Tuesday, September 23, 2008

Why Bulk Mortgage Modifications are a Bad Idea

(Felix Salmon) Matthew Yglesias:

There really is an urgent need to "do something" and also an urgent need to try to make sure we do the right thing. Middle class people are pretty desperately in need of some form of bulk modification of mortgages, a step the financial institutions and their hirelings in the GOP have been blocking for months. In theory, this question is separable from the bailout issue. In practice, the banks' desire for a bailout provides a key moment leverage and opportunity.

I'm not a fan of this idea. Yes, this is "a key moment leverage and opportunity". But that's no reason to do something which doesn't make fundamental sense. And a bulk mod makes very little sense for three main reasons.

  1. We're in the midst of a major banking crisis, and there's a reason why a bulk mod has been opposed by the financial institutions: it would cost them a lot of money that they don't have. Right now, there are too few loan modifications. But a blunderbuss approach where the main qualification for getting a mod is having a mortgage? Would mean far too many. Even a relatively modest bulk mod, in a world where there are $13 trillion of mortgages outstanding, could cause the loss of hundreds of billions of dollars in present value and bank capital.
  2. So you restrict the bulk mod -- to people with adjustable-rate mortgages, say, who bought their houses between this date and that date. But you still can't underwrite these things: it's a bulk mod. So a bunch of people who can afford the reset payments will end up getting free money off their mortgage payments, and a bunch of people who can't even afford the lower, initial payments will unhelpfully stave off the inevitable. Both of these groups of people will cause bank losses which we really don't need right now.
    And of course even an all-mortgages-eligible bulk mod is essentially a transfer from renters to owners, and from people who've paid off their mortgage to those who haven't. The more you narrow it down, the less fair it becomes: billions of dollars will essentially end up being spent on Californians who bought houses they couldn't afford, rather than the more sensible people across the country who didn't. This is not good politics, or good policy.
  3. Drafting a bulk mod is really, really hard, given the way in which servicers' hands are tied. You're basically violating a whole raft of securitization contracts, and the unintended consequences are bound to be legion. Remember it's not just banks who own these mortgages: they pop up in MBSs and CDOs held by investors all over the world. It would be much easier to just write checks to homeowners, to help defray their mortgage costs: at least that would be legal. But the politics of that would be even more lethal than the politics of a bulk mod.

There is lots of legislation which would be a really good idea right now. But I'm not a particular fan of even the good-idea legislation (like chapter 13 bankruptcy for homeowners in foreclosure) being stapled on to this bailout bill. Stapling on a rushed and necessarily complex loan-modification bill would be almost certain to end in tears.

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