Foreclosure Crisis: More Info but Less Knowledge

Yet another study — this one released last month by the Federal Reserve Bank of Boston — serves only to reinforce what we already know:  lenders were reluctant to modify existing loans during 2007 and 2008.  (Wash Post, 7/27/2009).  Although some 1.5 million borrowers were subject to some form of foreclosure filings during the first half of this year (2009), only around 200,000 loan modifications have been issued since March, when the Administration launched the new Making Home Affordable Guidelines.   Part of the difficulty in evaluating the data is that many lenders have only very recently begun to apply the new Guidelines, while study after study focuses on statistics from 2007 and 2008.  Part of the reason for the sweeping new Guidelines was to remedy the shortcomines of the previous programs.

The Washington Post reports that “Modification makes economic sense … only if the borrower can’t sustain payments without it” and the modified terms will allow the borrower to keep up.  Duh.  Another brilliant conclusion:  Borrowers who are likely to fall behind even if the loan is modified are not a good candidate for loan modification.   Double-Duh.  And this:  Lenders have little financial incentive to help delinquent borrowers, who with extra effort and a little luck, can catch up without a modification.  Well, you get the gist of it.  I hope they didn’t spend a lot of money on that study!  If we only had solid information like this back in 2006, we might have been able to avoid the whole problem, don’t you think?

Compounding the issue is a fundamental lack of critical knowledge:  is it more economically advantageous for lenders to foreclose or modify?  Even the Washington Post can’t make up its mind:  the headline says “Foreclosures are Often in Lender’s Best Interest.”  Then, they quote Laurie Goodman, senior managing director at Amherst Securities, saying “In some cases, lenders lose twice as much foreclosing on a home as they did two years ago.”  Apparently, falling housing prices — often a direct consequence of foreclosures — cause lenders to lose money in foreclosure sales.  Go figure.

So, did we learn anything from the Boston Fed study?  Well, we learned that only a small percentage of loan mod applications are actually being approved, as lenders are only just now starting to apply the new Guidelines.  The study seems to confirm what we suspected — lenders are focused on their bottom line, not the borrower’s.  Lenders are working on finding the right balance of when would be the most optimum time to proceed to foreclosure based on the projected price bid they can get.  If the loan mod will only delay foreclosure and housing prices continue to drop, it only makes sense to deny the loan mod and proceed to foreclosure.

Sadly, this often comes as a bitter blow to the hard working borrower who is just trying to get a temporary reduction in their monthly mortgage payment, either through a rate adjustment or an extended term, so they can meet expenses and catch up.  Where home values have dropped significantly below the amount of the loan, and the lender refuses to make a meaningful modification, the borrower has little incentive to keep the house.  The result — absent any intervening factors — will be more foreclosures, further reducing prices, and causing lenders to prematurely panic and sell before the prices drop further.

Obviously, this will not work.  The Treasury and HUD have summoned industry executives to a meeting to discuss how increase the pace of loan relief.  It would seem that if more loans could be modified, even if only temporarily, there would be fewer foreclosures and less downward pressure on housing prices overall, not just for foreclosure properties.  Achieving stability would be a good objective, but we still have not seen any studies of the application of the new Guidelines.  Maybe if we had some relevant information, we might gain some relevant knowledge.