The Moratorium Morass

*Why Putting the Brakes on Foreclosures Won’t Stop the Crash*
California did it. Massachusetts and Maryland did it, too. So did Fannie and Freddie. Florida and Ohio are talking about doing it. The sheriff of Wayne County, Michigan, didn’t wait around for a vote: He did it himself.
As the downward spiral continues in housing markets, lawmakers are suddenly hot for moratoriums on foreclosures. President Barack Obama and some of his Congressional counterparts have talked about instituting a freeze of their own, nationwide, for up to six months. It’s a proposal with friends in high places: Christopher J. Dodd (D-CT), chairman of the Senate Banking Committee, Barney Frank (D-MA), chairman of the House Financial Services Committee, and Obama himself.
Everybody agrees action is needed. There’s been one foreclosure every 13 seconds so far in 2009, according to a Center for Responsible Lending study, and few analysts think we’ve hit the bottom in home values yet. On February 18, the Obama administration announced a $75 million plan to tackle runaway foreclosures, one that pushes loan modifications and write-downs. It’s more ambitious than many industry observers expected, but it may not be enough—and there still are signs an across-the-board moratorium could be a part of the long-term vision.
When he was campaigning, Obama made no secret that he preferred a foreclosure freeze; last October, he said banks receiving a share of the government’s $700 billion bailout should halt action against distressed homeowners ""to give people the breathing room they need to get back on their feet."" Dodd—who’s currently championing ""cramdown"" legislation to give judges greater freedom in reducing loan principals in bankruptcies—tried to wedge a moratorium into last fall’s bailout bill, and he’s making it an issue in what he calls an ""aggressive schedule"" for his Senate committee this spring. In fact, on February 11, Frank—as well as the government’s Office of Thrift Supervision—publicly demanded a moratorium until the rest of the Obama mortgage plan could be implemented. ""Having someone suffer foreclosure because two weeks haven’t gone by for this program would be unacceptable,"" said Frank.
There’s more than just political posturing going on, too. In January, the Los Angeles Times reported that Dr. Kenneth Rosen, a Berkeley economist, met with the Treasury Department’s transition team to discuss his mortgage-industry proposals—which include a six-month freeze on foreclosures.
It’s not quite a nuclear option, but it could have a lot of toxic fallout for the economy, and especially for lenders, servicers, and filers. Critics say it’s an empty gesture at best—and, at worst, a bludgeoning blow to housing. ""The ripple effect of a moratorium would be huge and maybe bigger than the number of homes you could actually save in the moratorium,"" says Gerald B. Alt, the Illinois-based president of LOGS Network, which provides legal and title services for mortgage servicers.
It’s almost enough to make REO professionals throw it in. ""The rules of the game change daily,"" marvels Frank Veneziano, Cincinnati-based head of the real estate default group at the law firm of Weltman, Weinberg & Reis Co., L.P.A. He’s not alone in his skepticism. Cary Sternberg, SVP at American Home Mortgage Servicing in Irving, Texas, says politicians are looking for easy solutions, and with moratoriums, an easy solution is also an unfair one. ""When I pick it apart, I don’t see equal benefits, and that’s what bothers me,"" he says. ""The servicer is getting hurt for the benefit of someone that has no chance of keeping this loan active.""
*Not Learning from Our Mistakes*
""What people fail to understand is there’s not one single problem that got us into this, and there’s not one single solution to get us out,"" says Veneziano. He’s busy watching Ohio’s legislators wrangle over a possible 180-day blanket moratorium on foreclosures, and he fears lawmakers aren’t considering all the implications. For example, will it apply to vacant and investor-owned propertiesx That doesn’t make any sense, he says. ""If the property is vacant, and the occupants have left it, why should there be a moratorium on itx"" The already-long foreclosure process just gets drawn out longer, even when there’s no home dweller left to contest it. Likewise, he says, 25 percent to 35 percent of all the loans in default today are investor-owned, many of them tantalized by the house-flipping craze and then beaten by plunging home values. ""Those borrowers, they don’t even want to keep those loans. Why should there be a moratorium on themx"" In these cases, there’s no one disputing a foreclosure, yet no one can make a move—and the properties stay vacant, often in disrepair, depreciating further.
