Mortgage servicers’ role in nation’s foreclosure flood coming under wider, deeper scrutiny; White House plays shame game

August 7th, 2009 by Mike Hinshaw

Finally.

Mainstream media is starting to catch on and catch up: Here’s some recent headlines from The Washington Post and The New York Times, respectively:

“Foreclosures Are Often In Lenders’ Best Interest”

“Mortgage Servicers Have Little Incentive to Help Homeowners”

Readers of  The Bankruptcy Corner have known that for months. Here’s the takeaway graf from our detailed post of  March 7, explaining why the Helping Families Save Their Homes Act of 2009 should have been passed:

“Levitin explains it this way: ‘And in many cases, foreclosure is often more profitable to servicers than loan modification. Servicers receive fixed-rate compensation for a limited duration when a loan is modified, but get unmonitored costplus compensation in foreclosure. Therefore servicers are incentivized to foreclose rather than modify loans, even if modification is in the best interest of the MBS holders and the homeowners.’ ”

In the July 30 Times piece, Peter S. Goodman reports that Team Obama recently buttonholed mortgage company execs “to demand they move faster to lower payments for homeowners sliding toward foreclosure” and that Treasury officials encouraged them to ramp up hiring and training in order to handle the load of applicants who need help.

However, writes Goodman “. . . industry insiders and legal experts say the limited capacity of mortgage companies is not the primary factor impeding the government’s $75 billion program to prevent foreclosures. Instead, it is that many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans.”

Published two days earlier, here’s Renae Merle’s lead in the Post: “Government initiatives to stem the country’s mounting foreclosures are hampered because banks and other lenders in many cases have more financial incentive to let borrowers lose their homes than to work out settlements, some economists have concluded.”

Both papers cited a July 6 study by the Federal Reserve Bank of Boston, and among them they have whipped up quite the blogofrenzy. Which is understandable because the study cuts doughnuts around several issues then slides in edgewise toward its conclusion in a cloud of smoke and screech of Definite Maybe. For example, in a passage that the Times erroneously referred to as the paper’s conclusion, we get this dizzying conditional: “In addition, the rules by which servicers are reimbursed for expenses may provide a perverse incentive to foreclose rather than modify. Furthermore, because servicers do not internalize the losses on a securitized loan, they may not behave optimally. Another issue is the possibility that those investors whose claims are adversely affected by modification will take legal action. Finally, historically, SEC rules have stated that contacting a borrower who is fewer than 60-days delinquent constitutes an ongoing relationship with the borrower and jeopardizes the off-balance sheet status of the loan.”

The highlighted sentences recall Levitin’s conclusion; indeed Levitin is cited as a source. However, as Stephen Spruiell, writing in “The Corner” at National Review.com points out, the study’s authors do NOT believe that. In reference to the “perverse incentive” passage, he says the Times takes it out of context. “In context, though, this passage takes on a different meaning. The Fed study’s authors were listing a number of factors having to do with securitization that, in their analysis, do not contribute significantly to the dearth of modifications. . . .”

He quotes another passage from the study, ending in this excerpt:

“But some market observers express doubts about the renegotiation-limiting role of securitization. [...] Our empirical analysis provides strong evidence against the role of securitization in preventing renegotiation.”

In other words, Spruiell contends that the researchers have concluded that the investors who bought securitized “assets” are not going to sue mortgage servicers for modifying mortgages.

He also takes both newspapers to task, for disagreeing with each other.

“On Tuesday, the Post reported that mortgage lenders are not modifying loans because ‘modifying mortgages is profitable to banks for only one set of distressed borrowers, while lenders are actually dealing with three very different types.’ First, there are borrowers who fall behind on their payments but who will eventually start making them again, i.e. those who ‘self-cure.’ Second, there are borrowers who simply bought more house than they could afford and are likely candidates to redefault. Third, there are borrowers who could catch up, but only if they received a loan modification. Modifications only make sense for the third group.”

Then he mentions the Times’ piece: “Today, the New York Times offers a different theory: Banks are not offering modifications because the foreclosure process provides opportunities for servicers to extract lucrative fees.”

