Modifying mortgages is just a band-aid

Posted by: Dean Foust on November 11, 2008

The flurry of announcements by the government and major banks that they are engaging in a massive campaign to modify mortgages that are in or are hurtling toward default and foreclosure will certainly give rise to predictions that the housing market has been stabilized and disaster averted. If only it were so.

Make no mistake, policymakers and banking executives had to launch this concerted campaign to try to stop the wave after wave of foreclosures that seems to feed on itself. As lenders foreclose on one delinquent borrower, and then sell the home at what is invariably a steep discount, that just pushes a number of nearby homeowners so far underwater that they just move out and mail their keys in, which just sets the cycle in motion again.

But anyone hoping that this synchronized effort to modify millions mortgages that are in trouble is likely to be disappointed. Because behind the splashy headlines, there are limits to what the government and banks can hope to achieve. And trying to slow the free-fall in housing markets is akin to the government trying to put its finger in the dike.

The fact is that despite the double-digit declines in housing values in most cities, housing remains significantly overvalued in many markets by all of the traditional benchmarks: One key ratio – the median cost of a new home vs. median income – suggests that home prices nationwide still need to drop another 15% to 20% on average, as you can see in this chart compiled by money manager Barry Ritholtz. And the equilibrium price is far more than that in bubble markets like southern California and Florida. According to this “fair value” calculator, one suburban neighborhood outside Washington, D.C. that I checked (Alexandria, Va., where I lived in the mid-1990s) is now 47% overvalued. Ditto for a few communities in Los Angeles that I surveyed.

median_new_home_price_vs_hh_incom.png

A second measure – home prices to average rent –also remains out of whack, and would require another 20% to 25% plunge in home prices to make it more advantageous for the average apartment dweller to buy a home instead, particularly now that few homeowners have any illusion that their house is an “investment” that’s going to soar in value in coming years.

Providing relief to current homeowners who are in trouble is a politically expedient move, but at the end of the day, prices are still far too high for the next generation of buyers – particularly now that lenders have reverted back to demanding hefty down payments and using more conservative underwriting standards. Which means that the current imbalance in supply and demand will remain a problem and help push prices down for years to come.

Then there’s the presumably simple task of getting troubled borrowers out of a mortgage they’re struggling to repay and into one they can afford. Except that it isn’t as simple as you’d think. For one, there’s the fact that many mortgages were bundled into securities that were sold to hedge funds and other institutional investors – many of whom aren’t interested in modifying the mortgages they hold. And getting homeowners who might qualify to have the terms of their current mortgage modified isn’t necessarily easy.

Consider the experience of IndyMac, the big California thrift that was seized by the FDIC this past July. At the time, FDIC Chair Sheila Bair made clear she was going to offer loan modifications to as many troubled borrowers at IndyMac as possible. But in last October, Bair told Congress that roughly two-thirds of the 60,000 mortgage that were more than 60 days in arrears at IndyMac would qualify for an interest rate reduction and other modifications. But two months into her grand experiment, the FDIC had only contacted fewer than 20,000 of those delinquent borrowers – and fewer than 4,000 borrowers had accepted the government’s offer. (And since the government didn’t’ require borrowers to verify their current income to prove their eligibility for a rate reduction until the very end, it’s a safe bet that not all of those respondents would make it to the finish line.)

Why such a low success rate? I’d speculate that many of the borrowers who were initially qualified under those 1% teaser rates of yore couldn’t come close to affording the “reset” when the mortgage reset to a higher interest rate, and a point or two reduction isn’t much help. And presumably many other homeowners who bought in the past couple of years in bubble markets like southern California and Florida are so ridiculously underwater on their mortgage that paying a lower rate doesn’t solve the fact that their house is now worth $150,000 than what they paid – and they’d rather just walk than negotiate.

Policymakers probably know that, and their secret goal may be that the loan modification programs will help turn the current free-fall in housing values into a more orderly correction that plays out over years rather than weeks – and doesn’t take the broader economy down in the process.

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Reader Comments

Its the economy, stupid.

