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«Barriers to Federal Home Mortgage Modification Efforts During the Financial Crisis Patricia A. McCoy August 2010 MF10-6 Paper originally presented at ...»

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Capitalization and modifications share the ostensible objective of keeping homeowners in their homes. Other workout techniques require homeowners to vacate their homes. In a short sale, for example, the servicer allows a borrower to sell the home for less than the outstanding loan balance and forgives the remaining amount due. In a deed in lieu of foreclosure, the borrower deeds the house to the servicer and moves out, in exchange for full forgiveness of the debt.

13 Both Administrations also sought to expand refinancing opportunities through Fannie Mae, Freddie Mac, and the Federal Housing Administration. This paper does not address those refinancing programs; instead, its focus is on loan modification programs.

14 Bureau of Labor Statistics.

15 The Treasury Department reported that in 2009, lost income was the single biggest reasons why borrowers sought loan workouts under the Obama Administration’s Making Home Affordable program. Roughly half of all borrowers who received permanent loan modifications under that program did so due to loss of income.

16 See, e.g., Adelino et al. (2009), at 3; Congressional Oversight Panel (2009).

17 Some capitalization plans reduce monthly payments for a few months in hopes that the borrowers will get back on their feet.

Because the forborne revenues are added to the loan balance, eventually the monthly payments rise above the originally scheduled amounts.

6 The Bush Administration rolled out an initial federal loan modification program in midWith the change in Administrations, the federal government altered its approach to loan modifications and that approach continues to evolve today.

Bush Administration HOPE NOW The HOPE NOW Alliance, a private, voluntary program operated by the mortgage industry, formed the heart of the Bush Administration’s foreclosure prevention efforts. The industry launched the Alliance in mid-2007 at the urging of the U.S. Departments of the Treasury and Housing and Urban Development. HOPE NOW’s purpose was to coordinate servicers, loan counselors, and the securitization industry to identify distressed borrowers early on, get them into mortgage counseling, and persuade servicers to modify their loans. Its original members included Fannie Mae and Freddie Mac, credit counselors, eleven servicers servicing about 60% of subprime loans, and other mortgage market participants. By officially touting the program, the Bush Administration made HOPE NOW the focus of its repeated calls for servicers to modify more loans.18 HOPE NOW was strictly voluntary in nature: nothing required servicers to participate in the program or modify loans that met its guidelines. Between July 2007 and December 2008, the program reported completing 3.1 million loan workouts. 63% of those workouts (3.183 million), however, simply deferred or rescheduled borrowers’ payments temporarily without permanently lowering those payments. For many borrowers, these workouts were unlikely to succeed.

Another 37% of the workout plans (1.175 million) were loan modifications that lowered the interest rate, reduced the principal, or extended the maturity date of the loan.19 Subsequently, the proportion of HOPE NOW workouts consisting of loan modifications declined sharply. In December 2008, roughly half of all of HOPE NOW’s workouts consisted of loan modifications. By November 2009, that percentage fell to 30%.20 Meanwhile, the success rate of HOPE NOW workouts is unknown, because the program does not provide that type of data.

18 Paulson (2007a); Paulson (2007b).19 Hope Now (2008), at 7.20 Hope Now (2009).

7 Streamlined Loan Modification Programs by the FDIC and the GSEs In 2007 and 2008, Sheila Bair, Chairman of the Federal Deposit Insurance Corporation, took a different tack, calling for a systematic, streamlined approach to loan modifications that was better designed to handle the growing volume of distressed loans. The agency took the opportunity to put such a plan into effect after it inherited the servicing of over 38,000 seriously delinquent loans as conservator of the failed mortgage lender IndyMac in 2008. Unlike HOPE NOW, the FDIC was able to mandate participation in its program using its power as conservator.

Under the FDIC’s “Mod in a Box” program, all borrowers who were 60 days delinquent or more on owner-occupied loans but not in bankruptcy were considered for loan modifications.

