The announcement yesterday of new procedures for streamlined modifications of primarily prime mortgage loans in trouble was a perfect example of a good (albeit overdue) program being drowned by a really inept rollout.
Briefly, Fannie Mae, Freddie Mac, their conservator the Federal Housing Finance Agency, the Hope Now Alliance and a group of large banks announced standard procedures to do quick modifications-involving primarily an appraisal and verification of income-of seriously delinquent loans in either Fannie or Freddie MBS, or in the portfolios of either the GSEs or the banks. There are clear limits on what is involved. The big one is these are largely prime loans, and loans for which the servicer has relatively undivided loyalties. They are not the privately-securitized sub-prime and Alt-A loans that have caused the bulk of the problem to date, especially in lower income communities. That's a big limitation, but the fact is that the prime foreclosure rate is increasing steadily. And as of June 2008, there were about 373,000 Fannie and Freddie owned or guaranteed loans (many of them prime) that were seriously delinquent, and the number was climbing fast. That's Fannie and Freddie alone, not counting loans held in bank portfolios.
A second limit is that the borrower must be 90 days delinquent for the procedure to come into play, thus not helping borrowers who know they're about to get into trouble and want to proactively solve their problem before their credit is shot. Finally, the program doesn't really deal with the situation in which there are second and further junior liens on the property. A 38% housing-debt-to-income ratio may work if that loan is the only housing debt; it will strain any budget where there are additional liens.
The rollout was marred (that's being kind) by the Treasury trying to sell this for far more than it is, intimating that it is a substitute for aggressive action on a broader range of loans, including sub-prime and Alt-A loans and loans not yet seriously delinquent, such as the guarantee program that FDIC Chairman Sheila Bair has been pressing the Treasury to implement. The fact that the Chairman Bair wasn't around for the announcement and the Treasury spokesmen literally ran out of the briefing room to avoid answering questions didn't exactly help the picture.
Nevertheless, there is substantial value in what was announced. First, it may well break a log-jam with respect to Fannie Mae MBS in particular. Lenders have been complaining for some time that Fannie has been reluctant to participate in modifications in any meaningful way. Second, the program applies to all loans in Fannie or Freddie MBS, no matter who owns the MBS. This is a critically important point that the announcement essentially buried. Third, any deferred principal will not earn any interest. While the borrower will still ultimately be on the hook for it, the lender will lose all benefit of that part of the loan being outstanding. In some ways, this isn't really very different than the Hope for Homeowners combination of a big guarantee fee and a requirement that any equity gain be shared between homeowner and the party funding the loan (in that case in effect the government). Finally, if both the GSEs and the banks keep and make public careful records of what happens with these loans, and the program is successful (with limited re-defaults), those who want to apply similar broad standards to securitized loans will have a good case that doing so is in the investors' interest as well as the borrowers' and the country's.
On a related note, all the programs so far have carefully concentrated on owner-occupied primary residences. What that is understandable as a moral matter, especially in the face of substantial evidence of investor fraud in the single family market, it ignores two critical facts. First, each additional foreclosure, no matter who the owner, furthers the downward spiral of house prices, affecting everyone nearby. This is especially a problem in communities where there are a large number of foreclosures. Second, where the investor has rented the property out (common, of course, for 2-4 unit homes), a foreclosure puts the tenants on the street, even if they have been faithfully paying their rent. To some extent this is a matter of changing local laws and lender practices, but if we thought somewhat more broadly about the role played by good owners of small-scale rental housing, which is usually unsubsidized and affordable, we might be able to avoid the trauma in the first place.
*Update*: On Thursday, November 13, as FHFA James Lockhart discussed these and other topics relating to the conservatorship. He was joined by Barry Zigas of the Consumer Federation of America and Gregory Baer of Bank of America. Listen to or view the event.