November 11, 2008 05:54 PM

Resetting mortgage rates and payments is folly. While many overextended to purchase a home in the past few years, many who did not are now unemployed. Many troubled borrowers can't afford any housing payment. Until there is significant job creation there is really nothing that can be done to stabilize home values. Values have to come down relative to income, which in a McJob economy, thanks Bush and China, means home values will be in free fall for years, or pay has to go up.

jen

November 11, 2008 06:50 PM

the modifications are just a money maker for banks. they are not re-appraising the home and giving the difference off the loan amount. thats what they need to do. that is what is going to lower the payments. otherwise a 40 year loan gives them more money in interest payments. it is just a scam by the banks. I would just walk out of my home if this were a choice for me. i rather live on cash for 10 years then pay for 40 on a overpriced home that is worth half what i paid for it.
bush did not think of this outcome when he made the banks give out loans and caused this huge inflation of home prices in only 5 years.

joe

November 11, 2008 07:32 PM

The banks reveled in the fee income for all these toxic loans on the way up and it was their loose lending and toxic mortgages that created all this excess. Therefore they need to now foot the bill for all the costs incurred in the decline. Start by making all these crazy toxic loans illegal, then force them to re-write them all into legal loans that are no more that 80% LTV of current valuation and rates are set on a sliding scale based upon market rates, ability to pay and the due diligence (or lack thereof) the originating bank undertook to determine if the borrower could afford the loan. Only if the borrower cannot afford the loan at some rate that would allow the bank to break even should the property go into foreclosure. They take the haircut on everything as the disgorgement mechanism for their illicit gains during the bubble.

Jim

November 11, 2008 07:34 PM

What about me? I have no problem paying my mortgage (currently) in overpriced California but would love to have "a point or two" lopped off my interest rate. Where's my cake? Did I have to lie, cheat, and steal to now get rewarded? This whole thing (stinks).

Cindy

November 11, 2008 07:51 PM

I find this a grossly irresponsbile article. Any constructive move in this enviroment to help anyone stay in their home is positive. It should not be taken so lightly as strictly political. The author's credibility on the issue is seriously damaged by the grammar mistakes and missing words throughout the article.
Shame on you for taking a positive and turning it into such a negative.

Lewis B. Sckolnick

November 11, 2008 07:51 PM

Just end the late fees and other junk bank fees. People will then pay.

whatever

November 11, 2008 07:52 PM

Selling short? Great job.
Thank you.

Karl

November 11, 2008 07:52 PM

NOTHING is going to "save" the U.S. economy!!!!!!! It's been based on - LIES, DECEPTION, MANIPULATION, FRAUD, GREED, CORRUPTION, & the CONSTANT PURSUIT TO FINANCIALLY INJURE THE INNOCENT for far too long!!!! The COLLAPSE HAS BEEN TRIGGERED!!!!! "Turn out the lights, the party's OVER!" - 'Dandy' Don Meredith, from Monday Night Football in the early 1970's. P.S. Our economy, in my opinion, is JUST LIKE our GOVERNMENT!!!!!!!!!!!!!!!

Greg Fielding

November 11, 2008 08:07 PM

"their secret goal may be that the loan modification programs will help turn the current free-fall in housing values into a more orderly correction that plays out over years rather than weeks"

That's the problem.

Once we've hit bottom, people will become more confident because there will be nowhere else to go but up. Lenders will be more confident lending for the same reason.

The Government should be speeding up foreclosures, not delaying them.

Drew

November 11, 2008 08:22 PM

The entire plan is just a band-aid. The one sure fire way to get out of this mess is to start all over.

Neeraj Sharma

November 11, 2008 08:41 PM

I totally agree with Dean's posting. It seems to me Fed is living with-in an illusion that the problem is really fixable by bailing out the banks and financial institutions who really caused this mess at first place. The whirl that churning the mortgage crisis is so big and deep that there is no short term solution to reverse its direction.
There are some possibilities that it could be slowed down so buying some more time to really fix the problems but none of that efforts are made so far in my opinion.

Here is some of them.
1: For last consecutive 4 years, Almost all the counties in US enjoyed 20-40% of surplus of property tax. Now it is time to give that back to the people who are stuck in this mess. It is time now to waive off full property tax at least for next 2-5 years who bought properties from 2004-2007 and who will buy now until market fully recovered.

2: There are millions of legal skilled and non-skilled immigrant workers who have money to buy homes but stuck in the back log and waiting for the approval of their cases for 2-12 years. It is time to clear the back log so it will put couple of million new buyers in the market.

