Affordable Housing Institute : US

[Continued from previous Part 1, Part 2, and Part 3 ]

 

Now that we’ve devoted about 3,500 words to expositing Joseph R. Mason’s new article, Mortgage Loan Modification: Promises and Pitfalls, we can finally evaluate his proposed solution.

 

It’s easy to untangle this mess

 

First, a teaser:

 

Like securitization, modification has evolved in a regulatory vacuum. 

 

How dare those markets move faster than government!  As A. A. Milne wrote in When We Were Very Young:

 

James James
Morrison Morrison
Weatherby George Dupree
Took great care of his mother
Though he was only three.
James James said to his mother
Mother he said, said he:
You mustn’t go down to the end of the town if you don’t go down with me.

 

Lenders, he said, said he

“You must never re-look

A loan in your book

Without consulting me.”

 

Markets don’t stop while people wait for regulators to develop the appropriate regulation (to say nothing of the difficulty of crafting the right regulation).  As time ticks along, the only winner is the foreclosure option, which is usually bad for everybody and destabilizes neighborhoods.  Homeownership is the hillside sod of society, and we want to keep the economic hills from eroding. 

 

Even though debt normally speaks with a voice of distrust, workouts and loan modifications are inherently about trust — regaining trust, in most cases.  The asset manager who recommends a workout or loan modification is taking a personal risk.  In my experience, it’s very seldom done for ulterior motives [You’ve never worked in a subprime bucket shop! — Ed.].  

 

Professor Mason isn’t so sure about motives.  He wants more valves and more gauges:

 

Like securitization, the problem is not the lack of existing strictures that can be brought to bear on the practices, but that new business practices have evolved out of sight of regulatory and legislative authorities. 

 

He sees the risk in stark terms:

 

It does not make sense, therefore, to push a broad unmonitored application of loan modification onto the industry or the public without serious consideration. 

 

By definition, these borrowers are delinquent, in default, or on the brink of imminent default.  If there is no modification, these people will eventually be foreclosed, which is definitely the worst thing for any borrower not completely over his head, and often the worst thing for a community — especially if it is occurring, as here, in volume in some marginal neighborhoods.

 

A bad sequence

 

Doing so runs a substantial risk of consumers being used to prop up the mortgage industry in the short term by keeping financially strapped consumers in homes they cannot hope to afford.

 

Ay, there’s the rub — but even using the professor’s own figures, two thirds of those receiving modifications will be current two years later.  Saving two out of three is quite good, particularly as the alternative — a cookie-cutter approach — is guaranteed to distort the markets, as the professor acknowledges:

 

You’re all just alike

 

Legislative or regulatory intervention can easily upset the balance of discretion in loan modifications, imposing high costs on that already risky proposition. 

 

It’s hard enough to get a lender to agree to a modification.  Adding hurdles makes it that much harder.

 

If legislators or regulators require modifications to some group of borrowers regardless of their fundamental ability to make the loan payments successfully well into the future, that balance will be upset.

 

These borrowers are already in trouble. 

 

Without applying even existing regulations toward regulatory oversight or transparency in loan modification practices, however, it is hard to imagine long-term positive benefits for borrowers.

 

Oh?  How I might behave before I have put my foot in the bear trap is really quite different from how I behave after the jaws have swung shut.

 

Say, “ouch!”

 

You never want a workout to be “normal.” Yes, there are neighborhood risks, but promoting moral hazard will not help those. Furthermore, zero equity ownership speculators were not meaningful community members anyway. Nonetheless, occupancy is a reasonable goal, but can be separated from mortgages and ownership by moving toward rental policy.

 

True — and I’m a major proponent of a permanent professional rental sector delivering sustainable affordable housing — but it’s also true that homeownership changes behavior for the better.  Taking it away from people who’ve got it for the first time is worse than never having let them have it.  This it also strikes many as inequitable — which is why we see so much effort being made at the Federal and state level to create soft-landing or second-chance refinancing programs.

 

Who’s at risk here, and for what?

 

Regulation makes sense when somebody’s at risk for something — but in most modification situations, the risk has been taken, and a problem has already arisen.

 

Are the capital markets at risk?  As Professor Mason noted, loans can be ‘re-aged’ as performing when all that’s been done is repackaging stuff in a box — but there are already plenty of rules to cover that:

 

Regulators can already require modified loans to be reported as material considerations under Sarbanes-Oxley, with standardized reporting practices promulgated under FASB Regulation AB. 

 

If the problem today is due to ignoring or flouting the current rules, how does creating new ones help?

 

I advocate using existing regulations, unless those are being ignored by the attendant regulators.

 

You’re the blogger, you tell me

 

Even stated re-aging policies for nonbanks would be useful.

 

With a few exceptions, nobody gets offered a modification unless he’s already in default.  If he’s in default he’s probably had his assets drained already, so it’s difficult to exploit him again.  Nobody gets relief if it’s not in his interest. 

 

If the boat sinks, everybody loses

 

Relations between an originator and its stockholders or securitization partners are capital-markets matters and a securities disclosure issue. 

 

I just do not advocate developing a new risky lending technology immediately on top of a failed risky lending technology. Building further uncertainty upon what we don’t know is what got us here in the first place. I would also think that banks would want recordkeeping and best practices guidelines so that they don’t get caught in the trap.

 

Relations between defaulted borrower and lender are financial markets matters and a consumer-protection issue.

 

 

When in doubt, policy should enable lenders to take a chance on a good borrower, and not interfere.  Protect the borrowers with disclosure, allow them a legal recovery if they have been duped, but don’t impose an abstract and distant stencil over what is always a very individual negotiation.

 

Take a chance, sometimes it’s the best way

 

 

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