How to make mortgage relief work

By Felix Salmon
September 8, 2011

One of the problems with mortgage modifications, the way the big banks do them, is that they tend not to work very well. Borrowers who were underwater stay underwater; often their total amount outstanding goes up rather than down. The amount of time and effort expended by both borrower and lender is enormous, much of it duplicated due to bad document management by the banks, and policies requiring borrowers to get at least two modifications — one for a “trial period” and then a second, permanent one. Redefault rates are very high.

In that context, it’s easy to see why banks would shy away from expanding such programs even further: they’re clearly broken, after all, and even if they help borrowers (which isn’t clear), they certainly don’t seem to be helping the banks.

Which is why it’s encouraging to have seen a couple of pieces in recent days showing that well-designed programs for delinquent borrowers really can work, and work well.

First came James Orr and Joseph Tracy at the NY Fed, talking about government programs to lend money to laid-off workers so that they could meet their mortgage payments while unemployed. One program, in Philadelphia, has seen fully 80% of participants remain in their homes and pay off their loans in full. Here’s the key:

An important aspect of HEMAP’s screening process is evaluating the homeowner with respect to the reemployment prospect. In Pennsylvania, this is done on an individualized basis.

As any community banker will tell you, loans perform much better when you have an individual, human relationship with the borrower — something big national banks find hard to do, but which smaller banks can be quite good at. Ruth Simon today has the story of Webster Bank:

Webster is doing a good job at servicing its loans,” says Connecticut Attorney General George Jepsen…

At Webster, “you can actually reach a person,” says Martha Ross, a housing counselor with Neighborhood Housing Services of Waterbury, Conn…

Just 1.84% of the mortgages serviced by Webster were at least 30 days past due but not in foreclosure as of June 30. The U.S. average is 8.15%…

When it restructures a loan, Webster usually waives late fees, penalties and unpaid interest instead of adding them to the loan balance—and putting homeowners deeper in the hole. Borrowers don’t have to make months of trial payments before the modification is made permanent…

Employee bonuses are tied partly to the number of modifications…

“We try to figure out what can a customer afford [in order] to stay in the home—and are willing to make it happen,” says Webster Chief Executive James C. Smith, whose father started the bank in 1935.

The lesson here is pretty clear: individualized attention from staffers empowered to make individually-customized decisions pays enormous dividends. I can see how the risk-management types wouldn’t like it, or the Type A personalities wanting to run the bank and be in full control of everything. And that kind of system also doesn’t scale well: if you’re growing your mortgage-servicing department at the rate at which banks like BofA are growing theirs, an organization like this would be putting enormous responsibility onto brand-new and untested employees.

But the right thing to do here is known, and is, in theory, implementable. I just fear that the big banks are constitutionally incapable of adopting it.

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