3: It is so ridiculas if not reducing the interest rates at least available on the primary home loan. It should not exceed more than 4%.

With saying all these 3, I can gurantee you that market will recover otherwise I do not have any hope of recovery in less than a decade.

Flea

November 11, 2008 09:59 PM

Finally somebody is addressing the problem. Housing is just too expensive. Everyone who bought would not have even qualified for a house 15 years ago. Liberal house lending has done nothing but drive prices up and out of reach of responsible Americans. Those with good credit who waited like me will be screwed because of the bailout. We are rewarding failure and punishing responsible people. Unbelievable.

rob muehlenbeck

November 11, 2008 10:58 PM

Thoughtful and factually correct. I agree that the securitized pools represent a special and significant challenge - one idea to share: loss severity is running 50% or so in the securitized pools - so that, while servicers have enormous legal issues in renegotiating a loan, they would not have the same issues in selling the loan at, say, 70. Freddie/Fannie could offer to buy amounts of loans at 70 - requiring only an appraisal at 70, an owner occ certification and a signed restructure agreement form - cutting the rate to fixed at say 4% for maybe 10 years - Freddie.Fannie's current yield would be almost 6%- enough to cover a Treasury sort of borrowing cost, servicing and make some money - and the 30% discount would provide considerable coverage for the inevitable defaults in the resulting pool.
While a lot of the homeowners are underwater - cyclicality has always been a part of real estate markets - many homeowners certainly still believe that their home will be worth a bunch more in 5 or 10 years - so if they can get through to that day, a goodly percentage will soldier on, I think.

Gary

November 11, 2008 11:06 PM

I am really getting tired of all the expert opinions that are so negative. The economists are all convinced that there is nothing that anyone can do, yet do they offer real solutions? No, all they do is complain and whine and moan about how nothing anyone is doing to solve this mess will work and that it will only continue to get worse. It's time you all just shut up and go away unless you can offer something truly of value to address the problem.

Saunji

November 11, 2008 11:12 PM

checkout this article.

jesse lemons

November 11, 2008 11:35 PM

SOME WILL SOME WON

GLL

November 11, 2008 11:38 PM

The great unwinding continues, the bankers hoard their taxpayer bailout dollars and pocket the ever increasing spread on their FED money by not passing it on to the consumer. They would rather choke on millions of foreclosed homes than lift a finger to help the taxpayers that just bailed their banks out. Greed and stupidity continues to rule, but hey the new President will fix everything by appointing the same Fannie Mae/Freddie Mac/Goldman Sachs crooks who started this mess to fix it. Nothing changes and no one cares as long as they get their last fist full of dollars.

Clock

November 12, 2008 12:23 AM

"We are rewarding failure and punishing responsible people."

Thumbs up Flea!!!

bob

November 12, 2008 12:30 AM

There is no mortgage "rescue" program you are going to see that will help the average American ..... not one dime. These programs will be designed to save the Banks....and the freeloaders that didn't deserve the loans in the first place. I have a 7% owner-carry mortgage on property that has lost half it's value in the last year. There will be no line for me to stand in to get help from Big Daddy. But my taxes will go to keep some slacker in a house better than mine. It's time to get (mad) America........we've got no one fighting for us at all.

TWebb

November 12, 2008 01:11 AM

The solution is Job and Industry creation. Without industry and Jobs...you can't pay your mortgage. The wealth of any nation depends on its ability to create Industry. Service jobs are not enough to sustain the USA. When you have numerous people competiting for similar jobs and other industries and jobs being exported...the value of that countries assets will decrease in direct proportion. These idiots in Washington know this...but they are owned by the Multi-nationals who only care about Stock options and cheap labor. They should penalize these companies who export jobs with MUCH HIGHER TAXES. If they don't like it...they can leave and go live with their Cheap Labor Workers...who can't afford the very products they produce. This is pure BS.

Jack

November 12, 2008 01:22 AM

$2 trillion later, all that the bailouts has to show for is a rapidly rising unemployment. In the next 12 months, the unemployment rate will be at least 8%. But the government will be out of money for a real stimulus package to boost jobs.

mjw149

November 12, 2008 10:43 AM

There isn't a way to 'fix' this mess. This problem isn't unnatural, our prosperity was unnatural. Don't you all see? They were giving mortgages to people who couldn't remotely afford it. Restructuring can't help that, because the homeowners will NEVER earn that much money.

