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Don’t Let Servicers Be Mortgage Relief Gatekeepers (Again)

posted by Jean Braucher

Thanks to Chris Mayer for taking the time to comment on my earlier posting and for providing more information about his mortgage relief and stimulus proposal (with Glenn Hubbard). First, let’s focus on his statement that, “Servicers must run any program, but ours would be directed by the Treasury Department and would require compliance.”  HAMP, the administration’s troubled mortgage modification program, is run by the Treasury Department and theoretically requires compliance by participating servicers, but that is very different from actual compliance. Servicers, as I noted before, have done “a terrible job” under HAMP, to quote Secretary Geithner, who nonetheless has refrained from invoking enforcement powers. Debtors frequently experience a run-around trying to get a HAMP modification.

It is not the case that a new program, or the existing HAMP, has to be put in place by servicers. In the context of HAMP, it has been suggested that the government should approve modifications directly. See Wall St. J. here (discussing the idea that HAMP would have worked better if the government had dealt directly with applicants and decided which ones qualified). Servicers could be left to distribute payments on modified (or refinanced) loans, but they should not be the gatekeepers.  We don’t want them deciding whether to approve new loans under which they would lose existing favorable contract rights. We’ve been there. It doesn’t work.

Second, Mayer’s comment clarifies that the program he and Hubbard have in mind would only be for government-guaranteed mortgages, those generated by the government sponsored entities (GSEs), such as Fannie and Freddie. These mortgages are already guaranteed by taxpayers as a result of government action at the height of the mortgage crisis. The Hubbard-Mayer idea is to convert existing government-backed mortgages at higher interest rates into government-backed mortgages at lower interest rates, using refinancings and mortgage-backed securities as the means. Since defaults presumably would be reduced on lower-interest loans with lower monthly payments, there might even be some reduction in defaults that the government would have to cover.

It should be noted that HAMP has some degree of functional equivalence with this proposal, albeit with some important differences. HAMP involves modifications by investors; the Hubbard-Mayer proposal involves third parties buying out the current investors. HAMP writes interest rates down to as low as 2%, with rates going up to prevailing rates starting in year five; Hubbard and Mayer envision prevailing interest rates from the outset, so the interest rate breaks are not as good (so perhaps with this, we could kiss HAMP goodbye, not working anyway).  HAMP requires financial hardship; Hubbard and Mayer would give mortgage relief even to those with ability to pay under their current loans, with a stimulus purpose in mind.

The Hubbard-Mayer plan would leave out those not part of the GSE share of the mortgage market. As far as new mortgages being generated now, most are in the GSE share, but going back a few years (and these are the mortgages now most likely to be underwater and at risk of default), many were not part of the GSE share (the GSE share was 46 percent in the second quarter of 2007, for example—see here). Still, some mortgage relief is better than none.  But note that borrowers who are under water and who would get refinancing under this plan would still be under water aftewards, so that they could not sell their homes and pay off their loans without a short sale or other workout, which at a minimum is time-consuming. This plan works best for people rooted in one place and not so well for those who might need to move. And of course there are labor market consequences to locking people into their homes.

How would the government subsidize these refinancings? One way is in foregone interest on US Treasury holdings of GSE mortgaged backed securities (MBSs), over $185 billion as of May of this year. The Federal Reserve also holds a lot of MBSs in its System Open Market Account (SOMA)—over $1 trillion as of Sept. 15, 2010. See here. (SOMA, of course, is a term Aldous Huxley coined.)

To the extent loans in MBSs are refinanced at lower rates, the government's holdings in these securities would no longer get the higher rates. But maybe that’s a subsidy worth making for stimulus purposes. Lower interest rates on refinanced mortgages would have positive tax consequences for the government, as mortgage interest deductions declined. Whether there are any other elements of government subsidy or returns deeply embedded in the proposal is not entirely clear (at least to me). It may be that investors in underwater mortgages (from the outset) would want quicker access to payoffs on government guarantees as part of the terms, increasing government costs on default.

But if the economic gurus think this could work, my one clear plea is based on legal and empirical knowledge: Keep servicers out of a gatekeeping role! They will bury alive the best of plans.  

Comments

I completely agree with Jean Braucher. Servicers have consistently been a large part of the problem in the foreclosure crisis, and people have written about their conflicts of interest in doing workouts and their reliance on fee income for at least three or four years--well before HAMP was initiated. There is no reason to think that servicers would suddenly begin to cooperate under the Hubbard/Mayer program. Although bankruptcy cramdown has its pros and cons, one of the best arguments in its favor was its ability to eliminate servicer obstruction. The Hubbard/Mayer plan does not solve the servicer problem, and indeed to the extent that they would let servicers charge a fee for loan modifications and role those fees ino consumers' mortgage obligations, may be a step back from HAMP. And that is a sorry starting place from which to retreat.

Obviously, I need to construct another shrine in the shed - this one dedicated to Professor Braucher. Apologies, Professor Braucher, but I already sacrifice Oreo cookies to Professor Porter as often as time and budget allows. Would you be at all pleased by periodic offerings of frozen Devil Dogs or Ring Dings?

In all seriousness, I can't begin to say how reassuring it is to have those far more intelligent and learned say what I, and many other Mortgage Servicing Fraud victims, have been absolutely screaming now for close to two decades with regard to the actions of mortgage servicers,. You guys just happen to say it in far greater detail, depth and accuracy.

