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Here We Go Again
On March 27, 2013, the Federal Housing Finance Administration (FHFA) announced the introduction of still another mortgage modification program. Entitled the Streamlined Modification Program, it was intended to enable distressed borrowers to more easily qualify for a modification.
Unlike the HAMP modification program, borrowers will not have to show any financial hardship whatsoever in order to qualify. If their first lien is owned or guaranteed by either Fannie Mae or Freddie Mac, the only requirement is that they be delinquent for 90 days or more and complete a 3-month trial period. Also – they cannot be delinquent for more than two years and cannot have had two or more previous modifications.
Nice deal, huh? The obvious criticism is that it will only encourage borrowers to default in order to qualify. FHFA’s answer is that it will minimize losses to Fannie and Freddie by reducing foreclosures. Really?
The program was supposed to begin on July 1. But on May 12, FHFA announced that the program would become effective immediately. Servicers are required to send modification offers to all eligible borrowers.
The Failure of HAMP
The government’s HAMP mortgage modification program was begun in the spring of 2009 at the height of the credit crisis. Although they had expected it to help as many as 3 - 4 million distressed borrowers, only 816,000 permanent modifications were still outstanding at the end of March 2013.
According to the latest report from the TARP Inspector General, more than 26% of all permanent modifications had already re-defaulted. Over 1 million trial modifications had been canceled due to non-fulfillment of the terms by the borrower.
As early as April 2010, the Congressional Oversight Panel reported that more than half of borrowers who had received a permanent modification under HAMP were seriously underwater. Their average loan-to-value ratio (LTV) was 145%.
Even worse, this percentage included only first mortgages. The Obama Administration had estimated that roughly half of all at-risk borrowers were also saddled with second liens on their property. So the true LTV for borrowers under HAMP was clearly much higher.
Then in March of 2011, this same panel reported that recipients of permanent modifications were still badly underwater. They also emphasized another serious problem. After the modification, borrowers still had an average debt-to-income ratio (DTI) of 60%. This meant that 60% of their total income was being spent on servicing their debts. That debt burden was unsustainable for most homeowners.
Mortgage Modification Problem Goes Well Beyond HAMP
In June 2012, the credit reporting firm Trans Union issued the results of a study based on an examination of 600,000 borrowers from its enormous database who had received a mortgage modification between January 2008 and July 2011. It found that nearly 6 out of every 10 borrowers had re-defaulted within 18 months after receiving the modification.
The problem of re-defaults goes well beyond HAMP modifications. There are roughly $900 billion securitized mortgages outstanding which are not guaranteed by Fannie or Freddie. Take a good look at this shocking graph from TCW showing the re-default rate for loans modified in different years.
TCW
You can see that in the early years of modifications, nearly 80% have re-defaulted. For the most recent years of 2010 – 2011, the percentage is already approaching 40% and headed higher.
According to mortgage modification data provider HOPE NOW, more than 18 million mortgages have been either modified or provided with some so-called “workout solution.” You can imagine what the percentage of mortgages considered seriously delinquent would be had these not occurred.
Why Should This Time Be Different?
The obvious question is why should the new streamlined modification program have results much different than the HAMP program or any of the others? It will focus on the same pool of homebuyers who bought or refinanced during the bubble years of 2004 – 2007. More than half of them own properties which are badly underwater and nearly half have second liens as well.
Is there any plausible reason to expect that borrowers who receive a modification under this program will re-default less than those with permanent HAMP modifications? Perhaps those who dreamed up this new program really believe that the economy is strengthening. As they see it, homeowners with a reduced mortgage burden will be less likely to default in an improving economic climate.
Unfortunately, we have overwhelming evidence that underwater homeowners are much more likely to default than those who have equity remaining in the property. As I have repeatedly shown, the number of homeowners who purchased or refinanced during the bubble years boggles the mind. Take a look at this chart on refinancing originations during the bubble years of 2004 – 2006.
Mortgagedataweb.comIn these three years, 27 million mortgages were refinanced. Regardless of whether the refinanced loan was a first mortgage or a second lien, the overwhelming majority of these properties are underwater. That is the main pool of distressed borrowers whom the new modification will attempt to save.
The Terrible Burden of Second Mortgages
To get a sense of the enormity of the problem with which this new modification program will try to grapple, you must begin to understand the second lien disaster. In numerous articles, I have written about the burden of home equity lines of credit which has gone largely unreported by the media. Let me briefly explain the problem.
During the crazy bubble years of 2004 – 2006, millions of homeowners took out second liens to tap the growing equity in their home. Most were home equity lines of credit (HELOC). In California, it was not uncommon for banks to provide HELOCs of $200,000 and up. Some owners refinanced these HELOCs one or more times to pull still more cash out of their property.
In its 2004 report, the FDIC listed the ways in which banks were encouraging borrowers to open new HELOCs including providing automatic credit limit increases as the property increased in value. To increase the use of existing HELOCs, banks were actually charging “nonuse fees” on lines that were open but inactive.
Because qualifying standards were based primarily on the equity in the home, HELOCs were most attractive in those states where prices were rising rapidly – California, Nevada, Arizona and Florida. Homes had become a money tree which their owners could shake almost at will.
Homeowners opened an incredible number of HELOCs. Take a look at this chart from Equifax showing the total HELOCs outstanding from March 2008 through March 2013.
The green line shows that there were almost 15.5 million HELOCs outstanding in the nation at the peak.
Equifax
The green line shows that there were almost 15.5 million HELOCs outstanding in the nation at the peak.
The lunacy of HELOC borrowing was most apparent in California. During 2004 and 2005, a total of more than 1.4 million HELOCs were originated in California just for the purchase of homes according to figures I received from CoreLogic.
In those two years, borrowers in California would take out a HELOC to buy investment properties in other hot markets such as Las Vegas and Phoenix. While the loans were recorded as California HELOCs because the borrower’s property was in California, the purchased home was actually in another state.
When the housing market finally began to decline in 2007, banks were very reluctant to accept this change. They continued to shovel out millions of HELOCs. Equifax reported that a total of 4.6 million new HELOCs were originated in 2007 and 2008.
As late as the fall of 2009, a study published by Equifax Capital Markets found that 45% of prime borrowers with securitized first mortgage loans that were still current in July 2009 also had a HELOC. Worse yet, the average outstanding balance on these HELOCs increased steadily from roughly $83,000 in mid-2005 to $118,000 four years later.
If you add in installment second liens, there are a total of roughly 15 million second mortgages still outstanding on homes throughout the nation. I estimate that at least 90% of these properties are now underwater. This situation is rarely discussed in the media but presents a problem that no modification program can solve.
Moral Hazard
Allowing or encouraging borrowers to become seriously delinquent in order to qualify for a mortgage modification has become known as moral hazard. What sensible reason is there to eliminate the requirement that borrowers must show some financial hardship to qualify for a modification?
Doesn’t common sense tell us that some borrowers who can afford to pay their mortgage will strategically default so they can use this new program to obtain a better deal on the terms of their mortgage? Apparently common sense does not play a role with the policy makers at FHFA.
I have talked more than once to spokespersons for Fannie Mae on this moral hazard question. Their answer is simply to give me the party line: We are trying to help delinquent homeowners stay in their homes and avoid foreclosure. Those investors who own these mortgages do not elicit the same concern by FHFA to get paid back what they are owed.
Note: You can learn more about Keith’s new Capital Preservation Real Estate Report by clicking here.
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