Saturday, April 11, 2009

More evidence that loan modifications may not put a floor under foreclosures

The LA Times reports the broad results of a research paper produced at the Boston Fed, Reducing Foreclosures by Christopher L. Foote, Kristopher S. Gerardi, Lorenz Goette, and .Paul S. Willen. According to the Times:
Policies aimed at easing home loan terms for troubled borrowers may not be as effective in preventing foreclosures as more direct aid to homeowners, Federal Reserve economists have found.

Job losses and falling home prices have a bigger effect on delinquencies than mortgage terms, and modifications aren't necessarily a better deal for investors than foreclosures, two current and one former economist at the Boston Fed Bank and one Atlanta Fed researcher say in a paper posted Friday on the Boston Fed's website.
I haven't read the paper in full, but here are some bullet points from the introduction:
  • Debt-to-income (measure of affordability) at time of origination is not a good predictor of default. We estimate that a 10-percentage-point increase in the DTI (debt-to-income) ratio increases the probability of a 90-day-delinquency by 7 to 11 percent, depending on the borrower. By contrast, an 1-percentage-point increase in the unemployment rate raises this probability by 10-20 percent, while a 10-percentage-point fall in house prices raises it by more than half.
  • Investors (mortgage investors that manage the owners of the loan, the mortgage-backed security) and/or lender prefer foreclosure over loan modification. The gains from loan modifications are in reality much smaller or even nonexistent from the investor’s point of view.
  • We argue that foreclosure-prevention policy should focus on the most important source of defaults. In the data, this source appears to be the interaction of falling prices and adverse life events, not mortgages with high-DTI ratios or otherwise relaxed risk characteristics.
  • The results of this paper suggest that policies that encourage moderate, long-term reductions in DTIs face important hurdles in addressing the current foreclosure crisis.
Increasingly, borrowers are walking away from their mortgages, while at the same time, lenders may be unwilling to modify. This study suggests that Obama's loan modification package may face some hurdles. To date, the results of government efforts to stem defaults are not encouraging.

Rebecca Wilder


  1. Didn't the original opinions state that loan modification was going to help only a small number of those in trouble. Opinion is now true. Those who are upside down went way over the 10% maximum so fast they couldn't take advantage of it. I find the optimism of the markets just a bit premature. It ain't over!

    But the new 1st puppy sure is cute.

  2. "Interestingly, the number of people rolling from current to 30 days delinquent has only recently exceeded the levels of the 2001 recession, even though foreclosures have been far higher than they were then." [Reducing Foreclosures, Christopher L. Foote, Kristopher S. Gerardi, Lorenz Goette, and Paul S. Willen, page 19.]

    Focusing on foreclosure prevention is the wrong focus of government policy efforts. Successes in minimizing foreclosures will not minimize the underlying negative social impact of involuntary relocation on family stability and its members' physical and mental health.

    Negative income shocks (unemployment, illness, wage earner death, etc.,) are an excellent predictor of mortgage delinquencies. However, positive or negative home equity determines the extent that defaults turn into foreclosures. A delinquent homeowner with positive equity is able to sell the home, repay the principal balance of the mortgage, and avoid foreclosure. A delinquent homeowner with negative equity is unable to repay the principal balance of the mortgage through a home sale and must go into foreclosure.

    In both cases, an involuntary relocation takes place. If forced relocation is a societal concern, then policy interventions should not be limited to foreclosures. Society should attempt to minimize the dislocation caused by income variability. The paper's authors, Foote, Greadi, Goette, and Willen, recommend a program that focuses on "the effects of income volatility, helping people who lose their jobs get through difficult periods without having to leave their homes. For example, the government could replace a portion of lost income for a period of one or two years, through a program of loans or grants to individual homeowners." [Page 35].

    If the US government does not care about dislocations caused by an economic downturn, then foreclosure rates are not an important societal concern. If it does care about dislocations, then foreclosures rates are the wrong metric.

  3. These Fed Reserve researchers aren't too bright.

    This story is old and has been in full swing since August 2006.

    When a man lacks sufficient income to pay both living expenses (food, fuel, lights, heat) and debt service (credit cards, mortgage, car debt), a man shall stop paying on debt obligation.

    Income or the lack thereof counts.

    Dummy bureaucrats suffer from the false belief that cash rentees (those with mortgages) have no other bills and a steady stream of guaranteed income.

  4. I think the problem with loan modifications is that it's not for everyone. Obama's Making Home Affordable plans (modification, etc) will work only for certain types of loans that classify under certain rules/qualifications. There has to be other options that people should be aware of in case loan modifications aren't for their situation.

  5. To make a long story short, these programs aren't and won't be as effective as their designers hoped they would -- there are too many factors stacked against helping millions via loan mods. At this point we've identified nearly every factor: lenders tend to prefer foreclosures, re-default rates are high, home prices and economic conditions cause more stress than loan terms, etc. While I'll agree Obama's plan has some new strategies and incentives, I agree that the results (no matter which program) will likely not be too encouraging.

    Nice post,



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