FDIC Steps Up

February 26, 2010

Since I wrote and posted the piece that follows, Barry Ritholz at The Big Picture blog has also posted a thoughtful note on this titled “Underwater Homeowners:  Demand Principal Reductions.”  Commenting on the FDIC move described in my post below, Ritholz notes

It only requires basic math skills for all parties to recognize that it is in the banks interest to avoid foreclosures. Underwater borrower with this knowledge — and the cojones — should let the bank know they understand simple math: Foreclosures = 50% bank loss.

They can then “engage in an arm’s length, Wall Street style negotiation.” Not precisely a threat, but simply laying out clearly what the mortgagee’s options are.

He finishes up by observing that, 

My guesstimate is that of the 5 million probable future foreclosures, this mod would be applicable to about 20% of them. Note that a recent report from the Office of the Comptroller of the Currency implies that banks have figured this out: In Q3 of 2009, 13% of loan mods included a principal reduction, up from 10% in Q2 ‘09.

Of course, if Congress didn’t force FASB tio eliminate mark-to-market on holdings, the banks wouldn’t be able to, Japanese style, wait the whole mess out over the next decade or two.

As others have noted, this is how commercial borrowers and lenders negotiate all the time. Somehow, our concerns about the “moral hazards” of renegotiated debt seem to apply only to individual owners, and not the big boys and girls who play chicken with each others’ money all the time.  Some of you who have commented on my earlier posts about principal reduction have strongly supported such bilateral negotiations, but decried the notion of government paying for some or all of a reduction.  

Seems like Ritholz agrees with you.

Balance of Power

In reality, individual borrowers are not like Tishman Speyer or other commercial borrowers who have real loan officers with whom they deal and whose liabilities jeopardize the lender as much as themselves.  

In the real world of mortgage modifications, borrowers are still reduced to trying to break through 800 customer service numbers where they are likely to speak to a different staff person every time they call.  Documents are still provided by fax, sometimes to overseas fax centers.  

Trying to negotiate even a HAMP loan mod is proving to be difficult enough for individual borrowers.  A bare-knuckled negotiation with the lender to force a cram-down seems out of Everyman’s reach.

This imbalance of power and influence between the borrowers and the debt holders in the securitized system that we are living with is one of the root problems in getting to a swift resolution.  The lenders hold most, if not all, of the cards.  Individual borrowers on their own have scant power to negotiate, and servicers have small incentives to accommodate them with radical moves like principal reductions.

Hence, having the government step in on behalf of these borrowers seems to me to be an ideal use of government of, by and for the people.  

As proposed back in March, 2009 in recommendations to incoming HUD Secretary Shaun S. Donovan, government bulk purchases of the mortgage assets behind private label securities at discounts that reflect reality as Ritholz has described would enable it to follow with an orderly disposal of the assets with tools that could include steep writedowns reflective of the discount.

******************************************************************************

Once again, as it has so many times in this crisis, the FDIC has stepped up and announced it will launch a pilot effort to test ways to reduce principal amounts for overwhelmed and underwater borrowers.  

Under Chair Sheila Bair, the FDIC has been a strong and sometimes lonely voice for consumers’ interests and practical solutions.  She’s proof that the phrase “bipartisan policy making” is not always a euphemism for “food fight.”

According to the Feb. 26 Washington Post,

Under the FDIC program, borrowers would be eligible for a reduction in their mortgage balances if they kept up their payments on the mortgage over a long period. The performance of those borrowers would be compared with borrowers given more traditional mortgage relief packages, such as those that cut the interest rate on loans.

“We’re thinking about it in terms of earned principal forgiveness. If you stay current on your mortgage, you would earn a principal reduction. It would only be for loans significantly underwater,” said FDIC Chairman Sheila C. Bair. 

This comes a week after the Obama Administration announced a $1.5 billion pilot funding program to encourage innovation in the five states with the steepest housing price declines—California, Arizona, Nevada, Florida and Michigan.  This was a welcome initiative, as well.  But the amounts available will make only a slight difference in these beleaguered state economies, take months to get up and running with the gauntlet of submissions and approvals it includes, and take years to provide any useful data that could move them from state to national approaches.  Not reasons to stop, but reasons that it falls far short of what needs to be done.

As I’ve noted in other blogs here, principal reductions are emerging as perhaps the only reliable way of modifying mortgages for long term success. The FDIC initiative is a welcome break in the logjam that is keeping so many borrowers from getting a break that can help them keep their homes and keep paying on at least some of what they owe.