Mortgage Crisis: Will Loan Mods Bring Relief?

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A major obstacle to implementing an effective loan modification plan has been the difficulty of determining property values, which is essential if lenders and loan servicers are to consider modifications before starting foreclosure proceedings on delinquent homeowners.

If a loss-sharing provision ends up as part of any loan modification plan the Obama Administration decides to adopt, the FDIC will be required to monitor any losses resulting from re-defaults. Smithfield & Wainwright, a real estate appraisal firm in Jacksonville, Fla., says the Mo-Mod appraisal process it has devised would not only provide the FDIC with tools it needs for oversight and accountability but would also provide a data feed to the Federal Housing Authority, the Housing & Urban Development Dept., Fannie Mae, Freddie Mac and other loan servicers to help with repackaging modified mortgages for securitization and quicker liquidation of foreclosed properties. The firm's chief executive, Hogan Copeland, says the Appraisal Institute's nationwide network of 23,000 members could process up to 500,000 mods a month using Mo-Mod.

Incentives for Servicers

Yet another proposal, issued by three faculty members at the Columbia Business School on Jan. 7, likens the staggering task of getting consensus on loan mods among a vast number of investors in securitized pools of mortgages to that of large companies trying to get creditors to agree to debt restructuring. The proposal recommends two ways to get around barriers that keep third-party servicers from successfully managing the foreclosure crisis: an incentive fee structure that increases payments to servicers and better matches their incentives with those of investors, and legislation that would remove explicit barriers to modification of pooling and servicing agreements and reduce the risk of lawsuits for servicers who modify loans.

Professors Christopher Mayer, Edward Morrison, and Tomasz Piskorski, who collaborated on the plan, said it "might prevent as many as 1 million foreclosures at a cost of no more than $10.7 billion that can be funded by TARP money." They also said it would be much less costly to taxpayers than other proposals under consideration, with no requirement to provide pricey loan guarantees and losses for bad loans accruing to private investors instead of taxpayers.

"A homeowner is a candidate for loan modification when her income is sufficient to make payments that, over time, exceed the foreclosure value of her home," the Columbia proposal said.

Norm Miller, a professor at the University of San Diego's Burnham-Moores Center for Real Estate, says he likes the Columbia proposal but thinks the cost to incentivize servicers would fall between $50 billion and $100 billion for the borrowers who qualify for modifications.

Durbin's Amendment

If loan servicers remain resistant to modifying a substantially larger number of mortgages, the remedy for the looming foreclosure crisis could be in bankruptcy court. Currently, the U.S, bankruptcy code prohibits modifications to a mortgage on a debtor's principal residence, but on Jan. 6, Senator Dick Durbin (D-Ill.) re-introduced a bill that would amend the code by removing that prohibition, extending the time frame allowed for repayment in order to lower monthly payments, and permitting bankruptcy judges to replace variable interest rates with a new interest rate that would keep the mortgage affordable over the long term while also compensating creditors for risk. The bill would also allow judges to waive prepayment penalties and enable debtors to maintain their legal claims against predatory lenders while in bankruptcy. A parallel bill was introduced in the House the same day.