Saturday, December 20, 2008

Fannie / Freddie unveil their loan modification program

One would think that the entities holding $5 trillion in mortgage debt revealing their loan modification program would be a big deal. Supposedly streamlined loan modifications will be what saves the market and the borrowers from the debt burden they got themselves into. Unfortunately the reality is that few loan modification programs strike a balance between the incentivizing the borrower to stick with the loan or convincing the lender to take the haircut. The GSE loan modification model is a horrible deal for the borrower and it is hard to see where someone will take the loan modification and have their long term situation improve in any way.

Here are the basic steps for a Fannie/Freddie loan mod. (PITIA is Principal, Interest, Taxes, Insurance and Association dues)
  1. Taking any delinquent payments add it back into the loan.
  2. Extend the loan term to 40 yrs, if PITIA is above 38% go to step 3
  3. Reduce interest rate down to 3% in .125 increments to attain a 38% PITIA. If the final interest rate is at or above market rates then fix the interest rate on the loan for the life of the loan. Otherwise interest rate stays fixed for 5 years and then moves up 1% a year until it matches market rates at the time the loan is modified. If PITIA is above 38% go to step 4.
  4. Principal forbearance. Put the amount of principal necessary to bring the loan amount down enough to get the PITIA below 38% as a balloon payment due at the end of the loan.

The 38% PITIA as a sustainable housing payment is insanely high. It isn't even total PITIA this is all about the first lien mortgage and no other mortgage debt or any other debt is taken into account. Loan modifications programs should be designed to be sustainable if they have any chance of success but they instead are designed to milk as much cash flow out of the borrowers before the inevitable default. Also the property has to be more than 90% LTV of the mortgage being modified. This program is just like Hope 4 Homeowners, blatantly structurally flawed in such a way to ensure the programs failure. The only logic I can behind unveiling such a program is show the politicians they are "doing something" even if what they are doing will have little to no effect on the marketplace. For many borrowers in bubble areas it seems like stopping payments and saving money and staying into the home until you get kicked out is the most financially sound decision they can make. I don't see the GSE loan modification program changing the calculus of that decision much at all.

5 comments:

Noz said...

This is absurd....they are trying everything to not allow the market to correct itself. Prices are still far too high for most people to sustain....$2500-3000 month payments is just insane for a 2-3 bedroom home.

I don't know what they are thinking but this is only going to prevent people like myself from A) buying a home or B) just leaving this place altogether.

Effective Demand said...

I don't think this is a serious loan mod efforts, Nor any modeled after this formula. A serious loan mod would reduce principal.

I think some politicians are demanding action and I think this provides a fig leaf for these entities because maximizing net present value isn't going to be done in a streamlined fashion and the politicians simply do not want to hear that. I also think as long as TARP hangs around not buying assets it will make banks unwilling to cut principal because they will want to maximize the value of the loan amount when it sells.

Noz said...

A friend of mine who owns a home and obviously has a vested interest in home prices going back up keeps stating that he believes the bottom will be reached next year at the latest.

He believes the Fed will step in and bail people out themselves and screw the banks...which are now, he claims, hording the money they have been given.

Not sure if I agree with him but that's a bad scenario too.

Effective Demand said...

Noz,

Similiar things were said last year. Think about what has transpired in 2008, raised conforming limits, FHA secure, Hope Now, Hope for Homeowners, etc.

While the "waving of the magic wand" argument has been made before I just have a hard time seeing both the motivation and ability to do so. I think they are trying to stop an overshoot to the downside as much as possible but any reasonable person can see that keeping prices at bubble levels creates even more problems and for a longer period that returning the market to a natural equilibrium.

It will be interesting to see just how much input the Chris Dodd, Barney Frank, and to a lesser extent, Sheila Bairs of the world have in the next administration.

loan modification said...

it seems that they still wanted to prove something in here.