Commentary

Mortgage Rescue Fails Miserably

The real estate market is still in very bad shape. The relentless slide in home prices that started after the housing bubble burst is wreaking havoc on recovery efforts aimed at stabilizing the real estate market. According to Bloomberg.com, 20.4 million of America’s 93 million homes (which encompasses houses, condos and co-ops) are saddled with mortgages that are worth more than the value of the properties backing the loans. In addition, mortgage rates have been creeping up over the past few months, from a historic low of 4.78 percent in April, to just under 5.5 percent last week, reducing affordability at the worst possible time. Just this week, the Mortgage Banker’s Association reported that U.S. mortgage applications dropped the most since February of this year, plummeting by 19 percent. And, the economy shed another 467,000 jobs last month, bringing the unemployment rate up to 9.5 percent, meaning that more Americans will be late on their mortgage payments, and closer to default. The Obama administration is trying desperately to stem the downward spiral of real estate prices by allowing homeowners to restructure the terms of their mortgages. The problem is that these efforts are not working very well because they are focused much more on reducing monthly payments than on principal adjustments that reflect the true state of home prices. (For all of those real estate boosters out there, patiently waiting for a bottom and a quick rebound, all I can say is: Don’t hold your breath!)

The financial website, Calculated Risk, posted a pair of articles this week about mortgage delinquencies, derived from a recent report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision. Calculated Risk acknowledged some improvement on the mortgage modification front, but summarized the report’s troubling findings with regard to prime mortgages (which make up the bulk of overall home loans), as follows:

“Continued economic pressures, including rising levels of unemployment and a continuing decline in property values, resulted in an increased number of seriously delinquent mortgages and newly initiated foreclosure actions. This report covered over $34 million loans, equivalent to over $6 trillion in mortgage balances. The first quarter data also showed a relatively greater increase in seriously delinquent prime mortgages compared with other risk categories and a higher number of foreclosures in process across all risk categories as a variety of moratoria on foreclosures expired during the first quarter of 2009.”

Calculated Risk also presented the various types of modifications made, in percentage terms, to mortgages as part of the Obama administration’s efforts to save homeowners from defaulting on their loans.

“Of the modifications made in the first quarter of 2009, 70.2 percent included a capitalization of missed payments and fees, 63.2 percent included a reduction in interest rate, and 25.1 included an extended term. By comparison, 12.6 percent of the mortgages received modifications that froze the interest rate, 1.8 percent included a reduction of principal, and 1.1 percent included a deferral of principal.”

The disturbing conclusion from this report is that missed payments and fees are being added to principal amounts, leaving homeowners with greater amounts of negative equity, and increasing the likelihood that more people will walk away from their homes. (Calculated Risk notes that approximately 30 percent of modified loans re-defaulted a quarter after loan adjustments were made, and close to 50 percent did so within a year.) Although some would argue against reducing principal amounts due to the downward pressure it would exert on home prices, I believe that inflating mortgage balances through the capitalization of missed payments and fees will cause more defaults and foreclosures than a reduction in principal. The increase in negative equity could encourage more homeowners to sour on the concept of ownership, and cause a flood of cheap homes to hit a weak real estate market, putting even greater downward pressure on prices. This can easily induce a vicious cycle, pushing still more homeowners to walk away from their mortgage obligations – and it will put further strain on the lending institutions holding these mortgages, forcing them to write down the value of the loans on their books, increasing the need to raise more capital and decreasing the availability of credit to the real estate market.

The Obama administration’s efforts to stabilize the housing market are focused on affordability, a short-term issue, which can be easily accomplished by lowering the interest rate charged or extending the term of the loan. Those modifications are helpful, but a reduction in the amount of principal would do more to help keep owners in their homes. If homeowners think they will never recoup their investment, why bother paying the mortgage? Why not default and live with your in-laws? The affordability strategy put forth by the White House is a short-term fix that is already starting to fail. Lenders made huge mistakes by extending excessive amounts of credit to those least deserving; they also created dubious, and in many cases, criminally complex mortgage products that stressed short-term affordability over the long-term prospects of repayment. Now those lenders need to swallow a reduction in the principal amounts of many of these troubled mortgages that were peddled with reckless abandon over the past few years. Without this unpleasant adjustment, the real estate market and the financial system will be in for even more trouble, reducing the chances of a a sustainable recovery.

Here are the links to the Calculated Risk articles quoted in this piece:
OCC and OTS: Prime Delinquencies Surge in Q1

Modifications and Re-Default

And here is a link to a great article on HUD’s new efforts to address negative equity from Bloomberg.com:
Fannie, Freddie to Refinance Larger Underwater Loans

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