Such failures of foresight sunk moratoriums in states like Massachusetts and California, Veneziano says. In fact, the flops in those cases are so extreme they might give lawmakers pause. Last May, Massachusetts Gov. Deval Patrick—a staunch Obama ally—prevailed upon legislators to pass a three-month moratorium on foreclosures in the state. Indeed, filings plummeted over the summer . . . and promptly skyrocketed, by 465 percent, in September after the moratorium was lifted. ""Let’s say the borrower owes $2,000 per month and is three months behind,"" says Alt. ""Do you think they will put next month’s payment in a cookie jar and work toward finding the restx No, they will pay other bills, probably credit cards and living expenses so they end up further behind. At the end of a 90-day moratorium, they may be six months behind with no hope to catch up or refinance—so I predict, and history shows, that the foreclosure rates will actually be higher afterwards.""
That makes a bad situation worse, the experts say. Once the inevitable post-freeze wave of foreclosures hits, the market will be flooded, further decreasing home values and making it virtually impossible for lenders to sell those properties because of the incredible gap between demand and supply. ""A moratorium is not saying we’re going to stop foreclosures,"" says Sternberg. ""It’s saying we’re going to postpone the inevitable.""
*The Demand Problem
*
Fans of a freeze respond that it could actually aid home values, somewhat, by slowing the REO supply. A report last summer by the Congressional Research Service, for example, says: ""A moratorium on foreclosures may give state and local governments more time to remove vacant properties to try to support prices.""
But for that to happen, there needs to be buyers—and chances are, if you can afford to buy in this atmosphere, you’re staying put to see if prices have hit bottom yet. ""The demand right now is not such that it’s going to be able to soak up what’s available,"" says Sternberg. ""It’s not like gas, something we all need to get around. I don’t have to buy a house.""
If prospective buyers think that most troubled homeowners will still emerge from a moratorium in foreclosure danger or needing to sell cheaply—and the evidence from Massachusetts seems to prove just that—then the buyers will wait, with the perverse effect of driving prices further down—and foreclosures up. ""They know what’s happening,"" Veneziano says of would-be homeowners. ""They know that we’re going to have a backed-up supply three months or six months down the line, when a moratorium ends. What’s that going to do to valuex""
But even some moratorium proponents acknowledge that such a measure by itself probably isn’t enough to lift home prices. Economist Rosen advocates a moratorium as part of a larger plan that he says ""must focus on the housing consumer""; he’s also calling for looser housing credit and tax credits for buying new, foreclosed, or first homes.
*We Can Work It Out . . . Maybe
*
Could those measures do the trickx It’s hard to tell. So far, states and GSEs with moratoriums have concentrated on loss-mitigation measures rather than direct benefits for buyers. The trouble is, workouts just aren’t working. Last December, the Treasury Department released the results of a study that tracked the success of mortgage modifications made earlier in 2008. According to John C. Dugan, the Treasury’s Comptroller of the Currency, ""After three months, nearly 36 percent of the borrowers had redefaulted by being more than 30 days past due. After six months, the rate was nearly 53 percent."" The data, he said, was pretty constant throughout the rest of the year. ""Put simply, it shows that over half of mortgage modifications seemed not to be working after six months,"" he said.
And that’s in the cases where workouts are possible. When it comes to modifications, the servicers don’t have the type of latitude people think they do, Sternberg says. Lowering the principal and dropping the interest rate ""are not things they can do without the permission of the investor,"" he says. Alt found that to be the case in his daily work, too. ""What we saw were people wanting to sell their home at the current value and not being able to do it because the investors wouldn’t or couldn’t approve taking that big of a loss on their investment,"" he says.