To top it off, he then dismisses everybody: both papers, the Fed’s study itself–and, by golly, Team Obama and the horses they rode in on: “It seems pretty clear to me that, whatever other evidence the Times may have for its theory, the Fed study doesn’t count. Inconveniently for the administration and its, ahem, supporters, the study’s authors dismiss the idea that vampiric fee-extraction plays a significant role in the foreclosure process. Instead, they conclude that banks are making decisions based on each borrower’s ability to repay. Considering that it was a complete deterioration of lending standards that blew up the housing market, shouldn’t that be a welcome change?”

Despite the apple-pie appeal of “sound lending practices,” Spruiell misses the mark. Here’s the actual nut of the study’s conclusion:

“We argue that the data are not inconsistent with a situation in which, on average, lenders expect to recover more from foreclosure than from a modified loan. At face value, this assertion may seem implausible, since there are many estimates that suggest the average loss given foreclosure is much greater than the loss in value of a modified loan. However, we point out that renegotiation exposes lenders to two types of risks that are often overlooked by market observers and that can dramatically increase its cost. The first is ‘self-cure risk,’ which refers to the situation in which a lender renegotiates with a delinquent borrower who does not need assistance. This group of borrowers is non-trivial according to our data, as we find that approximately 30 percent of seriously delinquent borrowers ‘cure’ in our data without receiving a modification. The second cost comes from borrowers who default again after receiving a loan modification. We refer to this group as ‘redefaulters,’ and our results show that a large fraction (between 30 and 45 percent) of borrowers who receive modifications, end up back in serious delinquency within six months. For this group, the lender has simply postponed foreclosure, and, if the housing market continues to decline, the lender will recover even less in foreclosure in the future.”

In other words, it is often in the best interest of the lenders to simply let the homes slide off into foreclosure–exactly what both headlines said in the first place.

Perhaps the quickest, easiest handle to grasp is visual; the Post has a graphic called “The Lender’s Calculus, which shows that, from the lenders’ point of view, of those facing foreclosure:

  • 50% should get no help because they’re going “re-default” later, anyway, so the lender makes less on a further depreciated property
  • 30% should get no help because they’re going to find a way to make and keep the loan current, so why incur refinance costs
  • 20% should get help, and the lender will make less than on the original note but more than via foreclosure.

What this completely overlooks, of course, is renegotiating a meaningful deal in the first place with that 50 per cent crowd. The Post offers this example: “American Home Mortgage Services, based in Texas, was willing to modify Edward Partain’s mortgage on his Tennessee home last April after business at his beauty salon slowed and a divorce stretched his budget. But after months of negotiating with his lender, Partain said he was surprised to learn that it would only lower his payments by $90 a month, instead of the $250 decrease he expected.

” ‘At $250, I would have had a chance, but after they added in late fees and payments, I couldn’t do it,’ he said.

“Partain soon fell behind on his payments again and went back to American Home Mortgage Services seeking a more affordable payment. Partain said he was told that he was ineligible for another modification because it had been less than a year since his last. A foreclosure sale was scheduled for late July.”

Perhaps the most balanced response comes from the Business section of The Atlantic (which even takes time to explain the Times’ confusion of the terms mortgage lender and mortgage servicer)  in this pithy excerpt:

“First, this is troubling, but it’s different from the way credit card companies charge high fees on delinquent balances. It’s worse. Credit card companies don’t want their customers to go bankrupt — they want them to be delinquent as much as possible, but never actually reach the level of failure. With mortgage servicers it’s different: they appear to have an incentive to see the mortgages they manage fail.

“Indeed, when people stop paying their mortgage, servicers aren’t getting any more fees from them. Those fees are coming through the foreclosure sale itself, as the Times explains. Credit card companies want to see you struggle, but mortgage servicers want to see you fail.

It sounds to me like banks need rethink the incentives in place for mortgage servicers. As it stands, they are literally paying servicers to fail. A servicer’s job should be to keep a borrower from foreclosing — especially at a time when home prices have drastically decreased.”

Team Obama’s response to all this? From an August 4 Miami Herald business article: “The Obama administration on Tuesday offered the first of what will become monthly reports on mortgage modifications, including a name-and-shame approach that’ll allow the public to see which banks are and aren’t working to help keep struggling Americans in their homes.”

The idea is that public outrage will shame the bankers into doing what’s right.

Of course, that assumes a capacity for shame.