It’s tough to modify your way out of a hole

July 14, 2009

jamessaft1(James Saft is a Reuters columnist. The opinions expressed are his own)

If you thought the U.S. housing crash could be blunted if only lenders would cut delinquent borrowers a break, it is perhaps time to move on to another vain hope.

That’s right, the loan modification movement – pushed by the U.S. administration and others as a means of keeping non-paying borrowers in their houses, keeping those same houses from flooding the market as foreclosures, and even helping beleaguered lenders – is running into a reality-shaped wall.

An exhaustive study of loan modifications by economists at the Boston Federal Reserve, under which delinquent borrowers are given lower rates, more time, or even cuts in the principal amount owed, showed fundamental problems with the way that idea works when put into practice.

Looking at data that covers about 60 percent of U.S. mortgages the authors, Manuel Adelino, Kristopher Gerardi, and Paul S. Willen, came up with two important conclusions.

First, securitization, whatever its other shortcomings, is not an important factor in stopping loan servicers from cutting deals with delinquent borrowers.

Second, and even more importantly, lenders don’t renegotiate for a simple, unanswerable reason: it is not in their best interest financially.

Virtually every rescue plan in the U.S. since the crisis began in 2007 has been in part a loan modification program, the most recent being the Making Home Affordable plan the Obama administration unveiled in February.

The thinking is that, as a foreclosure can cost the lender between 30 and 50 percent of the value of the loan, deals can be struck with borrowers for a lot less than that leave everyone better off.

Sadly, very few loans are being modified – only about 3.0 percent of delinquent loans – with many blaming securitization, which can make a loan modification toxic for one class of lender but beneficial for another.

Seeing as how securitization was part of the way finance spun of control and the bubble was inflated, this was a satisfying narrative, but a false one according to the Fed study. They found no significant differences in the rate of renegotiation among loans that were in private-label securitizations and those actually owned by the servicer doing the negotiating with the borrowers.


The real issue is that, in the vast majority of instances, banks are better off not modifying.

For one thing, about 30 percent of borrowers who become delinquent get back on track before foreclosure. Since its very hard to know which borrowers will become payers again, this implies that 30 percent of the money expended in modifying loans is wasted, at least from the lenders point of view.

Secondly, a huge percentage of borrowers who are given new improved terms go and become delinquent all over again. A whopping 40 to 50 percent of borrowers who get modified loans are 60 days delinquent again six months later.

For them, and for their banks, it is just delaying the inevitable, and expensive to boot, as falling property prices make putting off foreclosing and liquidating costly.

The implication is that unless the government wants to pony up much larger amounts of money to entice lenders to modify loans, we are not going to make much of a dent in the wave of foreclosures washing across the economy. This could be done, and possibly support house prices in the process, but at a very high costs.

The real issue is that there are too many houses for the supply of credit worthy borrowers. The re-default rate shows that, as does the low clearing price when banks sell foreclosed houses.

Housing needs to fall in value, less of it needs to be built, and more people should become renters. That is going to continue to eat away at bank capital and act as a drag on growth.

Beyond that, there is a real question about the long-term consequences of mass loan modification. If the incentives are there more borrowers will become selectively delinquent and fewer who become delinquent will in the end catch up with their payments. Why should they?

That means higher loan rates than would otherwise be the case.

The thinking behind loan modification has interesting parallels in the rest of the economy, where policy makers are following similar strategies for banks and corporate borrowers.

Rather than simply cutting back on leverage, probably via default, there seems to be a consensus for stringing struggling borrowers, and lenders, along, hoping that something turns up.

