Lehman’s indefensible mortgage modifications
In the standard narrative of the mortgage crisis, there were prescient bears who got it right, and then a head-in-the-sand majority which missed what was going on until it was too late. But in a fascinating article about a lawsuit against former Lehman subsidiary Aurora Loan Services, Kate Berry of American Banker shows that it’s a bit more subtle than that.
A large part of the bear case, when it came to mortgages, was that there was a huge number of adjustable-rate mortgages whose “teaser rates” were going to expire, landing homeowners with massive monthly payments they could never afford. In reality, however, the notorious “exploding ARMs” didn’t explode at all. And now a chap named Andrew WeissMalik is suing Aurora because his ARM didn’t explode, and he wants all the benefits that should have come his way as a result of his interest payments going down.
It turns out that in July 2008, Aurora wrote to WeissMalik — he says he never got the letter — telling him that they were going to modify his loan, and that it would lock in his teaser rate of 5.875% rather than let it explode. He didn’t need to do anything to accept the offer, he just needed to keep on making his monthly payments. Which he did, and his rate stayed at 5.875%, rather than falling as low as 2.625%, as it would have done had the loan not been modified.
Aurora certainly didn’t make it easy to opt out of this modification, which WeissMalik claims has cost him some $20,000:
The form letter, which WeissMalik eventually obtained, says that “we will assume that you have accepted this offer if you make two on-time payments following your adjustment date at your current, unadjusted monthly payment amount.”
The letter describes only one way to decline the offer: it told borrowers that if they did not make the two required mortgage payments, the servicer “would assume that you declined our offer and we will adjust the interest rate and monthly payment as provided in your mortgae note.”
“To reject Aurora’s ‘offer’ for modification,” Davidson said, “WeissMalik would have to be required to default on his mortgage loan … thereby damaging his credit score and putting himself at risk of other adverse risks of nonpayment.”
There’s a malign view of what Aurora did — which is that it could see the writing on the wall, reckoned that the Fed would be forced to slash interest rates in order to save the economy, and therefore locked in the teaser rates before they fell sharply. I don’t buy that entirely.
More likely, I think, is that Aurora knew that its borrowers couldn’t afford to see their interest rates explode, and had no ability to refinance. So it decided to just keep them on their teaser rates instead, on the grounds that it would have many fewer defaults that way. And because it was an incompetent Lehman Brothers subsidiary, Aurora failed to modify the loans in a legally or ethically defensible way — even if its heart was in the right place.
Still, I don’t think Aurora has a remotely colorable defense in this case. I wonder how many other people accepted the modification and don’t even know how much money they’ve lost as a result.