Discovering a subprime solution: Part 1, gathering the clans
Almost as if he were reading AHI, Treasury Secretary Henry Paulsen has been slaving over a hot speakerphone to put together a pre-packaged workout/ loan modification program for a large slice of the subprime market.
This’ll give them all a bhang
As reported in Friday’s Wall Street Journal, the broad concepts have been agreed and the details are being finalized:
Back in late September, more than two months ago, I posted on the value of anticipating the prepayment bulge:
The idea is that we want to tackle people who haven’t yet had their mortgages reset. And we need to move fairly quickly, as illustrated by the following compilation from John Mauldin’s truly outstanding [Meaning ‘free’ – Ed.? And worth reading! – Auth.] weekly newsletter, From the Front Lines:
As Mauldin puts it:
The first six months of next year will see more than the total for 2007 or $521 billion. This suggests to me that the number of foreclosures is due to rise dramatically from the already high current levels, putting more homes into a weak housing environment.
We are still in front of the wave, but we have only about 4-8 months left.
We’re still in front of the wave; hence the urgency of
The Administration suggested it would be a good idea for us to get together
An accord could reassure investors and strapped homeowners, both of whom are anxious as interest rates on more than two million adjustable mortgages are scheduled to jump over the next two years. It could also give a boost to the Bush administration, which is facing criticism for inaction amid the recent housing turmoil.
Who cares about the boost? It would be the right thing to do
The plan is being negotiated between regulators including the Treasury Department and a coalition of mortgage-related companies including Citigroup Inc., Wells Fargo & Co., Washington Mutual Inc. and Countrywide Financial Corp.
As I posted during November, Countrywide was already moving that way:
Showing eminent common sense, and uncannily echoing AHI’s pre-default recapitalization program, Countrywide Financial (which has been taking a beating lately, in the press and stock market), is making moves to pre-empt a wave of destabilizing defaults that would otherwise likely occur upon mortgage resets, by offering prepackaged modifications.
Countrywide has brought along others into its coalition of the worried:
Should I join a coalition?
People familiar with the talks say the individual members have agreed to follow any agreement reached by the coalition, which is called the Hope Now Alliance.
Details of the plan, which could be announced as early as next week, are still being worked out. In general, the government and the coalition have largely agreed to extend the lower introductory rate on home loans for certain borrowers who will have trouble making payments once their mortgages increase.
Since this proposal so closely follows AHI’s prescription, allow me to post it again:
Many subprime loans carry a low “teaser” interest rate for the first two or three years, then reset to a higher rate for the remainder of the term, which is typically 30 years in total. In a typical case, the rate would rise to around 9.5% to 11% from 7% or 8%. That would boost an average borrower’s payment by several hundred dollars a month.
For the servicers (and even for the investors), heading off interest rate hikes that people cannot pay isn’t actually losing money, it’ll save them money, as I explained in October:
As the subprime mess continues to unfold, with rate and payment resets looming, Federal and state agencies rushing to offer refinancings or borrower relief, a gradually swelling chorus is advocating loan modifications and restructurings. As I’ve previously posted, securitization has made loan modification more complicated, and a legislative fix might be in the interests of lenders as well as borrowers.
Surprise!
Still, the devil is always in the details, and the details are not yet available:
Don’t worry about the fine print
Exactly which borrowers will qualify for the freeze and how long the freeze would last are yet to be determined. Under one scenario, the freeze could run as long as seven years. The parties are developing standard criteria that would determine eligibility. The criteria should be finalized by the end of year.
Standard criteria are critical, since the relief to be offered should apply to all borrowers, regardless of from whom they obtained their loans.
Mortgage servicers — the companies that collect loan payments — are a key part of the coalition, because they are the companies that deal directly with borrowers.
They’ll be the ones doing the work.
Often the servicer is different from the company that originally made the loan.
Securitization does that, doesn’t it? It creates blockages to workouts. One must motivate the servicer:
Unseen Forces Are At Work:
Bang the default ball into the servicer – what happens?
There’s a lengthy clacking linkage that goes:
Loan servicing is the business of opening envelopes, capturing the checks that fall out, associating them with a particular loan, and updating the loan amount due. (In these days of modern times, they do it with computers, but it’s fundamentally an administrative function.) Pace the Times, the reason borrowers sometimes find servicers unresponsive is not “because modifying loans cuts into profits.” Profitability in loan servicing is all about efficient processing. Modifying a loan has nothing to do with the servicer’s profits — rather, paying attention cuts into the servicer’s profits, because they’re not set up for it.
Since consistency and scale are both important, it was critical to assemble a large enough group. This they have done:
Citigroup and Countrywide are among the nation’s biggest mortgage servicers. The mortgage servicers in the coalition represent 84% of the overall subprime market. The coalition also includes lenders, investors and mortgage counselors.
Five out of six are on the spot already
The Bush administration has been looking for ways to stem the fallout from the mortgage crisis. Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson helped assemble the coalition so that government officials could have a single counterpart with which to discuss terms of a plan.
While the government can’t force the industry to modify loans, Mr. Paulson and other administration officials have been using moral suasion to push for workouts, telling the companies it is in their interest to avoid foreclosure since most parties can lose money when that happens.
It’s the bully pulpit, and in this case, it’s helping save the lenders from themselves.
If ye don’t modify these loans, ye’ll burrn in the fieriest pits o’ foreclosure!
Come and be saved, ye miserable worms!
As I put it back in September:
In proposing a blanket solution, one with a retrospective application, haven’t we just done violence to contract rights?
I can’t bear to see contract rights trampled
Yes, we have – if not violence, then at least impact and harm. But it might nevertheless be in the mortgage industry’s interest to agree or acquiesce.
Workouts are time-consuming; and as we’ve seen, the process of securitization slices up responsibility and slows down resolution of individual cases, in part because borrowers have many things they try before succumbing.
Here’s why the industry ought to embrace a general solution. Penalties are intended as incentives for individual or isolated cases. They work individually, not against hordes. A standardized solution gives the servicer the power to cut deals, without trying to find the particulars of a given investing lender. That’s probably in the investors’ interest … if only they knew it.
Good ideas are usually discovered by multiple people simultaneously:
A similar plan to freeze interest rates temporarily was recently announced by California Gov. Arnold Schwarzenegger and four major loan servicers, including Countrywide.
Freeze your interest rates
Among the holdouts have been investors, who typically hold securities backed by mortgages. If interest rates are frozen, they would lose the potential benefit of higher payments. But investors have cautiously moved toward cooperation, likely on the grounds that it’s better to get some interest than none at all.
It is.
At a meeting at the Treasury Department yesterday, coalition members told Mr. Paulson and other regulators that they are on track to announce the new industry guidelines by year’s end, according to a senior Treasury official. Among those attending were representatives of Wells Fargo, Washington Mutual, Citigroup and the American Securitization Forum, a group whose members issue, buy and rate securities backed by bundles of mortgages.
“There has been a convergence of thought on this,” said William Ruberry, spokesman for the Office of Thrift Supervision, which is also involved in the discussions.
A spokeswoman for the American Securitization Forum, which earlier resisted a broad approach to changing loan terms, said: “We support loan modifications in appropriate circumstances and are working to establish systematic procedures to facilitate their delivery.”
Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups:
I want my loan to be Clint!
[Continued tomorrow in Part 2.]
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