Every time I see a piece like this published anywhere, but especially by someone with any kind of assemblage of the alphabet after their name, I feel a little less like the guy standing out in the corn field describing how the lights came down out of the sky and stole my cow. Thank you.

This has been documented many times. Bill Moyers talked about it many times on his "Journal" show on PBS many months (maybe over a year) ago, and if I remember correctly there were at least 2 terrific NYT articles on how banks were ignoring/losing applications for mortgage adjustments, sometimes losing the paper work 3 separate and sequential times (after 3 applications were sent in by the same mortgager).

When they had the second round of blogger meetings with Treasury, one of the Treasury officials seemed to imply they knew the whole process (HAMP) was a joke from the start and were just doing it to spread out the foreclosures over a longer time frame so it wouldn't hit the economy all at once.

I think it extremely sad when high ranking members of Treasury basically admit they were knowingly sacrificing those at the bottom rung with a useless program so they can "save" the economy.

Ted K is right: HAMP has been a dog and pony show that has served little purpose beyond letting creditors time when they will drop the hammer while avoiding accounting pain in the meantime. Few debtors get into the program, and effectively none get through. Even with reduced interest, payments don't get made, typically due to job loss or medical bills. I don't see these risks reducing any time soon, so I don't see how the proposal will have substantially better default rates than HAMP unless it significantly changes what "default" means. Also, without a strip-down provision, HAMP leaves the debtor under water on any foreseeable time line. This is a huge disincentive for staying with the program and simply walking away. If the proposal actually passed through Congress and became law, would we find that it provided for stripping down? Or would we find that another class of debts was now nondischargeable in bankruptcy?

Hi Jean (and others)-

Thanks a lot for your comments and insights. As we envision this plan (and as you suggest), there would be no role for servicers approving anything; ALL borrowers would be approved. This is a critical part of the process. It has to be streamlined. Other commentators have suggested similar programs to help refinancing that focus only on reducing costs of refinancing. We believe that is not enough. Our plan is very aggressive in this regard.

Second, the failures of HAMP are a prime consideration in our proposal. Avoiding costs of refinancing and removing discretion from the process should make this program much more successful at modifying mortgages. While I agree that we need to do much more (e.g., helping those with bank portfolio loans or bank loans), no single proposal can solve all problems in this market. But helping 2/3 of all mortgages is a really great and ambitious start. Ed Morrison, Tomek Piskorski and I have made policy proposals and done research aimed at trying to help reduce foreclosures. A key part of this is trying to do things in scale. Time is against us here.

Third, the computations about the cost to taxpayers is complicated. We are now doing these calculations in more detail, but believe the balance of payments will cut in favor of this proposal. We believe that any possible losses on MBS held by the government should be more than offset by lower costs of future defaults for the GSEs. First, having fewer defaults and foreclosures will lower guarantee costs. Lowering mortgage costs will not only reduce defaults on American hammered by the recession, it will also reduce strategic defaults. While strategic defaulters will not get help under any existing programs, they still cost us, as taxpayers, lots of money. Second, as you point out, there is a partial offset through reduced mortgage interest deductions (this is complicated by lost taxes from investors on the other side). But since appreciable numbers of securities held overseas, we believe that the net effect will benefit taxpayers. Even if it were a close call, the macroeconomic impact of $50 billion or more of additional income to middle class Americans should generate more than enough economic activity to help ordinary Americans and taxpayers.

Once again, we appreciate your feedback. We hope this is a proposal that can get support across the political spectrum. Comments can help refine this. But the status quo is not a good place to be.

-Chris Mayer

Chris-- I understand clearly now that servicers would not approve/disapprove loans. Everyone is approved, within a broad class of homeowners. But what is the lever to get servicers to do this work? I had remembered the op ed suggesting payments to servicers but isn't that what HAMP tried? In your opinion, is it merely that the amount of the servicer compensation was too low? Or could it be that the servicing industry is structurally incompetent to carry out this kind of task? I would appreciate any education you could provide me on these matters.

Thanks, Katie. The payments to servicers in our program would occur only after the refinancing is completed. One would clearly want to set the right fee so that you make it in the interests of servicers to do this, but not provide a windfall. For servicers, this would be a win, as they get the same servicing fee whether or not there is a modification or foreclosure. So lower payments mean fewer defaults, so servicers should like the program. That isn't the goal, obviously, helping homeowners is the goal, but it increases the likelihood that servicers make it work,

In my view servicers have been a problem in this crisis, but part of the reason is that we have not tied their compensation closely enough to performance. In this case, performance is keeping people in their homes and current on their mortgages. My original proposal to deal with foreclosures in early 2009 (with Ed Morrison and Tomek Piskorski) strongly emphasized this point. In our proposal, payments to servicers only happened when homeowners were in their homes paying their mortgage. That is a strong incentive to make modifications work.

That said, we should also observe that HAMP requires a lot of unneeded checks and bureaucracy that have made it difficult to implement even for servicers who really tried hard. Our program is designed to avoid that problem.

The link below takes you to a summary of my previous writings on the crisis with various collaborators, including this proposal: http://www4.gsb.columbia.edu/realestate/research/housingcrisis

-Chris

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