Watch this insightful video on how we got to where we are just from one year ago….
The Times’s Andrew Ross Sorkin, Gretchen Morgenson and Joe Nocera recount the events of the weekend that Lehman Brothers failed and discuss the lessons learned from the financial crisis…
Everyone knows that hindsight is a wonderful thing. Now our friends at the Federal Reserve Bank of Boston have issued a voluminous study of mortgage modifications during 2008. Until October 2008, the financial crisis had not reached full bloom. However, the study is extremely insightful into the rational behavior of banks and why mortgage modifications, up until now, have been something of a failure.
First and foremost, the study validates the fact that principal balance reductions in mortgage modification were truly an urban legend.
How mortgage modification shops were set up to influence individuals into thinking that they could get massive reductions in principal is beyond me…
However, at least for 2008, the verdict is now in. Only about 1.3 percent of all mortgage modifications included any principal reduction at all. Frequently, mortgage modifications have included increases in the outstanding principal balance. In fact, in the third and fourth quarters of 2008, principal balance increases occurred on 70.9 percent and 61.5 percent of all loans respectively.
What did occur, however, is there were indeed meaningful reductions in the monthly outlay that individuals had on their particular mortgages because of increasing the term of the loans as well as substantially reducing the monthly interest due on the loan. Thus, the average loan that was modified in the third and fourth quarter of 2008 saw a 21 percent reduction in monthly payments. In a few cases, however, approximately 6 percent of modifications during that same period actually saw an increase.
Now it is very important to understand that in 2008 President Bush was still in office and President Obama had not yet implemented any of his financial stimulus packages. Thus, anecdotally, we are now starting to see, on occasion, principal reductions in certain modifications. Certainly, the number is well in excess of 1 percent, but is not something that is occurring on every loan with any certainty.
Policymakers and individuals frequently do not understand why banks are so reluctant to reduce the principal balance of a loan to the value of the property. I always thought that the reason was that the banks were concerned about creating a contagion of individuals who possibly could afford to pay their mortgage, but have decided to seek modification because they don’t feel it’s fair that their neighbor is getting a modification while they are not.
In fact, as previously discussed in my prior blog about foreclosures and social networks, researchers have distinguished “strategic foreclosures” to be when an individual walks away from their home because it does not make economic sense to continue making payments when the property is underwater. While the term does not exist in the area of mortgage modification, perhaps banks are concerned about continuing to modify too many loans thereby unwittingly encouraging “strategic modifications.”
In fact, a bank’s decision to not embrace modifications is actually quite simple, yet it lurks beneath the surface…
Loan Modifications and Decreased Values
First and foremost, the reason many banks chose not to embrace modifications was that property values were going to continue to erode and decrease. Under such circumstances with knowledge that many such modifications would fail, the bank would net even less money than they would if they brought the foreclosure immediately. Thus, the banks thought they should just get it over with, take the medicine and this would leave them in better shape than if they allowed for a modification that then subsequently failed. The fact of the matter is that, certainly in the past year, the banks were not wrong in that prices have continued to fall and thus by doing a quick foreclosure they would be in better shape than allowing the property to linger and continue to deteriorate in value.
Loan Modifications and “Self-Curing”
The second reason that the banks were reluctant to conduct modifications is because they felt that they would be shooting themselves in the foot. Specifically, the banks know that a fairly decent percentage, as much as 30 percent of all loans that are in default, will “self-cure” and bring themselves back into compliance— meaning that they will no longer be in default. Obviously, if the banks decided to modify an entire portfolio of mortgages they would lose the opportunity to receive the additional income from those mortgages or individuals that decided to self cure their default. When the bank factors in the loss of “self-curing” mortgages their loss is much higher than when they decide to only modify certain loans and then anticipate that other loans may indeed “self cure.”
The problem with the self-cure analysis is that it is based on an economic environment where equity in homes historically had not fallen more than 20 percent below the mortgage amount. As discussed previously we are now in an environment’ where many homes are as much as 50 percent underwater and the idea of self-cure is highly unlikely.
The Feds paper concludes, that “if the presence of ‘self-cure’ risk and re-default risk do make renegotiation less appealing to investors, the number of easily ‘preventable’ foreclosures may be far smaller than many commentators believe.”