The program’s objective was to maximize net present value relative to foreclosure while reducing the borrower’s front-end debt-to-income (DTI) ratio to 38%. The program sought to achieve this through a sequence of workout steps. First the program capitalized arrears. Then, the program sought to get the DTI ratio below 38% by first reducing the interest rate. If that was not enough, the term was extended, and if more was needed to hit the target, the principal could be reduced. The servicer received $1000 for each modified loan. Between August 20, 2008 and February 1, 2009, 9,901 or about 26% of IndyMac’s seriously delinquent loans were modified.21 In the latter part of 2008, the new Federal Housing Finance Agency introduced a similar streamlined loan modification program with slightly different triggers and targets for delinquent conforming loans guaranteed by the two government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.22 Both streamlined loan programs had their limitations. The FDIC’s program suffered from narrow coverage. The GSEs’ program applied to more loans, but did not cover the private-label securitization market, which contained the bulk of subprime loans. Commentators queried why the programs were limited to serious delinquencies and did not take negative equity into account. They also asked whether the DTI targets were realistic or took sufficient account of the borrowers’ other debts.23 Despite these issues, the two streamlined programs would later form the template for the Obama Administration’s loan modification initiatives.

Obama Administration 21 Kiff and Klyuev (2009), at 16-18.

22 Kiff and Klyuev (2009), at 16-18; Federal Housing Finance Agency (2010); Government Accountability Office (2010), at 18.

23 See, e.g., Congressional Oversight Panel (2009); Kiff and Klyuev (2009), at 19. The FDIC later lowered its DTI ceiling to 31%.

Government Accountability Office (2010), at 18.

8 Bankruptcy Cram-down Legislation By the time the Obama Administration took office in January 2009, foreclosures were poised to surge while permanent loan modifications were sorely lagging. As one of its first actions, the new Administration sought legislation to increase the bargaining power of homeowners facing foreclosure. At the urging of the new Administration, in March 2009, the House of Representatives voted to allow federal bankruptcy judges to reduce the outstanding principal on first-lien, owner-occupied mortgages of bankrupt debtors. The banking industry lobbied heavily against a bankruptcy cram-down, however, and the Senate defeated the bill.24 The failed bankruptcy cram-down campaign was the one major instance to date where the federal government sought to increase the cost to servicers of threatening foreclosure.

HAMP Had the bankruptcy legislation passed, it would have given distressed homeowners a stick to prod servicers to make loan modifications to avoid a possible cram-down in bankruptcy court. With the legislation’s defeat, the Obama Administration turned to subsidies to achieve its goals. Its major innovation was to revamp federal loan modification policies in two respects: to streamline loan modification protocols and to pay servicers to modify more loans.

The result was the “Making Home Affordable” program, which the Treasury Department unveiled in February 2009. The program’s central plank was the Home Affordable Modification Program or HAMP. HAMP sought to alter the financial incentives of servicers by paying them to modify loans where the net present value of a loan modification would exceed that of going to foreclosure.

Initially, HAMP offered servicers $1000 to modify a first mortgage that was at least 60 days delinquent and $500 to modify a home loan at imminent risk of default. In addition, the program rewarded servicers with an added $1000 per year for the first three years following a modification if the borrower did not redefault. The federal government financed the subsidies with $36.9 billion in Troubled Asset Relief Program (TARP) funds.25 HAMP built on the basic streamlined design of the FDIC’s “Mod in a Box” program, albeit with more generous parameters. To qualify for HAMP, borrowers had to be ownerBernard (2009).

25 Government Accountability Office (2010), at 6. There were special incentives for modifying loans of borrowers who were current on their loans but at imminent risk of default. For these modifications, mortgage holders received $1500 and servicers, $500.

Department of the Treasury (2009a); Department of the Treasury (2009b).

