A recently published study by economists at the Federal Reserve in Boston indicates that mortgage modifications are not an effective method of combating foreclosure. Unaffordable loans are rarely the cause of buyer default, the study reveals. Instead, buyers tend to default due to a combination of suddenly reduced household income and falling house prices. The study also indicates, contrary to popular opinion, that foreclosure may often be an economically preferable option for lenders, indicating that the high number of foreclosures relative to loan modifications is the result of sound fiscal policy by lenders, not mere obstinacy. The Reserve economists recommend the government pursue policies to prevent foreclosure by ameliorating the immediate effects of unemployment, rather than encouraging loan modifications.
first tuesday take: Readers who want to understand the structure of mortgage lending, from the debt to income ratio (DTI) to the pooling and servicing agreement (PSA) controlling the mortgage loan arrangements, are advised to read the federal reserve’s study – especially if they intend to become an “all service broker.”
The Fed’s study contains an excellent analysis, in relatively plain talk, of the workings of pooling arrangements. These arrangements sold bundled mortgages to the world’s individual investors, which as tranches (tiered priorities of pool investor rights to the interest, paid on mortgages held by the pool) caused losses to some bond investors in a pool while others lost nothing. The study plainly digests the servicer’s role as the agent of these pooling arrangements, but leaves out the known fact that servicers make more money foreclosing from both ends of the foreclosure process than they will ever make arranging a modification of delinquent loans.
The pillar of truth missing from the research analysis, a point crucial to the study’s discussions about modifying and converting bad loans into good loans based on DTI ratios, is the absolute need for a cramdown of the principal balance to the value of the property for loans in default.
Until someone gets on the cramdown bandwagon, and demonstrates that owners with crammed down loans (which require the owner to have a stable income) are unlikely to redefault, the modification discussion will continue ad nauseam.
Re: “Public Policy: Reducing Foreclosures”, from the Federal Reserve Bank of Boston.