What Loss Mitigation Taught Us About Housing Finance Reform

by Patricia McCoy
Guest Blogger

From time to time, Housing Perspectives features posts by guest bloggers. Today's post was written by Patricia McCoy, Liberty Mutual Insurance Professor, Boston College Law School, and former Assistant Director for Mortgage Markets, Consumer Financial Protection Bureau.

Since 2007, the federal government and servicers have groped toward striking the right balance between cost-effective loss mitigation and unavoidable foreclosures for homeowners with delinquent home mortgages. Among other things, this painful experience resulted in a cornucopia of data about the right way and wrong way to do loss mitigation. Nevertheless, none of the leading housing finance reform proposals has incorporated these lessons. Take, for example, the Johnson-Crapo bill, which was the leading reform contender and made it to the Senate floor. That bill would vaguely require servicers to establish “loss mitigation options that seek to enhance value” but says nothing about the best way to do so. That oversight is unfortunate because it sets us up to repeat the mistakes of the past.

First, some history. Eight years ago, the federal government became focused on foreclosure prevention as mortgage delinquency rates began to spike. The George W. Bush Administration sought to achieve that goal through moral suasion and voluntary compliance by servicers under the aegis of HOPE NOW. Later, the Obama Administration turned up the heat by offering a carrot and a stick: a carrot consisting of the HAMP Program, which paid servicers to grant loan modifications when doing so would increase recovery, and a stick through rulemakings and enforcement. One of the results was a rich trove of data on what makes loss mitigation work and why.

So what did we learn? I address this question in some detail in a chapter in the Joint Center’s latest book, Homeownership Built to Last, but here are a few quick takeaways:

1. Standardized decision tree, or “waterfall,” such as that employed by HAMP to lower monthly payments, is key to minimizing default rates (by cutting the interest rate or, if necessary, reducing principal).
   
   
2. Foreclosure prevention is more successful the sooner it is granted after a homeowner’s first delinquency – ideally within two to three months.
   
   
3. The federal government should offer meaningful relief to people who are temporarily unemployed and need help making their mortgage payments until they get back on their feet.

These three techniques are a win-win for distressed homeowners and for investors by avoiding needless foreclosures while maximizing investor recovery.

But there’s one final lesson that is directly relevant to housing finance reform. We can’t implement lessons one through three unless we remove servicer barriers to effective foreclosure prevention. In 2007 and 2008, the private-label mortgage-backed securities market collapsed and that market remains moribund today. In the aftermath, servicers rushed to foreclosure in too many cases, saying that pooling and servicing agreements with investors (PSAs) tied their hands. Investors disputed those claims, complaining that the PSAs did not in fact bind servicers’ hands and that foreclosure prevention would have enhanced recovery in many of those cases. 

After that sour experience, investors will not be eager to rush back to the private-label market unless loss mitigation rules give them stronger protections. It is important, going forward, that PSAs in future deals give servicers no excuse to deny loan modifications that will increase investor recovery vis-à-vis foreclosure. Since PSAs are privately negotiated, the only real way to assure that is to prescribe standard loss mitigation protocols and require PSAs to follow those protocols in any housing finance reform law that Congress enacts. The protocols should require servicers to evaluate loan modification requests by distressed borrowers using a standardized waterfall that is designed to reduce monthly payments to an affordable target level. Under that waterfall, servicers should attempt to attain the target payment level first through interest rate reductions and then, if need be, through principal reductions. The statutory protocols should also set time limits for loan modification decisions to help encourage early intervention. With these protocols in place, we can help avoid the experience in recent years where useless foreclosures pushed down home prices and delayed the economic recovery.

Foreclosures: The Great Untold Story

by Chris Arnold
Guest Blogger

From time to time, Housing Perspectives features posts by guest bloggers. Today's post, written by NPR Housing and Economics Correspondent Chris Arnold, reflects thoughts from a panel he moderated at the Harvard Kennedy School on March 26, 2013. The panel was entitled "Foreclosures: The Great Untold Story" and included panelists Mike Calhoun (Center for Responsible Lending), Gary Klein (Klein Kavanagh Costello, LLP), and Bruce Marks (Neighborhood Assistance Corporation of America)


People know there’s a foreclosure crisis.  Yes, the housing market crashed and lots of people are losing their homes.  But most people don’t realize that about half of foreclosures don’t need to happen. 

