The US loan-mod fail

By Felix Salmon
January 28, 2010
two-part blog entry on the state of the mortgage market, and it only reinforces my belief that the crisis isn't over and that both the housing and the banking sectors are going to get much worse.

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Mike Konczal has an excellent two-part blog entry on the state of the mortgage market, and it only reinforces my belief that the crisis isn’t over and that both the housing and the banking sectors are going to get much worse.

Konczal describes the government’s HAMP loan-modification program as “a long, stressful process which appears to leave nobody better off”, and highlights this chart:

foreclosures_closed.jpg

The key thing to note here is the bottom, darkest line: while delinquencies and initiated foreclosures have been rising, there’s a limit to how many foreclosures can actually be completed, and that limit seems if anything to be falling.

What this says to me is that while we aren’t going to see a wave of foreclosures, we are going to see a large and more or less constant number of foreclosures for the foreseeable future — with all the gratuitous value destruction that implies.

Konczal also looks long and hard at the banks’ refusal to write down the principal on their loans, despite the fact that if you modify a loan so that it remains seriously underwater, you’re pretty much guaranteeing an extremely high redefault rate. After all, negative equity is pretty much the best single predictor of delinquency.

Why are the banks behaving like this? I think the obvious answer is the right one: they’re holding these loans on their books at much more than they’re really worth, and they can’t afford to take the write-downs which would accompany principal reductions of roughly the same magnitude as the decline in housing prices. This kind of head-in-the-sand behavior can only possibly work if housing prices suddenly rebound in the next couple of years, and that ain’t gonna happen.

Both the Bush and the Obama administrations tried to put together programs to deal with the banks’ toxic residential real-estate assets: the original TARP was one, the PPIP was another. Neither went anywhere, and as a result the problem is just as bad now as it’s always been. Remember that, when you look at the enormous 2009 bank bonuses, and ask yourself whether any of them will be clawed back if it turns out that last year’s profits were dwarfed by the write-downs that banks should have taken and didn’t.

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