loan modification

From my industry contacts and investigation of the loan modification “business” there are several conclusions easily reached:

– The Internet is extremely crowded with unknowledgeable, coarse idiots who are all attempting to haphazardly create businesses doing loan modifications. Very few of them have thought through whether or not they can be profitable, or the long term destination of the new industry.Many of the new loan mod businesses are being started by unemployed members of the mortgage brokerage industry who helped to create the very problem that they are now offering to cure. In fact, the very same people who were “helped” by the mortgage industry by getting them approved for subprime and Alt A mortgages are now on the top of the calling list as potential “loan mod” customers.

– The press is highly critical of anyone who tries to assist homeowners with loan modifications. Beyond news driven stories, the only loan mod stories are about bad providers who charge huge upfront fees and deliver little or no results, or others who are simply defrauding customers outright.

– The press and the government, for lack of a real solution, see the idea of loan modifications as THE solution to the housing crisis. If payments are lowered for 2 million of the country’s biggest financial losers, the economy will snap back immediately, job losses will cease and all will be well. The consensus seems to be that the government should pay for this, and make rules about which people are “distressed” enough to receive a lower rate and mortgage payment through a loan mod. The cost of all of this, as you may guess, will be borne by those who handled their finances responsibly and did not borrow themselves into oblivion speculating on the certainty of eternal home appreciation.

Here is where I think things are going:

– In response to concerns about fraudulent or unknowledgeable companies assisting with loan modifications, most states will implement licensing requirements, as is already happening. Among other things, to maintain the license, you will be subject to strict guidelines on how much you can charge for loan modifications. The fees will be low enough to make any business which exclusively performs loan modifications unprofitable; the theory being that people behind on their mortgages should not have to pay since they are in financial difficulty. Several states have recently created licensing requirements. Colorado was the latest: http://www.rockymountainnews.com/news/2008/nov/20/loan-modifications-require-mortgage-broker/ .

– As more of our nationalized banking system is pressured/required to do loan modifications, certain universal standards and calculations will develop. These will eventually evolve into a simple calculation that will require only a few inputs to determine exactly how a loan will be modified. This may even reach a point where banks routinely modify loans without even taking an application. This technology provider for the mortgage industry just released an early version of such software: http://www.marketwatch.com/news/story/Lender-Processing-Services-Announces-New/story.aspx?guid={58FCD216-F636-4EF9-8B93-5C1C1A41AD2F}

– The government will eventually fully endorse the idea of loan modifications for troubled homeowners and subsidize the losses. Of all the problems the country faces, for some reason the politicians will decide that keeping 2 million “homeowners” (who should be renters) out of foreclosure is the most pressing issue, instead of letting the free markets, via time and price solve the problem. With the government involved, the criteria will become even more formalized and systematic. Loan servicers or banks will be encouraged or required to deal with borrowers directly. The entire process will become formulaic and there will be little need for an outside party to assist with the loan modification.

– As modified loans default again and further borrowers fall into distress, whatever small scale plan the government implemented will be expanded dramatically. The government will increase pressure and incentives for banks and loan servicers to perform loan modifications en mass. Getting a loan modification will become as easy as it used to be to get a loan. Of course, one may wonder when it last occurred, that a government solution to a problem actually worked. Nonetheless, as home prices continue their inexorably decline for years and given the inability to find a better solution, this program will continue and expand, attempting to artificially arrest the decline in home prices that will occur anyways. Someone should clue in the powers to be that unless we want to totally socialize our economy, the free market, if left to do its work, would quickly solve the housing crisis by bringing prices to the point where they are worth investing in again and at a ratio of family income to cost that is sustainable for qualified borrowers.

Conclusion

Loan modification as a stand alone business is transitory since circumstances will change to make the current business models obsolete. At the same time, the fees that will be legally allowed will be too small to allow most businesses to be profitable. To turn this into a business, one would need to align his strategy to be way ahead of the curve and I have only seen one business model for loan modifications that would work if applied by an industrious and ethical entrepreneur.

