The Fairness of Mortgage Modification

I know, I know ... you are paying your mortgage. So am I. Why should we support any sort of plan that bails out those who lied, cheated, and manipulated their way into a mortgage in the first place ... only to find themselves unable to make the payments?

Because we have to ... that's why.

I think we all know that there were short-cuts, excesses, greed, etc. at work in getting us into this mortgage mess. Mortgage brokers lied and changed mortgage applications to get the loans approved. True. We don't know the extent to which this happened, but we know from anecdotes that it did. Borrowers lied and said they were going to live in homes that they never intended to live in - homes they simply bought to turn around and sell for a profit. We don't know the extent to which this happened, but we know that there are borrowers out there who also bought homes with fictitious lease agreements prepared indicating that they were arranging financing for a rental investment. We know this happened because Fannie and Freddie are putting programs together to finance rental properties again, but this time requiring the borrower to have 6 months or more in rental payments in cash in a bank account. We know that borrowers lied about their income - there is now a whole class of loans known as stated income or no doc loans, now known as "liar loans" as a result of the number of lies now understood to have been perpetrated. We know that lenders continued to move down the credit spectrum in approving more and more marginal borrowers in order to keep their mortgage origination flow. We know this because of the extraordinary shift in approval rates now experienced in this market.

So why support these plans to modify loans?

Ultimately, if your neighbor loses his/her house to foreclosure and the lender takes that home back and has to sell it to try to recover some of the loan balance, I guarantee in this market, that house is going to sell for less than its last purchase price. You, as the neighbor, will realize a decline in your home's value. And when lenders have more and more homes in foreclosure to sell, the lender is going to cut corners and sell the home as quickly as possible. These auctions where hundreds of homes are sold on a single date are not likely to bring top dollar for any home. And not your neighbor's home.

While the lender waits to sell the home, it's not like they are particularly good at maintaining properties either - it's not their expertise. Sometimes the home isn't even locked down - around where I live there were many news accounts this winter about foreclosed homes where the pipes froze and burst because the lender didn't know to drain the water lines after the utilities were shut off. Certainly, complaints over tall grass and weeds distract from the value of the foreclosed property ... and don't add to the value of your neighboring property either.

The idea in any modification plan is to slow the roll of delinquent mortgages to foreclosure. By slowing the process, perhaps the volume of properties becomes easier for the lender to manage. By slowing the process, perhaps the local real estate market becomes less saturated with cheap properties and has a chance to absorb the inventory of homes on hand through household formation, with help from a cut in new housing stock. And naturally there are households out there that but for some bad luck, job struggles, medical bills, and unexpected changes in household wealth could have continued to make their mortgage payments. Helping those honest, hard-working folks in the end helps you.

It is also important to recognize that the mortgage market has gone through a complete, structural change. With the exception of Fannie Mae and Freddie Mac, few lenders are willing to extend their balance sheets for the purpose of taking on any kind of risk at this time. Banks and financial institutions no longer have the capital to support risk. While much-maligned, the securitization market was a tremendous support for the housing market by allowing financial institutions to move outside of Fannie Mae and Freddie Mac for funds. The securitization market is dead. Funds are not available. Therefore, there is a large class of borrower and a large swath of current homeowners out there who cannot refinance their mortgage, who cannot finance a future home purchase, and who are nearly trapped in the current mortgage. Mortgage rates are at historical lows yet again, but many borrowers cannot take advantage. The modification plan will help an incremental percentage - though probably not enough of them - to take advantage of some of the current rate environment.

Ultimately, the housing market must reach a bottom in order for housing to return as a modestly profitable investment. In addition to the modification plan and other loan modification and housing incentives offered by various groups, banks, and government agencies, there are structural factors in the economy that will ultimately help housing recover. Household formation - i.e., couples marrying, starting families, job creation and job transfer, divorces, family expansion, and even natural disasters affect housing demand. As Warren Buffett said today, however, household formation takes time. He mentioned laughingly that no one is promoting 14-year olds getting married to increase the rate of household formation. Job stability would also help housing. People in fear of their financial future and jobs are unlikely to make a major financial investment, particularly one they now perceive as paying a minimal (or even negative) return, even if they believe they are getting a bargain. And clearly the American public has changed its savings and investment habits significantly in response to market conditions.

Housing will, however, stabilize. The sooner it happens, the better.

And mortgage modifications are going to be an important component, among other factors, in helping the housing market recover.