REQUIRED READING: Do Moratoria Simply Delay The Inevitable?

Written by John Clapp
on February 04, 2009 No Comments
Categories : Required Reading

No fewer than four state governors have said they would consider it. President Obama made it a central part of his election campaign's economic platform. Freddie Mac and Fannie Mae have implemented their own, as have several financial institutions. And despite repeated calls from consumer advocacy groups for its adoption, the mortgage banking community has generally resisted it.

The ‘it’ in question is a foreclosure moratorium. As criticism ratchets up against the government for its failure to craft a comprehensive solution to housing-market woes, some mortgage professionals are wondering if the oft-rumored nationwide moratorium will, in fact, come to fruition.

The concept, that the government may force servicers to press pause on all foreclosure proceedings, has been met by tremendous skepticism from mortgage companies. A recent informal survey conducted online by National Asset Direct Inc. (NAD), a purchaser of performing and nonperforming residential assets, found that the majority of respondents (servicers, lenders and others in the real estate finance world) believe the impact of a moratorium – whether nationwide or state-level – would be either minimal or negative.

If the purpose of stopgap measures such as moratoria is to buy time to allow for more negotiation between lenders and borrowers, the questions that begs asking is whether states with longer timelines are doing a better job of preventing foreclosures than the states with shorter timelines, observes Matt Stadler, NAD's principal and chief risk officer.

"The answer is no," he says. "You don't see Pennsylvania, New York, Michigan and the like having more success, because they have that additional nine months to work something out. The problem is not having enough time; the problem is not having enough capacity."

As an example�
A look at recent state-level efforts may support the survey respondents' gloomy predictions. The state of Massachusetts essentially imposed a stay on foreclosures when its law changed last May, requiring lenders to issue borrowers 90-day right-to-cure notices before beginning foreclosure. The immediate results were positive, with foreclosure levels dropping.

But once the initial 90-day period expired, initial foreclosure filings jumped (a 465% increase from August 2008 to September 2008, according to RealtyTrac).

Austin King contends that the example of Massachusetts is reflective of poor-quality loan modifications more than proof that the moratorium-and-mod approach does not work. King is the national director of the Financial Justice Center belonging to ACORN, a nonprofit group that has a petition campaign calling for a 90-day national moratorium. He admits that implementation of a nationwide moratorium is probably not realistic, and the campaign instead serves as a "call to arms."

King adds that a moratorium is not, in and of itself, a solution, but rather a means for providing lenders and borrowers ample opportunity to arrive at meaningful and sustainable loan modifications. Steven Horne, president of specialty servicer Wingspan Portfolio Advisors, echoes that sentiment.

"Particularly in your shorter-timeline states, it is absolutely possible to foreclose faster than your loan resolution effort can keep up with," Horne says. "So building in a little more time can make sense, but the key ingredient there is, are you following up with effective loan resolution efforts or are you just giving the borrowers a free ride?"

King additionally cites the ACORN-endorsed Residential Mortgage Foreclosure Diversion Pilot Program in Philadelphia as evidence that moratorium-like approaches can prove beneficial.

The City of Brotherly Love instituted the diversion program last June, mandating that owner-occupied properties scheduled for foreclosure and sheriff's sale be reviewed by borrowers, servicers and the court before they are sold. Judge Annette Rizzo of the Court of Common Pleas told the New York Times last September that 230 of the 553 homes referred to the program were permanently removed from sale, and 200 postponed their sales for one to five months.

Still, if one looks at the historical example of foreclosure moratoria imposed during the Great Depression – as the Federal Reserve Bank of St. Louis did in its Review publication – an argument could be made that moratoria can result in more harm than good. Granted, the comparison is not a direct parallel, as most of the 27 states that imposed moratoria during the Depression did so in response to rising farm foreclosures, and examples of "blanket moratoria" were few.

The bank's report notes that loan availability was scarcer and interest rates higher in states that enacted moratoria. In other words, the burden was shifted onto future borrowers.

Loan mod fever
Several high-profile figures – from Federal Reserve Chairman Ben Bernanke to House Speaker Nancy Pelosi – have recently demonstrated a renewed sense of urgency in regard to tackling the issue of foreclosure. Although foreclosure has clearly remained on the government's radar for well over a year, mismanagement of the Treasury's Troubled Asset Relief Program and the automobile industry's struggle for government assistance seem to have distracted policy-makers from enacting meaningful change.

All the while, one possible foreclosure abatement solution – systematic loan modifications – has pressed on. Introduced originally by Federal Deposit Insurance Corp. (FDIC) Chairwoman Sheila Bair as a way to resolve problem loans serviced by IndyMac, the systematic approach has both inspired imitators and received criticism.

The government's intervention with Citigroup forced the company to adopt the strategy, and the government-sponsored enterprises similarly modeled their streamlined modification program after the FDIC's plan. Critics argue that a one-size-fits-all model is inherently inappropriate for modifying loans, as each borrower's situation is unique.

Wingspan's Horne says he's heard stories of blanket modification programs not factoring important considerations – like back taxes – into the equation.

"We've seen instances where borrowers have had a mod dropped on them and then a month later, we see a notice from the servicer that – even though their payment has just been reduced – it's now increasing by a larger amount because they're starting to escrow for taxes and there may have been a delinquent tax situation that's forcing them to catch up in a very short amount of time," Horne observers.

Regardless of where one stands on the issue of streamlined approaches, it is clear that loan modifications are viewed as one of the most appropriate tools in a servicer's loss mit kit.

The difficulty, as explained by Paul Koches, executive vice president of subprime servicer Ocwen, is in finding the "proper point where borrower affordability on a sustained basis meets at the pass with maximizing net present value to the loan owner when compared to the foreclosure alternative, which invariably involves a loss" and doing so in an efficient, scalable manner.

Ocwen reported in December that it was experiencing success with its "loan-by-loan" approach, with only 24.6% of its loans falling back into 60-day buckets six months after being modified.

Koches notes that Ocwen added a psychology department early last year, and the addition has helped the company's customer representatives determine several key factors that might otherwise be hard to pinpoint, such as the genuineness of a borrower's desire to stay in the house. The jury is still out, however, as to which specific modification has the best success rate.

"It's too early to tell whether there are material differences between interest-only modifications versus interest plus other components, such as principal reductions," Koches says. "But we are tracking that, and thus far, the data seem to be in sync. They're about the same in continuing-performance statistics."

Principal reductions are typically considered a last resort by loss mit specialists, but some suggest that they are necessary for modifications to be effective. Valparaiso University School of Law Assistant Professor Alan A. White recently updated a study of loan modifications that he published last summer. White found that many modifications do not reduce principal debt, but actually increase total mortgage debt.

"[M]odifications and moratoria are slowing down foreclosures but are not getting homeowners into sustainable debt repayment, yet," he wrote in his Consumer Law & Policy blog. "Many of the failed modifications from 2008 will be back in 2009; the question is whether we will have learned enough, and broken through the legal and other obstacles, in order to start the process of deleveraging homeowners in earnest."

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