Lowering mortgage interest rates will not by itself keep hard-pressed owners in their homes, Washington Attorney General Rob McKenna said last week.
He said lenders will have to accept reductions in the principal due if they want borrowers to stay in their homes.
The alternative is foreclosure, and associated costs of roughly $60,000 to $80,000 per home.
Monday, we will find out if Treasury Secretary Tim Geithner proposes a bailout plan for the nation’s financial institutions that includes some types of foreclosure prevention. But if he pays much heed to two Treasury department heads, his remarks may disappoint.
The Office of Thrift Supervision and Office of the Comptroller of the Currency in December released a study that found 55 percent of those who obtained modified mortgages were in default within six months. The results reinforced assertions by many that government intervention would not solve the nation’s foreclosure problem.
But McKenna is among attorneys general and bank regulators in 14 states who say the two federal agencies are exaggerating the default rate on mortgages modified by lowering interest rates, extending the term, or deferring principal.
The State Foreclosure Prevention Working Group, in a letter delivered to the two federal agencies last week, said its survey of 13 companies that service mortgages turned up default rates as low as 21 percent.
“We are concerned that the statistics publicized by the OCC/OTS Report are misleading and likely to lead policymakers and the public to develop misperceptions about the effectiveness of loan modification programs,” members wrote.
The group would like to compare its results with those of OCC/OTS, but the agencies have given the states the cold shoulder since the group formed in 2007.
“They weren’t interested in hearing from us,” McKenna said.
OCC/OTS have also advised seven of the largest mortgage service companies to not share their information. They do not want the states looking over the shoulders of national banks.
Fortunately, some servicers have begun to accept that reduced principal will be a necessary component of modifications that work for lender and borrower alike.
Litton Loan Servicing LP estimates that marking down principal cuts default rates in half. Lenders may avoid losing an average 60 percent of their investment, and as much as 95 percent in some markets.
McKenna says part of the explanation for the high re-default rate reported by OCC/OTS lies in the fact the overwhelming majority of modified plans increase monthly payments.
“It doesn’t do any good to put the borrower in a position where they still can’t pay,” he said, especially if the principal balance exceeds the value of the home.
John Mechem, a spokesman for the Mortgage Bankers Association, said lenders are doing all they can to work with borrowers, sometimes modifying mortgages multiple times. Some people, due to job loss, divorce or other setbacks, are beyond help, he said.
If principal reduction becomes part of the equation for reducing foreclosures, investor concerns will have to be addressed, Mechem added.
Some proposals, notably one advocated by Federal Deposit Insurance Corp. Chairman Sheila Bair, buffers the impact on lenders by guaranteeing government repayment of principal or a split on the losses.
The FDIC has successfully used a version of the plan to work out foreclosures on subprime loans made by IndyMac. In a report to the U.S. House of Representatives Committee on Financial Services last week, FDIC Chief Operating Officer John Bovenzi said even if re-default rates were to hit 40 percent, the value of the loans exceeds foreclosure value by an average $50,000.
Bovenzi also said foreclosure numbers could top 4 million in the next two years if nothing is done.
“Foreclosures beget foreclosures,” said McKenna, and that’s why the states want to do what they can to help find solutions. But if everyone is working with a different set of numbers, answers will be hard to find.
The states are getting support from an unlikely quarter. Rep. Barney Frank, chairman of the Financial Services Committee, said he has told Geithner to get OCC to back off pre-empting state consumer protection laws, lending regulations included.
“States do a better job,” he said.
Now that’s a principle that should not be modified.