Fed: Lenders Shun Unprofitable Mods

A ""new report"":http://www.bos.frb.org/economic/ppdp/2009/ppdp0904.pdf from the ""Boston branch"":http://www.bos.frb.org of the U.S. central bank warns that servicers have been reluctant to renegotiate mortgages since the foreclosure crisis started in 2007. No matter whether the workout takes the form of a payment lowering modification, capitalizing repayment plan, short sale, or deed-in-lieu of foreclosure, the ""Federal Reserve economists"":http://www.bos.frb.org/economic/ppdp/2009/ppdp0904.htm who spearheaded the research concluded that quite often, lenders expect to recover more from foreclosure than from a modified loan.
Using a detailed dataset from ""Lender Processing Services"":http://www.lpsvcs.com (LPS) of more than 650,000 residential mortgages, the researchers said they were able to document the fact that servicers have demonstrated a tendency to avoid workout scenarios over the last two years. The analysis showed that during this timeframe, lenders and their servicers performed payment-reducing modifications on only about 3 percent of seriously delinquent loans, and another 5.5 percent received workouts that did not lower payments.
The Fed paper also pointed out that this reluctance does not result from securitization, as many critics of the secondary mortgage market have purported. The researchers found that servicers renegotiate similarly small fractions of loans whether held on their own books or owned by a private securitization trust, calling the disparity between the two types ""neither economically nor statistically significant.""
According to the report, workouts for defaulted loans are unattractive to both lenders and investors for two primary reasons - the high risk that a borrower will re-default after a costly renegotiation, and the possibility that a seriously delinquent borrower will become current without renegotiation. The study showed that up to 45 percent of those borrowers that received assistance ended up behind again, while about 30 percent of delinquent borrowers were able to pull themselves out of default without their lender’s help.
The prevailing consensus among the administration and policy makers has been that concessionary modifications are the most, or possibly the only, effective way to prevent foreclosures.
The Boston Fed’s paper quoted the Congressional Oversight Panel as having written, ""Any foreclosure mitigation plan must be based on a method of modifying or refinancing distressed mortgages into affordable ones. Clear and sustainable affordability targets achieved through interest rate reductions, principal write-downs, and/or term extensions should be a central component of foreclosure mitigation.""
Indeed, most major policy actions implemented to date to combat the housing crisis have involved encouraging lenders, in one way or another, to renegotiate mortgage terms in order to reduce borrowers’ debt, the most recent being the Obama administration’s Making Home Affordable program. But even with government prodding and monetary incentives, the Fed research finds that lenders’ inclination to pass on renegotiations could thwart the success of federal mortgage relief programs.