Felix Salmon

Lehman’s indefensible mortgage modifications

By Felix Salmon
February 10, 2011

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.

5 comments so far | RSS Comments RSS

Incompetence is more common than fraud, especially since most of the top employees can’t see beyond their next bonus.

Posted by TFF | Report as abusive

Felix: you’re giving them too little credit. Your argument requires that these banks realize losses back in 2008 in the hopes of reducing future losses. If they are ok with such a strategy, then they wouldn’t have fought so hard against “mark to market”. (There is also possible opportunity cost: if they foreclose, they could potentially find a better buyer.) Also, if this is such a great thing for customers, they would have explained it clearly instead of using marketing trickery.

Posted by junkcharts | Report as abusive

First, The Bank’s heart was in the right place. The … Bank’s … Heart. Yes. Of course.

Moving on, I think this article mis-uses the term “teaser rate” – it doesn’t look like WeissMalik had a “teaser” i.e. a rate that was lower than a normal 5/1 ARM rate than would then adjust up to a normal 5/1 ARM rate after a few months – he just had a 5/1 ARM, and his interest rate would start floating after 5 years.

Unlike Option ARMs, Neg-Am mortgages and ARMs with real teaser rates, 5/1 ARMs aren’t that complicated or exotic. It’s pretty obvious that the bank took advantage of the mortgage chaos to keep their income high. If their little gamble on the Fed rate hadn’t worked out, they could have simply sent out another “notification letter” saying that the rate would float again, just keep making your payments if you agree , etc. etc. and on and on.

Posted by wah718 | Report as abusive

I’m big on signed contracts, especially for deals running tens of thousands of dollars…

A tacit opt-in on a mortgage modification? They don’t have a leg to stand on.

Posted by TFF | Report as abusive

It’s technically wrong that he had to default to reject the modification. He could have chosen to make the payment based on the adjustable payment and not the fixed rate Aurora was offering. That said any agreement that does not require signed consent is bad law and should be illegal.

Posted by Sechel | Report as abusive

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