And if you can modify the loan to an amount the borrower can afford, that’s no guarantee the borrower will still accept the new terms. Even if you’re talking about major principal reductions—which nobody is—the borrower can still find himself in big-time trouble on a modified loan. ""What can you do when the house you financed (or refinanced) at $250,000 is now worth $150,000x"" asks Alt. ""It won’t matter what kind of recovery you have over the short term, it won’t be enough to make up the lost ‘value’ of the home. Unless the investor writes down the loan to the current value, you can’t do a loan modification or refinancing; if it forgives part of the debt under IRS rules, the borrower would have taxable income of the $100,000 you wrote down and of course no money to pay those taxes."" Out of the frying pan, into the fire.
*Outside Economic Problems*
Another reason loan modifications aren’t working—and a moratorium probably won’t, either—is that the mortgage crisis has been overtaken by other factors in the economy. Sky-high unemployment is creating more distressed homeowners every day and making it nearly impossible to stay afloat once they’ve defaulted. ""Where we’re going with unemployment, I’m not sure any moratorium can help,"" Veneziano says. ""If you don’t have a job and can’t pay, does it matter what the value of your home isx""
Gainfully employed borrowers might be stinging, too, from other borrowing habits. ""It’s the consumer debts that are also out of control,"" says Alt. ""Unless you can eliminate the credit cards, or settle those debts for less, there simply isn’t enough money in most people’s budgets to stay in the home and stay ahead of their total debt situation."" Job losses, a weak dollar, and lower overseas demand for U.S. goods are likely to keep Americans’ earning power down—and their credit balances up—for the duration. And that’s not all, Alt says: ""Add in families having more kids, the car gets old and needs to be replaced, illnesses, et cetera, and it becomes a monster problem that keeps getting bigger.""
So, even if a foreclosure freeze could shift supplies and home values, outside forces might mitigate those effects. ""The government can’t solve everyone’s problems,"" Alt says. ""What will they do nextx Give me back the 30 percent I lost in my 401(k)x""
*Killing the Industry
*
Finally, there’s the effect a foreclosure freeze would have on the REO industry as a whole. ""One thing not mentioned too much is the number of businesses that will go under because they relied so heavily on the steady volume all have become accustomed to—smaller attorney and agent shops,"" Alt says.
That attrition has a three-fold effect: First, it will create the need for mass layoffs industry-wide. ""In a 90-day across-the-board moratorium, most firms will fail or end up laying off perhaps 50 percent or more of their staff,"" Alt says. ""Mortgage companies will lay off people; we already saw the bankruptcy of LandAmerica Title a few months ago because there isn’t any closings and title business being conducted.""
Second, the industry’s stumbles will send ripples throughout the economy: The foreclosure attorney gets laid off; she stops using childcare, so the babysitter loses her job; she buys fewer groceries, gas, and the like, and so on down the line. Maybe she even defaults on her mortgage.
That’s bad enough. But once the small servicers or their staffs are purged, what will happen when a moratorium is liftedx ""Now you’ve got a glut of foreclosures,"" Veneziano says. ""Clerks and bailiffs that are really backlogged. Everyone’s buried. What do you think the volumes are going to be after thatx""
*Picking A Villain*
With potential downsides like these, why is a moratorium on foreclosures still being taken seriouslyx REO professionals say it’s because the recession is an unfolding melodrama—and every drama needs its heroes. In this story, the politicians are the heroes, swooping in to save the little guy who’s in danger of losing his house. ""Doesn’t the concept sound really goodx"" says Veneziano. ""No filings of foreclosures for six months. Doesn’t it sound greatx""
But such stories need villains, too—and REO professionals make easy targets. ""We’re the bad guy,"" Veneziano says. ""We’re absolutely the bad guy in this—always have been."" Sternberg agrees, but after 35 years in the real-estate business, he understands the primal tendencies that take over when things go bad. ""When your back is against the wall and the wolf is at your door, it’s the natural tendency to blame the wolf,"" he says. ""There’s plenty of blame to go around. But in the final analysis, we’re the wolf.""