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Thursday, March 5, 2009

From Loss Center to Profit Center

One thing that is overlooked in the President's plan for loan modifications and reductions is the incentive given to the banks, known in the plan as loan servicers, of $1000 for every loan modification done by them.

Currently, the loan modification process is done through the loss mitigation department. Currently, the loss mitigation department is a loss center. In other words, this department attempts to minimize losses to the best of their ability. Such a process requires careful scrutiny and a long and drawn out process. That's because this department carefully reviews each loan modification to see if a borrower truly can be helped and how to help them. Of course, loan modifications aren't the only things that loss mitigation does. They also make arrangements on payments that are behind.

By offering an incentive of $1000 for every loan modified, the government has turned the loss mitigation department from a loss center to a profit center. No longer will care and scrutiny be the order of the day. Now, the order of the day will be speed and volume. Loss mitigation departments will now be judged on volume. That's because each modification will receive a payment to the bank of $1000.

To try and understand just how dangerous this is, you need to appreciate the change in mindset that this will bring. Rather than being careful and detail oriented, the department will have a culture of speed. The err will no longer be on the side of caution but volume. In other words, the loss mitigation department will be run much like most sub prime banks were run for about five years between 2003-2007.

By turning loan modifications into a volume business, you pervert their entire purpose. Loan modifications were supposed done in extreme cases in which good borrowers fell on hard times. Now, they will be done for just about anyone with a housing debt to income of above 31%. The requirements for a loan modification done for loans through Fannie/Freddie are: two paystubs, last year's taxes, credit report, and a hardship letter. That's it. To say that such a streamlined process built on volume will allow fraud, waste and corruption is to make a massive understatement. When we look back, we will all realize that the incentive built into these loan modifications were the major driving force of creating the nightmare that I expect to happen from them.


Anonymous said...

I still think your point that the honest billpayer, now faced with banks trying to make up the lost revenue from being forced to provide lower-interest housing loans to deadbeats, will suffer, is the most poignant I've seen.

Every stimulus, every bailout, either via Bush or Obama, of the last couple of years, has been a disaster. I desperately hope that hyper-inflation isn't in our future, but I fear it is.

Time to spend my remaining 401k dollars on beans and rice, I think.

mike volpe said...

I agree that philosophically that is a huge problem with this idea. I am pointing out what the motivation in this plan will do to make the plan fail.

I absolutely agree that such a plan definitely rewards irresponsibility while punishing responsibility.