In the meantime, potential customers who are solicited to have their loans “modified” would be well advised to do a complete background check on the firm that they may chose to deal with. In addition, under no circumstances should anyone pay a nonrefundable fee upfront (other than a modest processing fee). Guidelines vary with each loan depending on the investor, but if you are dealing with a knowledgeable firm, they should be able to determine from an initial prequalification if someone qualifies for a loan modification and accordingly, should only charge a fee if the loan is successfully modified.

As to the financial cost and moral hazards of the loan modification scheme, one should consider the words of Representative Ron Paul, when speaking out against the original $700 billion bank/homeowner bailout bill:

“It is neither morally right nor fiscally wise to socialize private losses in this way. The solution is for government to stop micromanaging the economy and let the market adjust, as painful as that will be for some. We should not force taxpayers, including renters and more frugal homeowners, to switch places with the speculators and take on those same risks that bankrupted them. It is a terrible idea to spread the financial crisis any wider or deeper than it already is, and to prolong the agony years into the future. Socializing the losses now will only create more unintended consequences that will give new excuses for further government interventions in the future. This is how government grows – by claiming to correct the mistakes it earlier created, all the while constantly shaking down the taxpayer. The market needs a chance to correct itself, and Congress needs to avoid making the situation worse by pretending to ride to the rescue.”

Purchasers of mortgage debt, formerly known as investors but now known as bag holders were distressed that Bank of America (BAC) did not consult with them prior to deciding to modify customer mortgages, as reported by the Wall Street Journal. The problem was not with the mortgages actually owned by BAC, but rather the mortgages owned by others and merely serviced by BAC. Apparently so enamored with the idea of saving the banking industry by reducing the rate and loan balances of the lucky mortgagees, BAC decided to apply their therapy to mortgages that they merely service but do not own.

The problem with attempting to modify mortgage loans en masse is that many mortgages originated over the past 5 years were sold to investors as mortgaged backed securities. BAC maintains that they can modify these investor owned mortgages based on “delegated authority” per the loan servicing contract they have with the investors. Obviously some of the investors in the serviced mortgages don’t see it that way and are looking to BAC to make them whole on any write downs given to the borrowers at their expense. These are the types of issues confronting the industry in their attempts to modify mortgages.

Mortgage modifications are seen as a win/win situation by the FDIC, many banks and some of the mortgaged backed securities investors since it appears to offer the ideal solution – homeowners get to keep their homes, foreclosures decrease and the ultimate loss on the loan modification theoretically is less than foreclosing on the property. This may all be work out to every one’s advantage unless property values continue their decline which I consider to be a likely scenario. Home prices won’t stop dropping regardless of government efforts until the economy stabilizes and until the ratio of family income to cost of ownership reaches an affordable level.

The issue with loan modifications that I and others see is one of moral hazard; this program is institutionalizing the repudiation of debt on a national scale and the cost and negative consequences of this rationale are open ended. In an excellent article by Peter Schiff, he describes loan modifications as “the mother of all moral hazards” as follows:

“No doubt prodded by the administration, Fannie Mae and Freddie Mac announced a new attempt to stop the fall in home prices and foreclosures through a loan modification program that would cap mortgage payments so that a homeowner’s total housing expenses would not exceed 38% of household income for home owners who are 90 days delinquent.

In a classic case of unintended consequences, the plan will encourage a massive new round of delinquencies and household income reduction as homeowners will jump through hoops to qualify for the program and maximize their benefit. Those who could conceivably economize to meet their existing obligations will now have a strong reason to forgo such sacrifices. Those who are not 90 days past due will intentionally become so. In many cases, dual income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work related expenses will likely exceed the after-tax value of the lost paycheck.

Unfortunately, the last thing our economy needs is falling household incomes and even more bad debt. But that is precisely what this plan will give us.”

Transferring all the losses of homeowners, automakers, banks, insurance companies, credit card companies, mortgage companies etc etc onto the balance sheet of the US Government does not correct the incredible excess of leverage that has been ongoing in this country since the early 1980’s; it merely transfers the losses to the US taxpayers and shortens the day that the US Government itself will need to be bailed out.

Loan Modifications – Salvation For Former Mortgage Brokers?

Loan Modification – Someone Forgot To Ask The Investors

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