Some more thoughts on how to fix the housing crisis
Here is the smartest thing I've read yet about how to stabilize the housing market through loan modifications. If you want the short version, check out the testimony Columbia Business School's Christopher Mayer gave in front of the House financial services committee on Tuesday.
The argument, made with colleagues Edward Morrison (from Columbia Law) and Tomasz Piskorski (from the B school), comes in two parts: 1) Loan servicers don't have the right economic incentives to modify loans, even when it's in the best interest of investors, so we should use TARP money to incent them; and 2) Servicers are still a little afraid of getting sued by investors, so Congress should pass a law to protect servicers from lawsuits if they act in the overall best interest of investors.
To address the first:
We propose that servicers of privately securitized mortgages be paid a monthly Incentive Fee equal to ten percent of all mortgage payments made by borrowers, with a cap for each mortgage of $60 per month ($720 per year). The servicer would also receive a one-time payment equal to twelve times the previous month's Incentive Fee if the borrower prepays the mortgage, rewarding servicers that accept short sales... By paying an Incentive Fee only when borrowers make payments, we reward successful modifications. A servicer whose loan modifications are unsuccessful and result in a quick re-default would collect few Incentive Fees. Our proposal, therefore, rewards servicers for keeping future payments as high as possible without putting the homeowner in a position where he or she is likely to re-default soon after modification.
In other words, they want to set up a system that has the same set of incentives as mortgage-related securities held directly on banks' books, which are being modified much more frequently than those in private securitizations. They figure this would cost $9 billion.
To address the fear of lawsuits (which, I know, I was dismissive of the other day), they propose temporary legislation that, they insist, would pass muster under Supreme Court case law. Most servicing agreements allow for pretty free-ranging modifications (partly why I was being so dismissive), but in the few cases where the new law genuinely steps on the contractual rights of certain investors, the government could use TARP fund to compensate them. They figure that would cost no more than $1.7 billion.
Couple those two ideas with the earlier proposal Mayer made with Columbia Business School dean Glenn Hubbard to drum up demand among buyers by docking interest rates on new home loans, and we seem to have got ourselves a plan. Or at least they do, for us.
The one thing you might notice lacking is a change to bankruptcy law to allow judges to revise mortgage terms. Mayer finds that deeply problematic, wrought with perverse incentives for home owners and servicers alike, potentially ineffective modifications, and a long-term reduction in the number of people likely to be able to buy a home.
To me, this makes much sense all around. I'm not convinced that $720 a mortgage is enough of a carrot (even though Mayer et al go through the math to show why they think it is), but the structure of the incentive is still smarter than other ideas we've heard, where the reward for modification isn't linked to its ultimate outcome.
As for the legal half of the proposal, I like the admission that most servicing agreements already allow modifications. We can stop saying that investors in the aggregate are the problem. And then there's that wonderful twist, where they don't let the potential nullification of a few contracts hold up the entire process--simply pay those people off. What an elegant solution.
Barbara!
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1
Just so I understand, let's pretend that any excess money I have goes to saving for my three children's education, so if the government takes $500 away from me, that is $500 less that I have for my kids college.
The plan above would take money from me and my kids and pay loan servicers extra money to perform a service that they are suppose to be doing anyway so that people who bought houses they couldn't afford can pay back wealthy investors who didn't care who got loans.
Do I (and my kids) have that mostly right?
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2
rather than giving more money as an incentive to the people who screwed this up in the first place (and who should apparently be renegotiating mortgages), why not increase the disincentive to NOT modifying mortgages on securitized loans -- specifically, create guidelines under which mortgages should be modified and by how much, and make the servicers liable to the investors should they not act in a manner consistent with those guidelines and the investors get hurt.
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There are two ways of creating (dis)incentives -- one costs taxpayers money, the other doesn't. Unfortunately, the people who come up with the solutions tend to be "experts" with strong ties to the financial/banking/mortgage/real estate industries, and tend to offer ideas that will keep those special interests happy -- but at the taxpayers expense.
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Barbara!, it would be interesting if you could expand on what the current law regarding modification of securitized mortgages is -- for instance, when a mortgage is modified, can the pain be distributed across traches, or do those in the riskiest traches bear the full burden? (in fact, that would be a great 'explainer' piece for the managize!)
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for instance, you use the word "servicers", which to me usually means the people who collect, distribute, and keep track of the mortgage payments, etc. Is that separate and distinct from those who marketed the securities containing the "serviced" mortgages -- and how does that impact the potential for lawsuits? (While the law may allow for mortgages to be modified, those who marketed the securities might be liable to those who sustained losses based upon how the securities were represented.) -
3
I completely understand where you're coming from, rrsafety. So little of this is fair to people who have consistently made prudent financial decisions and never looked to the government for a bailout. I guess the best I can say is that it's in everyone's interest to stem grave problems in the housing market, not just to stabilize property values more broadly, but also to re-introduce some sense to the mortgage-related securities built on top of them. It looks like Bank of America is going to get billions of dollars more from TARP. I have a bad feeling that if we don't spend money at the level of individual mortgages, we'll just wind up spending it--and maybe more--somewhere else. That's not to say it's not a crappy situation all around. It definitely is.
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@plukasiak: Use a stick instead of a carrot, eh? I like it. I'm guessing, though, that creating guidelines, figuring out who isn't following them, and then taking legal action, would take a whole lot more time, on top of all the months already spent dilly dallying on the foreclosure issue. One thing I should be clear about: this plan is for third-party servicers, so not companies that originated loans and then kept them on their books. Those folks already have an economic incentive to reduce losses; this plan is meant to replicate that incentive in situations where you've got a middleman making the decisions.
