Quelle Surprise! Treasury Mortgage Mod Program Produces Zero Permanent Mods

For the record, zero is a very impressive achievement, so we have to give the Treasury department credit where credit is due. From Bloomberg:

More than 650,994 loan revisions had been started through the Obama administration’s Home Affordable Modification Program as of last month, from about 487,081 as of September, according to the Treasury. None of the trial modifications through October had been converted to permanent repayment plans, the Treasury data showed. That failure is getting the administration’s attention.

Treasury was clearly trying to blunt criticism of this program by having some new measures ready to go, as discussed in the New York Times yesterday. But the goose egg results, per Bloomberg today, are, even by the low expectations for this effort, a remarkably poor showing. And give the complete failure of the Bush, then Obama Administration efforts to get more mortgage mods within the considerable confines of current practice, why should we expect a different outcome?

The mortgage mod program is yet another ill-conceived effort to solve the problems borne of faulty technology, namely securitization. The FASB came out with a memo in 2004 that warned that warned about subprime loans and the current head of the FASB has questioned the entire premise of securitizing risky mortgages. In a 2008 roundtable, FASB chairman Robert Herz remarked:

In securitization accounting, there’s been in place, as part of the rules, a device called a qualified special-purpose entity (QSPE). It basically was a notion that if assets were placed into a trust, a vehicle, and then interests were issued out of that vehicle to various forms of security holders, what are called beneficial interest holders; basically the form of that vehicle, that trust, was to collect the proceeds on the assets and then remit them to various security holders. They were fairly passive, and the rules talked about how the powers would be very limited-entirely specified up front–and I think that worked for a fair amount of time.

But 1 think what we’ve learned in the last three to five years is in residential mortgages (also to a certain extent in commercial mortgage space and some other assets) that these assets are not passive in nature. Certainly, the subprime assets that were put into these vehicles called “Q’s,” with a lot of hindsight, because they took a lot of management when they went bad in terms of the servicing or having to restructure the loans, modify them, do all sorts of workouts. That clearly was not intended. I think the lesson learned here is that they were not actually “Q-able.”

Yves here. Now there may be remedies to prevent this sort of problem from occurring in the future, but that does nothing to solve the wee mess we have now. Residential real estate prices are sufficiently under water in a most markets that for a viable borrower (meaning one who still has a steady source of income), a deep mod can be a win/win. And before readers get moralistic, this isn’t charity, it’s practicality. In real estate downturns in the stone ages when banks held mortgages on their balance sheets, banks routinely did mods. And even in our current environment of more highly levered consumers, this practice has some empirical support. Wilbur Ross, vulture investor (ie, not predisposed to be a friend of the little guy) is an advocate of deep principal reductions based on his success with them as the owner of the biggest third-party mortgage servicer.

Now it was pretty obvious that the Obama mortgage mod effort would not produce much in the way of results. First, it provided subsidies to servicers, but much less than they would make from foreclosing. That means the banks have every reason to use the Treasury initiative to amass a track record that mods do not succeed (independent of whether they might succeed, as Wilbur Ross has shown they can).

Second, the program offered only a five year payment reduction program, with the lender then able to step up the interest payments to the fixed rates in effect at the time the sorta-mod was entered into. That does not do enough for the borrower. the redefault rate on mortgage mods that do not have significant principal reduction in the first six months now is high. When the initiative was announced, he New York Times reports that payment reductions are expected to be “hundreds of dollars” a month. Is that really going to make a difference with most borrowers, particularly since the interest portion is tax deductible and these mortgages are recent (ie, the interest component is a high proportion of the total payment).

Moreover, if a homeowner has negative equity, he still faces a big bill when he sells the house. What incentive does he have to work to keep current on the mortgage, or to invest in the house?

Now most people have focused on lack of servicer incentives, infrastructure, and experience to do mods, but we have another impediment, which the Treasury interest-only modification program clearly tried to work around. Losses are distributed differently in a mod than in a foreclosure. For a foreclosure, the losses go against the lowest tranches first, and then proceed to higher tranches. However, with a principal reduction, all tranches, including the AAA (or more accurately, what was once AAA) layer.

The interesting bit here, however, is the complete goose egg in the way of results. Most banks do own some mortgages they originated, and they should be able to renegotiate those freely. The failure to do so suggests either that they are concerned that modifying delinquent mortgages might require them to write down similar paper and/or they simply aren’t set up to do mods and are not really interested in creating the infrastructure to do so (and again note that what Treasury tried to create was a “mass mods” template, to reduce the work required by the lender).

The Administration did not throw its weight behind the only idea so far that could have cut this Gordian knot, which was to allow for the modification of mortgages in bankruptcy (the concept, which is well established in commercial bankruptcies, is to write the mortgage down to the current value of the collateral, and treat any remaining mortgage balance as unsecured credit). So now that this voluntary program is turning out to be an embarrassment, what will Team Obama do next? Back to Bloomberg:

“We are taking additional steps to enhance servicer transparency and accountability as part of a broader focus on maximizing conversion rates to permanent modifications,” Treasury spokeswoman Meg Reilly said in an e-mail yesterday. The Obama administration plans to announce additional steps tomorrow, including new private-public partnerships and resources for borrowers.

Given that “public private partnerships” has meant “large subsidies to banks that produce perilous little in the way of results,” I would not hold my breath. And the measures suggested in the Times verged on laughable:

“The banks are not doing a good enough job,” Michael S. Barr, Treasury’s assistant secretary for financial institutions, said in an interview Friday. “Some of the firms ought to be embarrassed, and they will be.”

Even as lenders have in recent months accelerated the pace at which they are reducing mortgage payments for borrowers, a vast majority of loans modified through the program remain in a trial stage lasting up to five months, and only a tiny fraction have been made permanent…

“They’re not getting a penny from the federal government until they move forward,” Mr. Barr said

Shaming bankers? What planet is Barr from? The industry is systematically predatory. If they had any concern about public opinion, they’d have used the Bush and Obama efforts as cover to try pushing back against investors in securitization vehicles. Before some of you go on about sanctity of contract, the father of mortgage backed securities, Lew Ranieri, seemed genuinely shocked in the Milken conference in 2008 when other participants said mods were restricted or prohibited in many securitization contracts. Ranieri said they did them routinely. Not only has the industry done anything more than go through the motions, one has to wonder whether they influenced Treasury in the design of the program so as to assure it would not be effective.