It looks like I am in the process of being proven wrong, but even if I am wrong, it is because I underestimated the stupidity of policymakers and the short-sightedness of the mortgage industry.
In September, Shiela Bair, chairman of the FDIC, had called on mortgage servicers to freeze teaser loans at their introductory rates. I said it wouldn’t happen (it would violate too many servicing agreements) and was a bad idea.
California’s Governor Schwarzenegger has gotten some large servicers to agree to keep their initial charges in place. Whether this is a sincere effort, PR, or convenience (as Michael Shedlock cynically noted, ” Here is the official translation. Countrywide cannot stand another 80,000 REOs”) is yet to be determined.
From Reuters:
A Schwarzenegger aide, Sabrina Lockhart, said the governor’s office negotiated an agreement with the Countrywide Financial Corporation, G.M.A.C., Litton Loan Servicing and the HomeEq Servicing Corporation that would allow the lenders’ mortgage borrowers in California to continue paying loans at initial rates if they live in their homes and make payments on time but are unlikely to afford higher payments when their mortgage interest rates are reset…..
The lenders have also agreed to seek out borrowers before their loan terms reset and to improve the process of determining whether borrowers can afford bigger mortgage payments when rates rise, Ms. Lockhart said.
If Jerry Brown had tried something like this, it would have been deemed socialism. The borrowers that can take it will get rate increases, the ones that can’t, won’t.
In theory, this could have simply been window-dressing a program to make more loan mods, which is the sensible way to deal with this problem. It is generally in everyone’s interest to keep the borrower alive if he is at all salvageable, but keeping borrowers going at all costs is damaging not only to the financial institutions but also to the weakest borrowers, who are better off taking their losses rather than compouding them. Countrywide had already announced a program to do so, so the Schwarzenegger agreement isn’t a new undertaking.
However, the comments from the companies confirmed that this program is intended to freeze some (many?) loan terms for five years as stipulated:
Litton Loan President Larry Litton Jr. said a five-year extension of current rates for some borrowers was justified given the housing market’s slump, financial hardship in many households and anxiety among mortgage investors.
“At the end of the day we’re able to align the borrowers’ interests with the investors’ interests, saving everybody money,” Litton said in a telephone interview.
Shedlock again: “This is nonsense of course and has nothing to do with “alignment”. It is a desperation move seeing to stop foreclosures and a buildup of REOs.”
It isn’t clear that these servicers can deliver (the deal was with the Litton and HomeEq servicing entities, and with GMAC and Countrywide). As noted before, they are required under the terms of their contracts to act on behalf of the investors. They have absolutely no obligation to borrowers.
One could argue that the deal the quartet signed in California is an act of bad faith. Investors no doubt will (via counsel) find out how the servicers intend to proceed. Possible outcomes: the investors are persuaded this arrangement is in their best interest; the servicers are browbeaten in private to curtail their activities under the plan (ie, they can take action that conforms with it but only to the extent it clearly helps investors or makes them no worse off); some investors decide to sue. There would probably be some private back-and-forthing to see if the servicers and investors could agree on a protocol before any litigation was filed, so don’t expect any immediate fireworks.
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I still haven’t seen the answer to this question. Suppose there is a five-year grace period. Does the borrower have to pay more than he would have after the five years is up, to make up for the amount he didn’t pay during the five years? That is, does the Present Value of the amount repaid stay constant, and is just shifted from one period to another. Or is the homeowner actually getting a reduction in the Present Value he has to pay?
a,
I haven’t seen anything specific either, but Bair’s proposal, and the Schwarzenegger crew said they took their cues from her proposal, made it sound as if no adjustment was made to principal. And I have a strong suspicion that this is the concept, as you put it, a reduction in NPV of the payments.
Now in fact that often happens in loan mods, so that isn’t as heinous as it might sound. But to do that on a broad scale basis is bad incentives, and therefore bad policy.
Two quick comments
1)
Since mortgage brokers have a fiduciary duty to act in good faith on their clients behalf in California;how is it not a breach of this duty when the lenders pre-emptively contact borrows who they believe may not be able to afford an increase adjusted rate in the future? Obviously it is to soon to know what the screening method they will to identify these possible defaulting homeowners; but we can rule out late payments since that is one of the pre-requites for qualifying for the rate freeze. I am guessing it will have to be something with their earning and potential to pay the higher rate.
If this is the case, the good faith requirements require that a broker may not knowing arrange a loan beyond the ability of the borrower to repay per the terms, or to enter a situation where the lenders may incur a reasonably foreseeable loss at the time the loan is made. It will be kind of hard to claim that they could not have “reasonably foreseen” that the homeowner could not afford the loan at the procurement stage, if they turn around and use the homeowners income information as a pre-screening tool for future defaults. It would seem to me that any adjustment or reaching out to specific homeowners, without a method of determination that became available after the closing of the loan and was not used at that time, could rise to a breach of this duty.
2) It would seem to me that any changing of the loan is a significant modification of the contract, enough so that it would materiality change the terms and render it invalid? So I wonder would you consider the restructuring of the loan as the dissolution of the old and replacing it with a new one? Or would you help them refinance the loan into another arm with a set rate? The reason I wonder about this is, by refinancing your loan in California it could be argued that it is not a purchase money order and therefore does not fall under the anti-deficiency statute of the state. While you could make the public policy argument that it fits within the intended situation envisioned by the legislative, that being the protecting of community value in the face of downward economic times, the district courts have been split on whether or not to allow this extension. What I am getting it is, you could see a rise in judicial foreclosure proceedings and personal judgments being sought between the lender and the homeowner for the difference between the foreclosed price and that on the loan.
I could be wrong, and if i am in my defense it is four in the morning, but none the less i thought i would post this.
Shedlock again: “This is nonsense of course and has nothing to do with “alignment” [of borrower’s and investors’ interests]. It is a desperation move seeing to stop foreclosures and a buildup of REOs.”
There is no contradiction here: stopping foreclosures and a buildup of REOs often does represent an alignment of everyone’s financial interests.
Empty foreclosed houses are targets of looting by opportunistic criminals, often within days. See Fortune: Crime scene: foreclosure. This is not merely petty vandalism: according to the article, “looters don’t take long to make a vacant property nearly worthless”. Everything of value inside the house is stolen, damaging walls in the process to take out piping. And the loss of windows, doors and aluminum siding exposes the house to the elements and causes even more rapid deterioration of what’s left. Repairing and renovating such houses would cost more than they could hope to sell for, and it would cost too much money even to raze them all. And then the drug dealers move in.
Faced with the near-total loss of value, not to mention the potential lawsuit liability if, say, a drug-related shooting takes place on or around your REO property, it may be a no-brainer to let the borrower stay on as an unpaid housesitter or de facto renter. Doing so is consistent with a servicer’s fiduciary duty to investors, to prevent a merely very bad loss from becoming a total writeoff.