There has been a lot of talk over the past few days about the new proposal by the Bush Administration to help stabilize the housing market by encouraging banks to modify loans for at-risk homeowners. The plan is to secure 31 million mortgages worth approximately $5 trillion which were underwritten by Fannie Mae and Freddie Mac and prevent them from going into default. The federal government took control of Fannie Mae and Freddie Mac in September when waves of foreclosures resulted in mounting losses on their portfolios. The Bush proposal mirrors what Citigroup, JPMorgan-Chase, and Bank of America have already been doing with their at-risk mortgages backed by Fannie Mae and Freddie Mac.
In order for homeowners to be eligible, they must meet the following criteria: they must be over 90 days behind on their mortgage payments, owe at least 90% of their homes current value, have not filed bankruptcy and it must be their primary residence.
Like a standard modification program, the payments would be adjusted either one of three ways; lower interest rates, longer repayment schedules or shifting the difference of the modified payment after being adjusted to below 38-40% of the homeowner's monthly income and amount of what the payment actually should be to the payoff of the loan.
James Lockhart, the director of the new Federal Housing Finance Agency which was created to oversee Fannie Mae and Freddie Mac, was quoted as saying, "We expect that it could significantly increase the number of modifications completed."
This all sounds good and seems to be getting a lot of positive media coverage. However, there are major issues with this plan that need to be resolved.
The main problem with this plan is the Bush Administration doesn't know if it will work because they are unable to determine the number of homeowners who will be eligible. Faith Schwartz, executive director of HOPE NOW was quoted in CNN Money as saying, "We think over time this going to affect a couple hundred thousand homeowners." This would equate to about 1% of the total number of mortgages Fannie Mae and Freddie Mac currently have in their portfolio.
Second, the majority of homeowners with Fannie Mae and Freddie Mac backed mortgages are not at risk because of the guidelines that Fannie and Freddie had in place for years. Unless the homeowner suffers a job loss or some other catastrophic event, his/her primary concern is being upside down and this plan does not address that issue.
Robert Van Order, an adjunct finance professor at the University of Michigan, who was chief economist for Fannie Mae until 2003, told the Detroit Free Press that he thinks the loan modification plans could be somewhat effective but it is not the solution to the housing problem. "There is an underlying problem they can't fix with this and that is people who are underwater on their mortgages. More people are going to be in trouble because they have negative equity."
It also doesn't address the issue of homeowners whose mortgages were not backed by Fannie Mae and Freddie Mac. Many of these toxic mortgages were acquired in the past two years when JP Morgan-Chase took control of Washington Mutual and their subprime division Long Beach Mortgage, Bank of America bought Countrywide and Merrill-Lynch (owners of sub-prime lender First Franklin), Citigroup bought Ameriquest and its wholesale operation Argent Mortgage. Many of these consumers were put in stated deals, adjustable rates, sub-prime loans or were improperly qualified for Option-ARM programs. These loans have a value of over $1.3 Trillion with over 7.5 million first lien sub-prime mortgages outstanding. Yet, these homeowners are considered low priority.
Another problem with the proposal is it encourages homeowners to destroy their credit ratings by telling them to fall 90+ days behind on their mortgage in order to get help. American Home Mortgage Servicing and Countrywide, among other sub-prime lenders are telling homeowners not to make their mortgage payments if they want a loan modification. Yet, they continue to report the delinquencies to the major credit bureaus.
There is a definite benefit to banks that modify these loans and on the surface it looks like a benefit to the homeowner. However, the banks are not promoting, and are not disclosing to the homeowner, the indemnification clauses in these agreements that hold the banks and servicers harmless for any fraud or misrepresentation that may have been used to induce the homeowner into signing the original mortgage. This means the homeowner is prevented from exercising their rights under TILA, RESPA and many other Consumer Protection laws.
One of first people to criticize this plan was Senator Chuck Schumer, D-NY, who says the plan does not go far enough. He said that too many of these loans won't be modified because the investors who own the loan will be able to block any arrangements made by the servicer and the homeowner. Schumer said, "These voluntary plans sound nice, but they don't do the job."
This initiative doesn't help the nearly one million people in non-Fannie Mae and Freddie Mac backed mortgages whose payments are set to recast by the end of the year or people who were victims of fraud-fraud that was committed by the same companies that now want to help these homeowners. With that said, the actions of the Bush Administration could be seen as something a bit more Machiavellian.
First, it gives the impression to the public something is being done when it really isn't. Perception is politics and politics is perception. What is more Machiavellian than the idea that deceit being a legitimate tool of statecraft? Henry Paulson was after all an assistant to Watergate conspirator and convicted felon, John Erlichman, who created, "The Plumbers" for Richard Nixon.
Second, the credit crisis has created an atmosphere of self-preservation with executives and managers of the major financial institutions. As mentioned, because these loan modifications have indemnification clauses in them, they are a way to insulate these executives from lengthy and costly litigation whose final judgment would rest in the hands of an unfriendly jury.
Right now, it is quite possible that juries are the homeowner's best and last hope to keep their homes. If lenders and banks are refusing to atone for their past sins by not offering all at-risk homeowners a viable opportunity to keep their homes then shouldn't lenders feel the wrath of the consumer?
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