That is, about half the time, when a homeowner falls behind on their mortgage payments, there is a better alternative that will keep the homeowner in their house and result in a smaller loss for the lender (often investors in RMBS).  

When president Obama came into office, in the spring of 2009, he started the Home Affordable Modification Program (HAMP.)  The goal was to prevent 4 million foreclosures by modifying the terms of people’s mortgages in cases where lowering a borrowers interest rate, and perhaps forgiving some principal, would be “NPV Positive” for the lenders.  In other words, the goal was to modify loans in cases where it made better business sense for the lender to keep people in their homes instead of foreclosing.  This also helps the housing market and the broader economy by reducing the overall numbers of foreclosures and the losses associated with them.

The problem is, while many economists thought that 4 million people estimate was a pretty good one, 4 years later the program has only reached about 1 million people.  There have also been 3.4 million non-HAMP mods over this period but data on the quality of these mods remains murky.

Meanwhile, according to recent data compiled by the JCHS (State of the Nation's Housing, 2012, Figure 20) there are still roughly 3 million seriously delinquent loans in (or heading into) the foreclosure pipeline.  

The JCHS recently hosted a panel of people working on the front lines to prevent foreclosures.  All are strong advocates for increasing the number of loan modifications in order to help housing markets.  They said there are still serious problems implementing the HAMP program, and that if some changes were made, there is still time to prevent tens, and perhaps hundreds of thousands of unnecessary foreclosures.  

The Panelists were (pictured above, right to left):

• Gary Klein, Partner, Klein Kavanagh Costello, LLP 
• Mike Calhoun, President, Center for Responsible Lending
• Bruce Marks, CEO, NACA (Neighborhood Assistance Corporation of America)

I hosted the panel, and these are the highlights of the recommendations from the group.  

Gary Klein has been suing the nation's largest banks for their alleged failure to provide loan modifications for people who should qualify for HAMP.  Often, he said, the major banks that “service” the mortgages on behalf of investors (the banks are responsible for qualifying homeowners for HAMP) drag out the process for far too long.  Homeowners can stay stuck in limbo trying to qualify for the program for 6 months, 9 months, sometimes for more than a year.  Klein says the HAMP agreement/contract documents signed by the banks and the homeowners state that the bank has 3 months to make a decision.  This agreement is struck when a homeowner begins the “trial period” of the HAMP program and starts making lower monthly payments.  Klein recommended that if a homeowner stays current, making payments, for those 3 months, and the bank has yet to make a decision, the homeowner should be automatically qualified for HAMP and receive a permanent loan modification through the program.  Currently there are more than 59,000 active HAMP trial mods according to the Treasury Department.  So Klein would like to see many of those automatically converted to permanent loan mods.  

Mike Calhoun has been studying the foreclosure crisis for years now at the Center For Responsible Lending.  He urged the regulator for Fannie Mae and Freddie Mac (the FHFA) to allow for loan modifications involving principal write-downs.  Loans not backed by Fannie and Freddie have been receiving principal write-downs more frequently as private investors calculate that it can make good business sense to avoid a foreclosure this way.  Calhoun urged Fannie and Freddie to follow suit.  

Calhoun also suggested expanding the administration’s HARP II refinancing program.  He’d like HARP II to permit delinquent borrowers (who are currently not eligible) to refinance into today’s low market interest rates.  In many cases, Calhoun said, just cutting a homeowner’s interest rate to what is currently available on the market can be enough to prevent a foreclosure. 

Bruce Marks’s organization NACA has been functioning essentially as an outsourced loan modification “qualifier” for all of the nation’s largest banks/ loan servicers.  Marks said NACA has enabled more than 200,000 homeowners to avoid foreclosure with a loan mod.  Like Calhoun, Marks would like to see more principal write-downs to avoid foreclosures.  Marks also said he wished that bankruptcy judges had been allowed to help rewrite the terms of mortgages (this was proposed by federal lawmakers in recent years but couldn’t get approval in Congress). 

One hopeful sign, Mike Calhoun said, is that the quality of the loan modifications done by loan servicers outside of the HAMP program appears to be improving.  But the panelists said the exact terms of many of those modifications remain unclear.