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The current law regarding how losses are spread among investors hinging on the serviving agreement that dictates the terms of each securitization. Most agreements are pretty vague on the issue of modifications--the agreements weren't written with the current situation in mind. Under those agreements, it shouldn't be too hard to modify, although, yes, investors in the riskier tranches do probably get hit first. But I don't feel too bad for them--that is, the people who knowingly bought the *riskier* tranches. The problem comes about in the minority of of servicing agreements where there are limitations on the number and type of modifications. Since those contracts would necessarily be ignored, the government would compensate investors, in order to preserve some sense of fairness in contract law. This will likely prove important the next time someone in our economy needs funding and makes some promises to investors in order to get it. -
4
I'm guessing, though, that creating guidelines, figuring out who isn't following them, and then taking legal action, would take a whole lot more time, on top of all the months already spent dilly dallying on the foreclosure issue.
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well, the guidelines themselves shouldn't be a problem -- First, the principle should be adjusted to reflect current market value, with the proviso that if/when the house is sold for more than the current value, the holders of the securities are made as whole as possible. (Restrictions on refinancing/second mortgages would also have to be included.) Second, the adjustment only takes place if the mortgage holder can afford to pay the mortgage at the "adjusted" price with a reasonable (fixed?) rate of interest -- no point in adjusting a mortgage for someone who can't make the payments.
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after that, what happens is really none of our concern -- if the servicers don't follow through, then the investors can sue, and they can fight it out in court.
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I also think that legislation should be passed that spreads the pain of modified mortgages (as opposed to foreclosures) around somewhat -- that the first trache should take 5% of the hit of any losses, the second trache 10%, the third 15% the fourth 20%, and the riskiest trache should see 50% of those losses. IMHO, the existence of the investment vehicle that created the safest traches was dependent upon the creation of the riskiest traches, and for that reason no one who invested in these instruments should get out completely whole. -
5
Pluk, we are on the same wavelength on this one. Modification to payable levels combined with an equity upside position for the mortgage holder makes sense.
Barbara, I understand your point, but the scheme you highlighted seems particularly insulting to the taxpayer. The security holders should all be taking there 30-40% hit and the servicers should be trying to do modifications. It doesn't make sense that I should pay for it. I'd rather have bankruptcy judges cram these down rather than me pay.
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6
@rrsafety: The investors *would* be taking a hit. Just less of a hit than if the house slips into foreclosure. The reason I like this plan, and called it elegant, is because it quickly creates a simple economic incentive to align investor, servicer and homeowner interest. I am still, despite everything we've witnessed, a big believer in the potential power of market forces. Set up the incentives correctly (correctly being a very important word) and you get a much nimbler, more efficient process than you could ever hope to achieve by dictating a long list of rules about what should happen when.
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7
Barbara,
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You are absolutely right. The rules, once legalesed, may come out have unintended consequences. There are any number of rules and regulations that have been interpreted *creatively* by the courts.
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8
You are absolutely right. The rules, once legalesed, may come out have unintended consequences. There are any number of rules and regulations that have been interpreted *creatively* by the courts.
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imho, its more difficult to create a fiscal incentive that won't be abused than to write regulations that provide "market" disincentives to bad behavior. And while its true that regulations can be badly interpreted by courts, its a lot easier to revise a regulation to make sure the courts interpret them properly than to change payout schedules, etc.
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And lets not forget that any such payout/fiscal incentive would have its own, likely highly complicated, set of regulations. so lets just cut out the middleman (us, the taxpayers) and let the market work through negative reinforcement!
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9
Sheila Bair at FDIC has been very active in clarifying that mortgages within securities can be modified. See the FDIC "Mod in a Box" program
http://www.fdic.gov/consumers/loans/loanmod/FDICLoanMod.pdf
This recent speech from Bair is also interesting
http://www.fdic.gov/news/news/speeches/archives/2008/chairman/spdec0408_3.html -
10
thanks dumde...
The only problem I have with Bair's proposal is that it puts the determination of the cost of foreclosure at the end of the process -- in other words, the servicer determines how to modify the loan, then decides if modification makes sense to the investors.
I think that determining the costs of foreclosure should be the first step, not the last. This is especially true because Bair allows for modifications that do not "fit" the formula devised -- that decision has to rest on the cost of foreclosure.
I also didn't see (might have missed it) a provision regarding investors having a right to recover their losses if the home is sold "at a profit". In general, the only equity stake that the mortgagee should get if the home is sold is money they put into the house (this would include not just mortgage equity, but capital improvements like a porch) -- they should not realize additional profits from the stabilization of the housing market unless and until the investors who lost money are made whole.
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11
Folks, the housing crisis is a symptom of the real problem.
If you want to verify it for yourself, go to http://www.KeepAmericaAtWork.com and download the free report that shows how we did away with over 1 million jobs from 2001 - 2007 that paid an average of 96,000 per year and replaced them with the same amount of jobs that paid an average of 34,000 per year.
This is the cause of the housing crisis.
The numbers don't lie and they were taken directly from the BLS (dept of Labor) numbers and I'll be more then happy to show you where they are located at so that you can verifiy them for yourselves.
- TIME See how states are waging war against the Asian carp | http://su.pr/2AeqoE - 52 minutes ago
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