Force Banks to Modify Their Behavior

There comes a point where the evidence is so overwhelming and so compelling that you are forced to reassess your position.  That has happened to me regarding forcing lenders and/or servicers to either modify mortgages or approve short sales.  My position was that even though lenders may act foolishly or even cruelly with regard to dealing with a home owner in trouble, it would be worse in the end to force a lender and/servicer to modify a loan or approve a short sale.  Not any more.  The evidence is in and we need to force banks to modify their behavior.

There is no doubt that lenders and mortgage servicers are working solely in their own interest and it should be just as clear that those interests are not aligned with the interests of anyone else; not the investors they are supposed to protect, not the borrowers whose lives have been torn apart and certainly not our nation as a whole.  The Obama administration has tried the carrot approach with financial incentives.  That did not work because the government wrote them a check for a few hundred million.  The lenders and servicers said thank you and went back to doing whatever they pleased.  The stick approach was also tried by “shaming servicers” into doing the right thing as if the servicing industry is capable of shame.  In other words, the servicers do not give a damn what anyone thinks.  Why should they care?  Absent government support they are already insolvent and they know that they will not be allowed to fail.

Of course servicers would argue they are being “overwhelmed”.  This is as if we should feel sorry for them because they are being burdened with dealing with all those “irresponsible borrowers” who did not see the absolute destruction of the capital markets coming around the corner the way nobody else did.  Being a lender or servicer is hard.  Let’s hold a telethon for them.

Let me get this straight, Bank of America, Chase and Wells Fargo expect us to believe that they simply cannot answer the phone.  Anything over a few hundred calls a day and these places shut down.  This is in spite of the fact that the financial sector is running at full employment and has received billions of our tax dollars.  I cannot listen to this drivel any more.  If they spent even a fraction of this money on hiring and training people to help in modifications and short sales, the national employment rate would drop by 2%.

Now let us look at the arguments these companies use as to why forcing them to modify their behavior is a bad idea:

Loan Modifications do not work because a huge percentage of borrowers redefault.  This is the dumbest argument ever.  We should all understand that the term “loan modification” is a synonym for “lower your payment.”  However, going back to 2008, over half the loan modifications resulted in higher payments.  Gee, who could have seen redefaults coming?

It’s not our fault, the investors made us say no.  This is perhaps the biggest lie.  Which investors said no?  Was it those investors that refuse to maximize their own returns?  Why would an investor refuse to modify an underwater mortgage in this market when the alternative is almost always more costly?  Unfortunately the public has bought into this lie.  I think the banks and servicers have counted on the fact that the public and the investors they are supposed protect did not read the pooling and servicing agreements.  Most servicing agreements basically say that the servicer must take steps to maximize the returns for investors.  This is something they never do.  Proof of this could be seen in September when Impac Funding, an investor that uses Bank of America and GMAC to service many of their mortgages started contacting borrowers directly.  It seems Impac was tired watching their servicers foreclose.  When Impac dealt with this directly, loans were modified within 72 hours and it has already improved their returns.

So what is the solution?

The answer is to reform the bankruptcy code.  If a borrower files for bankruptcy, the bankruptcy judge should be allowed to cram down the mortgage.  What this means is that if there is $400,000 mortgage and the home is worth $300,000; guess what?  You now have a $300,000 mortgage.  In other words, forced judicial modifications.  I would even go so far as to give this same power to judges in foreclosure proceedings.

The simple fact is that foreclosures are continuing to destroy the value of mortgage backed securities that are still on the balance sheets of our nation’s banks.  At some point, the taxpayer is going to have to buy those assets so these banks can return to some semblance of normalcy.  The lower the value of those assets, the higher the hit to taxpayers.

What is the argument against forced modifications or short sales?  If you do this, banks will not lend money, it will be harder to get a loan and interest rates will go higher.  To me, this is a crock.  Why?  The proposals for forced modifications would apply to only current mortgages, not future ones.  That argument goes out the window.  Even if this were not the case, just imagine what this country will look like if things continue the way they are going.  If we do not stop the march of foreclosures, our economy will head into a deflationary death spiral that will drag the economy down.  A recent research report by Deutsche Bank estimated that about half of all homes in the US will be underwater by 2011.  Just try getting a mortgage under those circumstances.  Unless we enact this reform, lenders will be in worse shape.  If home owners have no hope, if there is no hope of equity in the future, then home ownership in this country is on borrowed time, perhaps for a generation.  Our economy cannot survive under those circumstances. This cannot be helpful to investors and lenders as well.