The whole system of investments, financial stocks and insurance values were built on an assumption that the banks would see that income someday. That will never happen. It's like a pyramid scheme, they could keep the illusion going as long as no one assessed the subprime mortgages accurately, and they could find more borrowers based only on the 'equity' they built up from prices driven up by their loose mortgaging practices.

Maybe it IS 1929 all over again.

meme

November 12, 2008 11:38 AM

Who cares if you have good credit and waited. How does that help if you lose your job. Is somebody going to say oh wait you have good credit so you don't have to pay on your home anymore, we understand you lost your job. Not everybody who bought a home the last couple of years had bad credit, some people have lost a lot of what they used to have...has nothing to do with credit. Im tired of everyone saying that.

JB

November 12, 2008 01:55 PM

There will be a way out for the Florida RE market though.
Just wait for the next quality hurricane.
No houses, no debt. The insurances will bite the dust.
With half of the houses off the market the remaining ones face better evaluation ahead

Heather

November 12, 2008 05:37 PM

MEME:
I agree with you. The focus has been primarily on the "bad borrowers", the ones who bought a home with bad credit and not enough incoming to afford it. These people should be weeded out but you never hear anybody talk about the couple who worked there entire lives to save and build their credit in order to buy a home. Now they are in a home that will NEVER see a return. These buyers won't ever be able to even sell their home for 1/2 of what they bought it for. These are the people we need to BAIL OUT. God help us all!!!

Chuck

November 12, 2008 10:59 PM

Finally a writer that understands the problem and the economic realities that drive home prices. I've been saying the same thing for the last 2 years... Finally people believe me. Why are Americans so stupid when it comes to money!

David the Renter

November 13, 2008 02:08 AM

1st, screw the government and its socialist ways.

2nd, screw the homeowners asking for a bailout (go rent a house)

3rd, Just let the market correct itself.

This is not rocket science.

Cashgalord

November 13, 2008 03:47 AM

Brought a home in 06. Can't afford it anymore so I gave the bank notice early this year. So far I don't have to pay rent for the last 10 months ($3,4000 x 10 = $34,000) while the bank work it out. Don't have to worry about tax when the bank sales the house. Thank you Bush.

Ray

November 13, 2008 08:07 AM

Debt is a two way streak. I nearly fell into it because I wanted a specific house. A traditional 30 year loan for that house was more than I was comfortable with and I decided not to buy the house. Why should someone be helped now into a house that I could have bought with a 20 percent down and two years ago? Just remember, the house was never yours in the first place or you would not be paying a mortgage. I have no problem with market rate interest reduction and extending the mortgage years. But a principle reduction is Socialism. Why don't the government or my lender reduce my principle by $100K.

REPO4SALE

November 13, 2008 09:46 AM

Anytime a TRANSACTION HAPPENS, the Consumer looses & the business makes money! Less companies, less costs! Accounting 101. Finance 101 says, reduce the cost of goods sold to 10cents and when you sell at $1.00 you make 900%. Well, I average 1165% gross profit on my last 198 real estate sales. That means my average cost of "goods" or the properties was about 7.9 cents! My Finance & Real Estate professors would be proud of me! All this "paper dancing" is costing each consumer too much money! Suckers sale!

LiChou

November 13, 2008 12:26 PM

I say let the housing market self-correct. Already we are seeing signs that this is happening. The number of sales is increasing as more qualified people purchase homes via foreclosures and short sales at current market value. Keeping existing people in their overpriced homes through some sort of bailout or rescue plan is not the answer. It only prolongs the agony. Sure, there will be short term hardships for many, most of us will be better off in the long run. The ironic thing here is that many of people in distress will be able to rent for replacement properties for far less than it costs to own.

so you think

November 13, 2008 02:11 PM

Cashgalord - you may have some money in the bank but your scheme wont help you in the long run. If you have kids I feel sorry for them - they must lose respect for you and your ways (or they will turn out like you - shallow - which society does not need). homes are not an investment - they are a place to hang your hat and enjoy your family & friends. Nice life.

