« The Consumer Bankruptcy Fee Study | Main | More Bogus Lobbying Numbers from the Banks: Debit Interchange Rates »

Principal Reduction Mods--Greatly Exaggerated?

posted by Adam Levitin

There's an interesting piece in the news section of the Wall Street Journal about bank the extent of principal reduction loan mods banks are doing. I think the take-away from the piece is supposed to be that banks are actually doing a fair amount of principal reduction already. I'm not sure what way that cuts in terms of the AG settlement negotiations. On the one hand it would seem to imply that there's no need to goad the banks into doing principal redution mods, while on the other it would seem to take the wind out of the sails of arguments that it's unfair to do principal reduction mods. (Is Brian Moynihan admitting that Bank of America is engaged in unfair acts and practices by engaging in principal reduction mods?) 

The news story omitted two significant points that make it very difficult to judge the extent of bank principal reduction mods and make it likely that the number of meaningful principal forgiveness mods is much lower than that cited in the story.  

First, it doesn't make any sense to talk about the number of principal reduction mods without discussing the extent of those principal reductions:  what's the LTV post-mod and how deep in $ is the negative equity?  Going from 175% LTV to 150% LTV is a principal reduction mod to be sure, but it's just as easy to drown in 12 foot deep water as it is in 18 foot deep water.  There's a huge difference between deep and shallow negative equity, but this difference hasn't been digested by either policy makers or academics. (Too many studies keep looking at historical shallow equity situations and trying to use that to extrapolate about today's deep negative equity problem.) 

Core Logic's latest quarterly negative equity report shows that nearly half of homeowners with negative equity have deep negative equity (LTV>125%), and that over half of the $751 billion in negative equity is concentrated with homeowners who have LTVs of >150%.  The steady pace of foreclosures has actually kept these numbers down; once there's a foreclosure, negative equity disappears (foreclosures have been a major factor in US consumer deleveraging overall).  But if we see a continued drop in housing prices, these deep negative equity figures are going to go up. 

I don't know of any major bank doing principal forgiveness mods that is putting borrowers into positive equity or even at 100% LTV.  The reason--once there's positive equity, the homeowner can refinance and the bank will lose the servicing income.

There are a handful of private equity funds (e.g. Loan Star Funds) that are buying whole loans at a heavy discount from face and then doing principal reduction mods that create positive equity, but that's because the whole goal is to have FHA or someone else refi the loan, which is the realization moment. These funds buy a $200K loan on a property worth $133K (150% LTV) for $100K (50 cents on the dollar), write down the principal to$129K (97% LTV), and then refinance it into FHA, receiving $129K for a gross profit of $29K. These funds, however,  are only able to buy whole loans out of portfolio; there's no way to buy securitized mortgages, which are locked up in trusts, which limits the impact of these funds' activities. (This is another example of how securitization is creating restrains on alienability, which is anathema to property law). This is really how this market should be clearing.  Instead, we have market clearance by foreclosure. 

Second, principal forgiveness and principal forbearance are often lumped together (they even are in the graphic produced by the WSJ), but they're substantially different.  Principal foregiveness is the real deal.  Principal forbearance is equivalent to reducing interest rates as it just lowers monthly payments, without getting rid of negative equity.  Arguably it's even worse than interest rate reductions because there's no amortization and there's a balloon payment waiting for the borrower.

Program's like Ocwen's principal foregiveness with shared appreciation, while better than plain old forbearance, end up looking a lot like forbearance. While the homeowner is off the hook for any deficiency on default (I assume, but that really depends on the terms of the mod, and it doesn't matter if the loan is nonrecourse), the homeowner is not put back into positive equity and only gets a fraction of the appreciation. With a weak housing market outlook, I'm doubtful that an option on 50% of appreciation in, say, a Ft. Myers, Florida, condo is going to have a significant impact on borrower behavior. Shared appreciation is only a viable model for influencing consumer behavior if there is a likelihood of significant enough appreciation that the borrower's share will have real value. 

So bottom line is that before we get too excited about bank principal reduction mods, lets figure out exactly what's going on. We shouldn't be counting forbearance or even shared appreciation as principal reduction and we shouldn't be getting too excited by seeing token principal reductions for deeply underwater loans.  My sense is that once one accounts for these factors, the number of serious principal reduction mods is actually very small.  

Four years into the foreclosure crisis now, we still don't know a lot about the effectiveness of different types of mods.  The first Congressional Oversight Panel foreclosure report back in March 2009 had some interesting data on the importance of LTV (see p.29) to loan performance, but we haven't seen subsequent data that really sharpens our understanding. to I'd love to see some numbers about the performance of loan mods that put borrowers at say 105-100% LTV as compared with those that leave them at 125%, etc. I'll go dollars to donuts that the closer one gets to 100% LTV, the better the performance of the mod. (Ok, I've actually seen a proprietary financial model that predicts this). Now where would bankruptcy cramdown would leave borrowers? 100% LTV. Hmmmm. 


According to the Chicago tribune, 1700 foreclosure and judicial sales are being vacated due to false documents

uhhhh... I haven't seen 1 !!! ??

“If” Rudyard Kipling 1910

If, justice prevails… the American homeowner asking for a fair write down will be able to compel a formulated response in a personal Negotiated Debt Settlement.

There are so many opportunities to prove over and over again that predatory lending, sloppy securitization and, due process liberties were the norm and throw serious doubt into the banks claim there is nothing to see here.

If, the Banks followed the rules… the properly executed original documents will support that. Once discovery is compelled there are plenty of records on each loan from every involved institution that will require careful scrutiny but can clearly document a story.

Or, the Banks agree to just terms. There is a proper formula we must be responsible to find one loan/at risk American Homeowner at a time. Middle class America might depend on it!


American Middle-class Homeowner


WHAT? Unless they can drop some serious evidence (not isolated events) right here in my lap, I'm going to have to classify this as a bald-faced lie, and the Wall Street Urinal has just made an additional showing (as if one were needed) that it is not a news source but rather a propaganda organ.

I have seen hundreds of these cases, and all the principal reduction cases fall in one of two classes: 1) lien stripping and discharge in bankruptcy, and 2) principal restructuring as settlement of fraud claims.

Banks have singularly opposed principal reduction because it would interfere with extend and pretend, and they now additionally have the temerity to throw around accusations of moral hazard.

I'm still looking to see one. It's a Kentucky Fried Rat! I've heard of it but have never seen it personally. I think we did a couple hundred BK case last year...and the year before.... I've seen plenty that capitalize the arrears but no principal reductions...

The comments to this entry are closed.


Current Guests

Follow Us On Twitter

Like Us on Facebook

  • Like Us on Facebook

    By "Liking" us on Facebook, you will receive excerpts of our posts in your Facebook news feed. (If you change your mind, you can undo it later.) Note that this is different than "Liking" our Facebook page, although a "Like" in either place will get you Credit Slips post on your Facebook news feed.



  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless ([email protected]) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.