Ultimately, it seems likely that strategy is about as successful in the rest of the economy as it seems to be in housing.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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What housing crash prices are still above any long term average! Let housing get to 1995 levels then maybe talk about a crash. This is really about silly people being allowed to over invest in one asset class, let then suffer.
All expensive house prices do is take away from future consumer spending ( assuming pays are increasing at the inflation rate. More money spent on the mortgage less on consumption. ) They are not sustainable as we have found out. But thats no surprise they never were, just look at your history books.
Let property prices correct and the younger generation be allowed to enjoy the fruits of their labour. Stop taking on massive amount of national debt to support unsustainable assest prices for he silly generation

Posted by gd | Report as abusive

The house and land purchased is and always is backed by the federal government how they chose to do it based on the depth and breath which wallstreet lied to intiate a delusion that it was worth 3 times more than the value of the property that was agreed upon.

Posted by mike ward | Report as abusive

Good day Mr Saft. I believe what our oracle Mr Saft is saying is that all our governments are doing is pouring good money down the drain. To understand in laymans English, call it securitisation or whatever, the assets being propped up are not worth the large funds government are spending to prop up, but due to fear that the whole house may collapse what else can be done. It is amazing that all our so called respected economist and pundit can not call a spade a spade. The world is in recession, asset prices must crash, and if government want to do anything significant, buy up all this cheap homes and rehouse the homeless, and maybe in the next 20 years circle sell it back to the masses. What goes up must come down, vice versa.

Posted by P.Iggy | Report as abusive

Appears part of this article is more of a rant than a true investigation into facts. Your comments about 30 percent working themselves out without modification may likely be based in the past; however, given that many people are far upside down in their values, I argue that more are willing to go to foreclosure as a way out. All the scares about foreclosure being the ‘end’ and you are not likely to loan again for some time will likely vanish as possibly next year to clear inventory a lift on FHA guidelines governing the length of time a borrower can not borrow again after foreclosure.

More importantly, try not treating everyone like an idiot and research some more accurate data relevant to today rather than a mix of past figures applied to current conditions.

Posted by Mark | Report as abusive

Being from Florida in the U.S. and watching this melt down continue. The uneducated lead by the unwilling here have only pat to blame on this mess while on the news this very morning I watched as 250,000 U.S.$ homes were open bid at $500 U.S. What caused this problem? there are many reasons and no clear place to point the finger of blame ! while General motors is renamed Government motors and Yes!!! all those hugh bonus checks still flow. while everyone is busy blaming some one else and reporting that things are getting better when actualy the only difference is the color of the man in charge and the large size “and getting bigger” size of his cabinet as well as these Czars that go around all the set protocals set forth by the orginal framers of this great country! and All everyone else can do is say O my what a great job he is doing/ when he is adding fuel to this fire and fiddling while it’s burning around him

Posted by Charlie | Report as abusive

As I walk the streets of my neighborhood in Portland, OR, and see the prices people post on their for sale flyers, it’s painfully obvious that the market is nowhere close to a bottom. We shouldn’t be propping up the housing market, it is still unaffordable. There are still too many communities where two teachers at a local high school can’t afford to enter the real estate market while earning the prevailing wage in their profession.

What kind of community do you have when your teachers, firefighters, and police can’t afford to live there?

Let the housing market fall.

Posted by Josef | Report as abusive

You need to replace your portrait image by a smaller file. Currently the image weighs almost 2 megabytes, and takes several seconds to load in the page.

Posted by yr | Report as abusive

What Federal Government should do is acting more efficiently now and helping Main Street and middle class instead of Wall Street.
Unemployment rate is increasing, same as deliquency home loans and foreclosures. There is no sign of improvement at medium term.

Federal Government should take a bolder and heterodox action, coming with funds to help all homeowners to make up the difference between the market value and their mortgage value. This way Federal Government should force the banks to renegotiate all the loans, of course taking advantage that home loans mortgage are still low.
After this renegotiation, the homeowners and middle class will feel and see, immediately, money left on their pockets and will be able to return to consum and hopefully learning from previous mistakes, should start to save again.
There is no doubt that, in the long run, the price of houses will appreciate again. If the homeowners intend to sell it with profit, the Federal Government should tax properly to recoup the money disbursed before to stabilize the market.

