Coauthored by Harold Simon
The heat wave may have broken, but the news is still hot on the latest scheme to deal with underwater mortgages: getting them from the lenders through eminent domain in order to modify them and keep people in their homes.
The idea began to germinate at least a year ago, when dollars were piling up to buy nonperforming mortgages, but the pipeline had slowed to a trickle. Money always needs someplace to go. And so the keepers of that money came up with a clever way to get to those mortgages: have local governments force the lenders to sell.
Something certainly needed to be done. Washington, while playing an important role in resolving the crisis, was by many accounts being far too slow and far too timid in its interventions. As the foreclosures piled up and home prices tanked, more and more people became underwater. Those 11.4 million residential mortgage holders who owed more than their home was worth accounted for about 23.7 percent of all outstanding loans, according to CoreLogic, which tracks the mortgage market. Most of them would have to wait a long time, if ever, for their homes to again be worth as much as the balance of their mortgages. And as a predictor of default, being underwater ranks way up there along with illness and job loss , raising the specter of even more foreclosures on the way.
So it was a big problem begging for a big solution. One of the ideas that drove the late Steve Jobs was to simplify. Get as close to the essence of something as possible and don't build things that stand in the way of people getting to that. The eminent domain solution does sound simple -- though there are some serious critiques of doing it through a middleman company that stands to earn high profits and skim only the profitable properties. Either way, there's a question of whether the idea will survive all the controversy it has stirred and legal challenges it will face to actually get implemented. And, as all the words that have already been written about it attest, it has certainly stirred controversy.
But while that controversy rages, let's not fall into the trap of assuming that eminent domain is the only possible answer.
The easiest approach is still for the lenders themselves to just reduce the principal owed to them, bringing the mortgage in line with the homes' current value, as advocates and others have long urged. We know that lenders and servicers have been loath to go that route. The servicers have had incentives to bring a defaulted mortgage to foreclosure (plenty of fees, no complaints from investors), and the trustees of the securities into which slices of so many of these mortgages had been bundled have waved their PSAs (pooling and servicing agreements, the rules of the road for each package of mortgages) in the air yelling, "It won't let me do it!"
Fannie Mae and Feddie Mac, which control about 40 percent of the outstanding mortgages, along with the federal HAMP program and others, have been working to realign servicer incentives to prevent instead of promote foreclosures. And it turns out that the PSA problem is, to borrow another Silicon Valley concept, vaporware.
In an interview we conducted with Ron Faris, CEO of Ocwen financial, one of the nation's largest subprime mortgage servicers, he said that only about 5 percent of PSAs restrict principal reductions. The rest just require that the modification be in the best interest of the investor. A simple calculation would show that it is almost always better to keep homeowners in their homes, paying their mortgages at a reduced rate, than going all the way to foreclosure, leading Faris to claim that they are not only allowed to conduct principal reduction modifications, but arguably they are required to.
Much of the industry seems to have heard Mr. Faris. According to Amherst Securities Group, principal reduction occurred in about 25 percent of portfolio loans modified in Q4 '11, up from 18 percent the year before. On loans held in securities, eight times as many got principal reduction modification as the previous year (16 percent compared to under 2 percent). This year, they say, the rate could be 40 percent. Amherst reported that principal reductions had a significantly lower rate of redefaults than other kinds of modifications -- two or more times better in some cases. There's a ways to go, but it clearly works.
Ocwen and others are reducing the loan to a bit below current value, allowing the borrower to once again have some equity. To make investors feel more comfortable, Ocwen's modified mortgage splits later appreciation, if there is any, between the borrower and the lender. That same concept is in the recent legislation introduced by Sen. Robert Menendez (D-N.J.).
Another clever program has been launched by the Mortgage Resolution Fund out of Chicago (not to be confused with Mortgage Resolution Partners, the eminent domain group). This nonprofit is leveraging Hardest Hit Funds to buy pools of mortgages and modify them itself, with the help of intensive housing counseling. The program could reach into the billions of dollars and modify thousands of mortgages. The kicker? It doesn't require subsidy, only patient capital. At the end of the day, Treasury, where the Hardest Hit Funds come from, will get its money back. The program is underway in Illinois and will soon travel to other states. Similar programs are being tested in Arizona and Oregon (using short sales).
None of this is easy. And the eminent domain route may in fact result in the best and biggest solution. But it won't be the fastest. While the idea climbs the judicial ladder, for-profits and nonprofits around the country are coming up with their own clever strategies ... and actually doing them.
Harold Simon is the executive director of the National Housing Institute and publisher of Shelterforce.
Miriam Axel-Lute is editor of Shelterforce, a national magazine on community development and neighborhood revitalization. Based in Albany, N.Y., she is a board member of the Community Loan Fund of the Capital Region and the Community Development Alliance of the Capital District, and an award-winning columnist for the alt-weekly Metroland.