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Mortgage Workouts Not Solution

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When the foreclosure crisis began to heat up last fall, troubled borrowers got this advice: Call your lender and try to work things out. The Bush administration led the way on this, unveiling its Hope Now program — a hotline to connect borrowers with mortgage counselors and servicers to re-do loans on easier terms.

President George W. Bush and Treasury Secretary Henry M. Paulson Jr. touted the approach as a private sector-led effort to help homeowners who were falling behind on their payments. Hotlines and efforts like Hope Now sprung up at the state level as well.

But since its inception, Hope Now has run into trouble — criticized for serving too few people with too little results. Borrowers complained they couldn’t get through to counselors or servicers, and Bush didn’t help the situation by giving out the wrong hotline number at a news conference. Servicers seemed reluctant to modify large numbers of loans, and most recently, counselors say, some are agreeing only to two or three-year repayment plans, instead of restructuring the loans into 30-year, fixed-rate mortgages.

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Illustration by: Matt Mahurin

Hope Now, in the meantime, regularly issues optimistic progress reports as foreclosures continue to soar — filings rose by 55 percent in July, compared to a year earlier — and the housing market shows no signs of stabilizing.

At this point, both industry experts and housing counselors are questioning whether voluntary workouts are a useful solution to the housing crisis — and whether there’s any solution at all. It’s time to acknowledge that workouts are a band-aid effort at best, they say, a way for government and the lending industry to show they are doing something about the crisis, without actually doing much.

Workouts don’t work, in this view, both because borrowers are reluctant to seek help from lenders, refusing to open mail from them for fear it’s a foreclosure notice, and because servicers who negotiate workouts have little financial incentive or staff to help significant numbers of them anyway.

The problems with loan restructurings aren’t just about a fight between borrowers and lenders. The failure to secure a large volume of restructurings speaks directly to the entrenched, structural problems in the mortgage market that prevent simple or quick cures for foreclosures.

Servicers earn money by collecting fees, not from setting up restructurings. This gives them little reason to do more of them. Borrowers and lenders are at odds in the process, a roadblock to getting anything done. Hope Now, for example, counts among its members the American Securitization Forum, which represents financial companies that buy and sell mortgage securities, and which tells counselors to avoid across-the-board restructurings.

Hope Now is promoted by the government, but run by private industry, and lenders and servicers vary in their restructuring decisions. Some are big enough to absorb foreclosure losses and move on, giving them little impetus to accept restructurings. Smaller lenders, or those looking to buy a little time in the hopes the market will pick up again soon, are motivated to agree to only two-or-three year agreements — and then go after the property again if home values rise.

In the meantime, the government is pinning its latest hopes on the mortgage rescue bill that goes into effect next month, hoping lenders will voluntarily agree to take losses and refinance loans backed by Federal Housing Administration insurance — something they could have been doing all along, even without the new legislation.

“Why aren’t there more loan modifications? Because lenders are reluctant to do them, except as a last resort,” said Guy Cecala, publisher of Inside Mortgage Finance, a Bethesda, Md., publication that follows the industry. “Hope Now is something the government had to do to show it was doing something about the crisis. I think they’re hanging on to it as a public-relations gesture. It’s as much about p.r. as it is about having an impact on the problem.”

Consider how loan modifications are reported. Hope Now announced recently that it prevented a record number of foreclosures in July, completing more than 192,000 workouts. But the group doesn’t break down details of the modifications. So it’s unclear how many were restructured loans at lower rates and how many involved repayment plans that just stretched payments out over a longer period of time.

By contrast, in a new research paper, Alan White, a University of Valparaiso law professor and mortgage-industry expert, examined 4,300 loan modifications in subprime loan pools from July 2007 through June 2008. The workouts were completed by Hope Now and by other groups.

White found that virtually none of the modifications resulted in a reduction of the loan principal, and only about half reduced the interest rate and monthly payment.

Hope Now is under “a hell of a lot of pressure” from both the Bush administration and from Democrats like Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, to come up with results, Cecala said. But lenders don’t see things the same way, and instead believe that loan modifications are likely to fail in the end, making them not worth the effort.

“Don’t think for a minute that anyone in the mortgage industry, or anyone who knows anything about this, thinks workouts are some sort of panacea,” Cecala explained. “The feeling in the mortgage industry is that there’s no silver bullet and there’s no easy way to address this crisis. They’re just going to have to muddle through it somehow.”

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