Thus, it is still my contention that if the government wants to deal with the foreclosure crisis and make sure that it does not continue to get worse and become a contagion, that the focus must be on restoring an orderly pricing structure to the market by providing the proper incentives to individuals and investors to come back into the market and re-stabilize the housing market. Like any market, if there are too few buyers and too many sellers, prices will continue to decrease. If we are able to bring more buyers back into the market prices will stabilize, the number of defaults will decrease, people will be more reluctant to walk away from their homes, the number of foreclosures will no longer increase, and what economists call a “negative feedback loop” will finally be stopped in its tracks. And guess what? The banks will no longer be afraid to modify loans.
For more information view my video interview about banks and mortgage modifications.
Roy Oppenheim
As I was in court the other day, I couldn’t help but laugh as condo associations are now turning the tables on the banks. You see the banks are not exactly the best kind of homeowner. They don’t like to clean their pools, maintain their property… or pay their HOA dues. The judge even commented on the irony and the trend as expressed in a related article in the WSJ last week.
In fact, the Associations have had enough and are now foreclosing out the bank’s interest by suing the banks for back assessments as well as for new assessments that the banks have incurred since the bank became the owner of the property. Interestingly, the banks thought they were so eager to own the property and now have all the “joys” of ownership.
It reminds me of the proverbial proverb to “always watch out for what you wish for.” Here the banks wanted the property… well now they got it.
If you are on the board of a condo or homeowner’s association and would like our firm to evaluate the possibility of suing the real estate owned by the banks (REO) for failure to pay their association obligations please feel free to contact us.
Déjà vu. I awoke this morning to today’s New York Times top editorial Helping the House Poor . It was a direct reflection of my Florida foreclosure defense concerns discussed at length last night over the Obama Foreclosure plan. We had a full house of Florida homeowners facing foreclosure, real estate professionals dealing with the foreclosure and short sale markets, as well as WSVN’s Andre Hepkins reporting on this national economic foreclosure crisis.
The Obama Foreclosure plan problem: it does little for people who have a small amount or no equity in their homes.
The reason is simple: When you have little or no equity in your homes you have little or no incentive to keep the mortgage current. “Owner” becomes “renter”… of his or her own home. Meaning that at the end you will have built zippo equity after making your mortgage payments.
Thus, the consensus is building fast. The stock market too seems to be speaking. Until the markets and government address a way to eliminate the negative equity in the mortgage market we will likely not get through this foreclosure mess.
The House of Representatives spoke yesterday too! They passed a major change in the bankruptcy rules allowing a judge to alter the principal amounts of outstanding principal balances of mortgages when it exceeds the market value of homes. We all call that a “Cram Down”. Because the judge is cramming down the principal reduction down the throat of the banks. In other words it’s a forced modification. Some people consider it a cram up… but I won’t go there!
As a foreclosure defense attorney, I’ve been strongly advocating for the judges to have this new authority since it gives us attorneys a new weapon to negotiate with the banks. In my opinion, the threat of the cram down is as important, if not more important, than actually going through the whole bankruptcy process. In fact, just last night I noted this the missing “club” in the weapon’s arsenal of foreclosure attorneys to help level the negotiating playing field.
I must say it has been rather lonely out there– with little support from anyone including the courts. So, it’s great to see we finally we are getting some help from The President and Congress. But the law has not passed yet. The Senate still needs to vote and things are less certain there.
What can you do?
Do what we’ve been trained to do. Call BOTH your United States Senators and tell them what you think. And remember, if you live in one of the hard hit states for foreclosure: California, Florida, Arizona, Nevada, Michigan and a few others. This new law may determine you, your family’s and your State’s financial health.
For those who joined me last night at the Foreclosure and Bailout Workshop… I thank you for your time and input. Be my guest at my up to the minute Foreclosure Defense Workshops on the first Thursday of Each Month. Next one is schedule for Thursday April 2, 2009 at my office.
It appears that President Obama’s idea that federal bankruptcy judges will be given the authority to modify mortgages is picking up steam. Actually, judges already have such authority to modify mortgages balances, including modifying the principal balance… but only in commercial bankruptcies. Thus, while it may take a few more months, it is now a likely scenario that if you are in bad financial shape, and your house is worth less than the mortgage that Banks will know that they will be forced to modify your loan. Simply put, they know you could file for bankruptcy or in the alternative they will begin to negotiate true modifications where the banks will be forced to take into account the true value of the home. If the home value is less than the mortgage, the Banks will have no choice but to negotiate based on the realities of the market place. So stay tuned. It will only get more interesting!
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