Posted by Luiz A.P.Almeida | Report as abusive

The Federal government should be refinancing mortgages at about 3%, directly to home owners. Government should be loaning the banks’ and corporations’ money back to the citizens at sub market interest rates, instead of the other way around.

Posted by Aatos | Report as abusive

I am not an economist (I took two required courses in college and hated them both), so I’ll have to accept the conclusions of the Boston Federal Reserve. I doubt that they would say “people must lose their homes, so now we must move on before we make the situation any worse” if they didn’t mean it. That’s not really what anyone wants to hear, is it? It sounds so heartless, so very Republican.

The reality here in the US seems to be there’s going to be much more pain ahead for many, many families. One odd fact not truly appreciated by most outside observers is that the foreclosure crisis is not evenly spread throughout the country. I happen to live in a region that’s hardly been affected at all by the credit crisis. Oh, home sales have slowed a bit, but there hasn’t been a wave of foreclosures here. My region never had the hyper house inflation seen in FL, CA, NV, etc.

Of more concern to me is this notion of a “jobless recovery.” Can anyone please explain to me just what the h*ll that means? Who/what is recovering? How can there be a recovery without jobs? How can people afford to buy homes without jobs? How is the value of the stock market supposed to rise if people are unemployed? How do you a buy a car without a steady paycheck? How do you do anything without a job? I don’t profess to have any answers about how the USA digs itself out of this deep hole (ever hear of the decline and fall of a nation anyone?), but I smell a rat whenever I hear someone talk about a jobless recovery. Something doesn’t add up.

Posted by Bob Foster | Report as abusive

It looks to me like the solution is already in your article:

“more people should become renters”

And banks should become landlords. Question: Why don’t they?

PS. Funny comment on the size of the blog’s. If it were my picture I would switch to a low resolution. I am sure you don’t want the whole world counting the remaining hairs on top of your head.

Posted by Edmond Dant├Ęs | Report as abusive

Had the government not bailed out the banks, the biggest banks would have gone bankrupt, sold the mortgage securities for pennies on the dollar to smaller, better-run banks, and these banks would have had financial incentive to renegotiate with the borrowers. They could cut the payments in half and still make a good profit. This is what should have happened, but instead the government helped the banks at the expense of the borrowers. And now most people would be against the government equally helping out the borrowers. A shame.

Posted by jason | Report as abusive

The fed should NOT be giving these people ridiculously low 3% interest rates!

I agree on taxing the profits on houses that get bailed out, but the government I know will increase taxes on everyone, not just the ones who had the help, because otherwise it wouldn’t be “fair” to ask for money back…

We need to forget all this fair and equal crap. you do not have a RIGHT to a house, you do not have RIGHTS to healthcare, you do not have a RIGHT to a car, you do not have a RIGHT to internet, or tv or anything like that.

If you want those things, work for them. produce something useful or fill a role that society actually NEEDS, and you will be compensated for it.

That’s how the world works, and if Obama continues to mess with that, we will have more problems. Why should I work hard when the next guy gets the same stuff for doing nothing?

Posted by What are you talking about?!? | Report as abusive

About 2 years ago, a check I sent to my bank for a mortgage payment was misapplied to someone elses account. I found out when I received a “your payment is late, therefore we are beginning foreclosure” letter. By the time I called the bank, they had found the error and fixed it so I was no longer in foreclosure. (Although the fact I was once is foreclosure STILL shows up on my credit profile, even though I have repeatedly disputed it.) I wonder if I am in the 30% of homeowners who resolved their foreclosure without intervention?

Posted by kris | Report as abusive

James..In the first place why would anyone believe anything the FED has to say. They found “securitization is not an important factor in stopping loan servicers from cutting deals”. The ONLY way that conclusion could be reached is securitization was never part of what was studied.


Posted by steve | Report as abusive

from an insider: modified mortgages are going delinquent at astounding rates and being remodified. some folks who have 3% rates after first mod are demanding 1% rates and not paying until they are in f/c so that they will get it. some people seem to have entitlement issues and some simply just should be renters.

Posted by sandy | Report as abusive