAs/servicers are in a position of power to create hurdles to modifications and to deny modifications. We know that defaults outnumber modifications by more than 10 to 1. We know that several financial institutions have posted exceptionally large earnings despite the worst economic downturn since the Great Depression. We have not seen (publicly disclosed) investigations or research that revealed the smoking gun. We have seen motive, opportunity, and results.

AIG, with the backing of the government, has been treating CDS claims in a most un-insurance like manner – they have been paying the claims in full without conducting full investigations or audits. Never in history has an insurance company paid out tens of billions of dollars in claims without denying at least some part of the claims.

Simple forensic audits of the original mortgage loans could discover fraud, predatory lending, or other violations on the underlying mortgages and give cause to rescind the CDS contract. If the CDS contracts are determined to be insurance, the only proper action would be to deny the claim and return the premium. It is strange that so far, no claims have been determined to be fraudulent, none of the money paid out has been determined to be laundered, and apparently all taxes have been paid; yes taxes should be due because CDS contract is not officially recognized by any state insurance department as insurance and does not share the tax exemption of insurance.

Nothing will stop foreclosures, stabilize US home prices, and fix the economy more than removing the incentive to foreclose created by the CDSs. The investors will negotiate in good faith to make it attractive for the homeowners to start to pay their mortgages and with fewer REO properties on the market the homeowner will not have the incentive to walk away and buy a cheaper comparable property down the street. Markets will be more rational and not be propped up by illegal insurance that distorts true values. The taxpayers will save fortunes being flushed down the AIG black hole. And the added benefit to society is that people will stay in their homes without speculators and profiteers placing side bets on their home.

I do believe I said Servicers wouldn't be able to handle the volume. Now it seems they are profiting from it (knew that was coming)... (Not a I told you so.... well....maybe it is...:) )

Great article by Adam. As a real estate investor seeking modifications from my lenders I have been looking for a well thought out analysis on lender motivations to modify. Thanks for sharing this great insight.

This leaves me curious about why there is much speculation about what the lender considers when doing a mod and less actual explanations from someone in the lending industry that is making these decisions. Do lenders hold this decision criteria close to the vest or is there some way to go straight to the source and ask them how they make the modification decision?

Wow! Just got down to Bankometer's lesson on CDS's. Great stuff. I am sorry that I don't have anything to contribute here. Only questions. Most of the posts here are significant contributions so hopefully I am welcome with just my questions. For Bankometer, in your first paragraph. Isn't the amount the investor collects from the CDS offset by the price they originally paid for the security in the first place? Since they are buying a security with a future stream of payments would they not have paid a price higher than the face value of the loan for the security? So the gain to the investor of forcing the foreclosure would be the difference right? Typically, how big is this difference?

If this is the right way to look at it, would the investor then be comparing this difference with the cost of foreclosure to determine if they wanted to support a modification?

Is it better to try and keep delinquent borrowers in their homes with government subsidies, or expedite foreclosures and resell the homes to qualified borrowers?

Very interesting article. I am looking for more information on if or how credit default swaps (or other issues I am not aware of) cause lenders to prefer foreclosure over short sales even though logic and Arizona market statistics suggest $25 -$30 per square foot higher prices on a short sale. Can you suggest some articles or have you done one?
Thanks,

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