Cindy

November 13, 2008 02:24 PM

"Buyers" are a big group and a diverse one. They range from: Actual buyers who bought a house to live in and did nothing wrong, (though some may have been unwise to buy when prices were so inflated), all the way up to phony straw buyers who were part of a mortgage fraud scheme. In between were flippers, fools, and some who were complicit in fraud. Some of these buyers were defrauded, and they asked for govt intervention to catch crooks years ago and were told to shove it, basically. Now that the same fraud schemes have taken out some banks, the govt calls it fraud and steps in, not to help the original victims but to help the banks whose failure to do a modicum of due diligence is part of the problem. A person cannot buy a home they can't afford without a lender's big time help. Many of these lenders were operated by homebuilding companies. These industries need to be investigated as that's where the problem stems from. Going after buyers or blaming them is just going after the party least able to defend itself. A nice easy approach for govt which takes millions every year in campaign donations from these industries.

Gail

November 13, 2008 07:49 PM

My entire monthly income is $930 from a rental. Mortgage and loan payments are $927.xx each month. I get food boxes and energy assistance, and live small. As values go down, rents will go down as well, affecting my income downwards. This ideological Republican bailout is designed to help banks, who made the mistakes to begin with. I feel like foregoing my payments just to qualify, because life is grim on nothing each month. If I'm paying almost 100% of my income to stay in my house, can I qualify for a permanent reduction of interest to lessen my burden, which the banks would like to shift to our backs rather than shouldering themselves? Why are we helping the banks when they won't help us?

Over Supply Guy

November 15, 2008 10:17 AM

The current housing debacle actually has two components, only one of which is addressed by his article: easy credit and its affect on housing prices. The second component was the Ponzi mechanism itself: constructing more homes than the market could possibly absorb. The two were self-reinforcing. Bill Gross of PIMCO had the right idea when he joked that 1 million houses simply need to be bulldozed to the ground. I say we take our medicine in one fell swoop and be done with it. Fire up the bulldozers!

It's a SCAM

November 27, 2008 05:12 AM

The current crisis originated with the government by allowing the FED to flood the economy with cheap dollars, and by looking the other way while the R.E. orgy was in full swing. Banks loved it and so did the investors, but now that the market has gone south, banks and investors must be held liable. Those that have their money in toxic R.E. assets should go bankrupt and file for chapter 7. And the R.E. market should be allow to go on a freefall for a fast correction, instead of making it long and painful population.

But guess what? Now the Govn. will be buying the toxic assets from the banks and at the end of the day, we tax payers will end up footing the bill. Banks should be allow to fail regardless of how big they are. But, if the Govn. thinks that a bank should keep its doors open because for whatever reason it thinks it is in the best interest of society, then the Govn. should buy the bank at a fire sale price (which is not very much)and sell it back to private investors when things get back to normal and recoup tax payers' money.

Mike

December 2, 2008 02:01 AM

Agreed that those of us that tried to play by the rules will get the shaft. But the real problem as I see it is that most Americans have no idea what their government is doing. In the beginning, most of the lenders were "obligated" (ie: forced) to make a certain percentage of sub-prime loans because of the "Community Reinvestment Act" passed by congress. That one piece of legislation was the spark that set off the sub-prime wild-fire.

SUSAN DAY

December 3, 2008 01:12 AM

REFINANCE EVERY QUALIFIED HOMEOWNER AFFECTED BY NEGATIVE EQUITY AT UP TO 60% OF THE MARKET PEAK, STABLIZING THE HOUSING MARKET AT THAT VALUE. THE COST TO CURE IS 1.4 TRILLION DOLLARS TO BE ABSORB BY INVESTORS AND BANKS. THE PROPOSAL ELIMINATES THE TOP TWO REASONS OF FORECLOSURES NEGATIVE EQUITY AND HOMEOWNERS UNAFFORDABILITY OF A FIXED RATE MORTGAGE PAYMENT. IT WEEDS OUT HOMEOWNERS WHO SHOULD HAVE REMAINED RENTERS EXCEPT FOR THE EASY CREDIT OF LENDERS.

THE PROGRAM STABLIZES THE HOUSING MARKET BY STOPPING THE DEFLATIONARY CYCLE OF HOUSING FROM OVER-CORRECTING AND PROFITTING THE MAJORITY OF HOMEOWNERS WHO ARE PAYING THEIR BILLS.

sam

January 30, 2009 10:32 AM

hi

Thank you for your interest. This blog is no longer active.

 

About

BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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