9 occupants and have a housing debt-to-income ratio of over 31%. They also had to be in default (defined as 60 days late or more on their loans) or at risk of imminent default.26 At the outset, HAMP sought to lower borrowers’ monthly payments to 31% of gross monthly income by three means: first by reducing interest rates, then by extending the loan term to up to forty years, and then, if necessary, by forbearing part of the principal. Any forborne principal would be due at the end of the loan term, but no interest would be charged on that amount.27 Significantly, HAMP did not require servicers to permanently reduce principal in order to hit the 31% target. Nor did HAMP take high total debt-to-income ratios into account.28 HAMP broke the loan modification process into two parts. Initially, qualifying borrowers received a trial modification. If they stayed current on their trial modifications for three months – and submitted full documentation of qualifying incomes and financial hardship – then they would receive permanent loan modifications.29 Participation in HAMP was widespread. All servicers who serviced loans guaranteed by Fannie Mae or Freddie Mac were automatically eligible to participate in HAMP. A handful of servicers who received more than one bailout under the Troubled Asset Relief Program (TARP) had to participate in the program.30 Later, as part of the Helping Families Save their Homes Act in May 2009, Congress extended HAMP to FHA loans.31 As of January 2010, 113 servicers, covering 89% of eligible mortgages, had signed on to HAMP.32 Other Foreclosure Prevention Programs Many borrowers were not suited for loan modifications under HAMP because they could not manage to make even the reduced monthly payments at the target 31% DTI ratio. For borrowers in that situation who were otherwise eligible for HAMP, Making Home Affordable proposed offering financial incentives to servicers to accept short sales and deeds in lieu of foreclosure rather than going to foreclosure. The program was not slated to take effect, however, 26 The Government Accountability Office found that servicers have widely varying definitions of the term “risk of imminent default.” As a result, a borrower may qualify for HAMP with one servicer, but not another. Government Accountability Office (2010), at 13-14;

see also Office of the Special Inspector General for the Troubled Asset Relief Program (2010), at 26.

27 Andrews (2009); Department of the Treasury (2009a); Department of the Treasury (2009b).

28 Fitch Ratings (2009), at 7.

29 Andrews (2009); Department of the Treasury (2009a); Department of the Treasury (2009b).

30 Andrews (2009); Department of the Treasury (2009a); Department of the Treasury (2009b).

31 Department of Housing and Urban Development (2009).

32 Office of the Special Inspector General for the Troubled Asset Relief Program (2010), at 10.

10 until April 10, 2010.33 Meanwhile, some individual financial institutions offered their own private loan modification programs.34 The Pace of Foreclosure Mitigation to Date Through 2008, the pace of loan workouts and modifications remained slow. With the introduction of HAMP, however, the aggregate numbers began to improve. We can see this in data showing that foreclosure starts flattened out during the first three quarters of 2009, even though serious delinquencies and loans in foreclosure continued to surge. (Figures 3 and 4).

Still, as of this writing in spring 2010, temporary loan modifications account for most workouts under HAMP. The pace of conversions to permanent modifications has markedly improved in recent months but still has far to go.

2007-2008 During 2007 and 2008, when HOPE NOW was the main modification program, only a paltry percentage of mortgages at least 60 days past due received a workout of any kind. A Federal Reserve Bank of Boston study of those loans reported that only 3% experienced an interest rate reduction, a principal reduction, and/or an extension of the loan term in the first 12 months following the first serious delinquency. Only 8.5% received any kind of workout at all (including a principal increase, a short sale, or a deed-in-lieu of foreclosure).35 These are aggregate numbers, however, and over the course of that two-year time span, the success rate improved. Servicers of non-conforming home mortgages agreed to more loan workouts with each successive quarter in 2007 and 2008. In fourth quarter 2008, there were 7 to 8 times more loan workouts than in first quarter 2007.36 Over the period 2007-2008, the mix of workout techniques also changed. Workouts that reduced monthly payments became more prevalent and workouts that increased monthly payments declined.37 These numbers masked the fact that the bulk of loan modifications in 2007 and 2008 actually increased borrowers’ monthly payments instead of reducing them. In two path-breaking studies that brought this problem to light, law professor Alan White reported that over two-thirds 33 HAMP Update (2009); Department of the Treasury (2009a); Department of the Treasury (2009b).

34 Government Accountability Office (2010), at 18.

35 Adelino et al. (2009), at 13-18 & tbl. 5.

36 Adelino et al. (2009), at 11-12 & tbl. 3.

37 Fitch Ratings (2009b), at 10.

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