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Saturday, January 17, 2009

Comparing the Sub Prime Crisis With The Impending Loan Modification Bubble

While no two financial dynamics are ever the same, unfortunately, I am fearful that many of the same things that caused the sub prime crisis are now rearing their ugly heads in the new chic niche of loan modifications. Loan modifications, again, is the process by which borrowers struggling to make their mortgage payment have their terms re negotiated with their bank in order to make them more affordable. In other words, if you can't afford the mortgage you have there's nothing to worry about because loan modifications will give you a better deal. Here are the most startling comparisons between the previous crisis and the one I believe we will see soon.

1) Government stimulation causing an unnatural market boom.

With sub prime, the Federal Reserve lowered its Federal Funds Rate to 1% and kept it there for more than a year. This encouraged banks to take risks because the over night rate, the Fed Funds Rate, was so low. Since real estate was the only thing moving at the time, banks used their new found liquidity to invest in mortgages and eventually sub prime. This unnatural government stimulus lead directly to an unnatural market boom, and of course that boom eventually crashed.

Now, all levels of government are doing everything they can to stop foreclosures. Loan modifications are at the center of most government action. In California, banks can't foreclose unless a borrower first receives a loan modification. The FDIC is now insuring millions of loan modifications. It's also clear that this is only the beginning of government intervention to make loan modifications easier. The Obama administration is considering legislation that removes fees from the loan servicer in case of foreclosure. Right now, loan servicer get no extra fees for a loan modification and thus such legislation would encourage all involved to get more involved in the process of loan modifications. There are any number of ways for the government to encourage loan modifications and it's likely we will see many of them implemented because the government is determined to do everything it can to stop foreclosures.

By doing so, the government is also creating unnatural stimulation. Unnatural stimulation leads directly to a unnatural expansion in the market. This leads directly to a bubble. It happened with sub prime and it is bound to happen with loan modifications.

2) Banks, borrowers and mortgage brokers.

The very same banks, borrowers, and mortgage brokers that were at the center of the sub prime explosion will be at the center of the process of loan modifications. Most mortgage companies now have a division for loan modifications. Many mortgage brokers have stopped doing mortgages entirely in order to do loan modifications.

Who will have loan modifications done? It will overwhelmingly be borrowers in sub prime loans. Who will approve loan modifications? It will overwhelmingly be sub prime banks. In other words, the exact same players that were intimately involved in creating the sub prime crisis will now be at the center of the loan modification mess I predict.

3) No rules

By the end, sub prime included a loan known as 620 Stated Stated to 100%. This means that someone with a 620 credit score (somewhere in the bottom 30%) could state their income, their liquid assets, and do all of this will buying a property with absolutely nothing down. In other words, by the end, you needed little more than a heartbeat to get a loan.

Well, the process of loan modifications maybe even worse. In fact, there are no rules. There is the nebulous concept of hardship. In other words, if it looks as though you are having trouble paying your mortgage you are a candidate for a loan modification. That pretty much includes everyone. There is no set rules for hardship and thus, a good loan modifier can make just about anyone look worthy. About the only rule is that the borrower must be behind on their current mortgage. That's why I predict that all sorts of folks will eventually fall behind on their mortgages in order to qualify for this process.

4) A confluence of events that caused time and place

In many ways, the sub prime crisis exploded through a perfect storm of events. Many of them I just relayed. The bad economy lead to lower rates. Those lower rates eventually made real estate more attractive. Then, the Fed pushed banks into sub prime. The heating real estate market exploded and sub prime exploded with it. A monster was born.

The same thing is in place. Foreclosures are at alarming levels. No politician can look as though they will simply allow poor borrowers to get foreclosed on. Loan modifications are the perfect tool to stop it. Soon, banks will want to do anything possible to stop foreclosures. This will cause them to be less and less discriminatory. The same players that manipulated sub prime will begin manipulating this process, and another monster will be born.

1 comment:

Anonymous said...

I am not a Mortgage Broker, but I did write loan applications and everybody points their fingers at the Brokers. Well I think if the Banks who were the entities who loaned the money irresponsibly! If they didn't offer these sub prime loans where a person could get a 106% mortgage with a stated self-employed FICO score of 580, then Brokers would not have submitted the loan applications would they? After all they are not submitting those applications today are they ? Why not? Because the Bank will not fund the loan!

If the Bank wasn't offering modifications then Brokers would not process them would they? Why not keep the focus where it belongs?

With the people who gave that money away. Not the Brokers they only respond to the market. They are small potatoes trying to squeeze out a living themselves trying to avoid foreclosure. Brokers don't have the power! Banks have the Power! Government has the power! Wake up people!