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Saturday, July 18, 2009

The President's Loan Modification Plan and Its Lessons for Universal Health Care

The president's plan for loan modifications has been an abysmal failure. The reasons for its failures should be examined especially in the context of the president's plan for universal health care.

With a bit of fanfare, the president announced his plan to save up to seven million households from foreclosure. The eligible loans were any loans securitized by Fannie Mae/Freddie Mac. Any borrower living in the property they wanted to modify, with a hardship, no more than a loan to value of 105%, not already in foreclosure, a mortgage amount of less than $759,000, and a new housing debt to income of 31% with an interest rate of 2% or more would qualify. (among other rules) Meanwhile, banks could participate voluntarily but they would receive an annual stipend of $1000 and they would get a monthly stipend equal to the difference in payment between 38% and 31%. Borrowers would also see their balances reduced by an extra $1000 for every year they made their payments on time.

The whole thing seemed relatively simple enough and everyone was ready to save their homes. So, what's happened since then? What's happened is nothing short of mass confusion. Here's how one executive at Bank of America summed it up.

I’ve had a lot of frustrations in trying to come up with plans that work,” Dodd, a Connecticut Democrat, said during a break in a hearing on the programs today in Washington. “I’m concerned that we’re just going through the motions. I don’t get the sense of urgency.”

A Bank of America Corp. executive told Dodd’s committee that the administration stokes “confusion and delay” among lenders when it announces anti-foreclosure plans before completing the program details, while Senator Richard Shelby of Alabama complained that the programs have fallen short of goals.

“Existing modification programs have not been very effective,” Shelby, the ranking Republican on the Senate Banking Committee, said. “Sustainable policies must be based on economic realities and facts, not wishful thinking.”

The administration has “encountered a few difficulties” in starting the Making Home Affordable refinancing program for troubled borrowers, said William Apgar, an adviser at the Housing and Urban Development Department. The program, intended to help as many as 4 million people, has so far extended modification offers to about 325,000, he told the committee.

So, what's the problem? On paper, it seems as though the administration has set up rules. In reality, all they've set up are broad strokes. These broad strokes have all sorts of interpretations once there is a specific loan in front of a bank. For instance, during a loan modification every debt: food, gas, electricity, etc. is accounted for. Each one has to be categorized and given a "reasonable amount". For instance, borrowers can't claim that gas costs $4000 monthly just to look more desperate. So, what are the rules? They're buried deep inside the plan and difficult to interpret. Every bank wants to make sure they qualify for the Obama program, and get paid, so every part of the modification winds up going from the bank to Fannie to the Obama administration. That can create all sorts of confusion.

The second problem with loan modifications is that their guidelines actually wind up wind up disqualifying most of the folks that need help. First, by only including Fannie/Freddie, it eliminates all sub prime loans. The many other rules like the LTV limits, the loan limits, occupancy limits, etc. also work toward shaving away those that are in need of help.

Finally, state lawmakers have taken toward curbing abusive practices in loan modifications. For instance, here in Illinois, first lawmakers outlawed collecting payment before the process was done. Then, lawmakers made the maximum that could be charged the combined one month's worth of payments of the mortgage, taxes and insurance (PITI). Well, the second law has only encouraged many loan modifiers not to pursue lesser loan amount modifications.

Now, look at what we have with the president's universal health care plan. First, the rules seem simple enough. Medicare will be increased to include all those with incomes that are 400% above the poverty line. Medicaid will be increased to 130% of the poverty line. All businesses with revenues above $250000 will be mandated to provide health insurance. All citizens will be mandated to have health insurance coverage. Meanwhile, a public insurance option will be created to compete with health insurance companies?

What could go wrong? The devil here is in the detail. You're now creating a very complicated bureaucracy including businesses, hospitals, insurance companies, and the government. If you think that figuring out the maze of bank, Freddie/Fannie, and the government is complicated, wait until you try and figure out the bureaucratic maze of universal health care. Since every business will have to qualify, every business will have to present its health insurance plan to the federal government. That will create a mountain of paperwork between the business, the insurance company, and the government.

Of course, all of this will have to qualify under the government's rules. After all, individuals and businesses couldn't possibly be allowed to get any health insurance plan or it would allow for many to get something very, very cheap just to avoid paying the penalty. After all, the point isn't merely to have everyone insured but to get everyone healthy. So, we'll have a series of tests and rules that insurers, employers and individuals will have to pass. Just as there are a plethora of details that have to be worked out between the government banks, and fannie/freddie in loan modifications, so too will there a be a plethora of details to be worked out between hospitals, insurance companies, employers and the government in universal health care. Just as those details created chaos and confusion in loan modifications so to will it create chaos and confusion in universal health care.

Meanwhile, this won't stop states from mucking up the system even more. We can all only imagine what sorts of things state legislatures will come up with to complicate the process even further.

The main similarity between the president's loan modification plan is that both are billed as simple augmentations to the system meant to help those in need when really they are revolutions that will totally turn the industry upside down. Loan modifications used to be things that banks did on a case by case basis with their own discretion. Now, they are an industry that turns the loan modification department into a profit center. (since they are paid per loan) In the same way, universal health insurance is sold as a system in which all those that are happy now will see nothing change. It will only change things at the margins, they claim. Can this be? After all, if it's only changing on the margins why are they promising revolutionary savings in the system?

Yet, it's exactly because the loan modification system was so revolutionary that it's failed. The program turned the whole loan modification world on its head and that's why the system is so confused. Yet, loan modifications are downright simple compared to what universal health care will look like. The chaos seen in loan modifications are infinitesimal compared to the chaos created by a total revolution in health care.

8 comments:

Anonymous said...

A big issue to me, that I'm not seeing anyone really talking about is the loans themselves don't exist in their earliest form. John and Jane Smith get a mortgage from Home Town bank. Home Town bank then sells the loan and it is then sliced and diced by Wall Street into various tranches, which are then purchased by various investors as different CDOs.

Act two: John and Jane Smith get behind on the mortgage, and who do they go to negotiate a new loan? The bank that originated the loan no longer owns it. The Wall Street firms that sliced and diced it no longer own it. The investors who bought the CDOs do own bits and pieces of it, but who exactly knows what and where? In some back office there are records of where the bits and pieces of the loan are, but where, and who can get to them?

So here we are in the Mouth of Sauron scene, where he asks, "Is there any one in this rout with authority to treat with me?"

Who will suffer from the reduced loans? The pension, public and private that purchased the CDOs as investments. They are having a lot of trouble figuring out how to rob Peter to pay Paul, because they can't find Peter.

Katherine

mike volpe said...

The borrowers deal with the current bank. Of course, there are also a lot of mergers going on and in those cases they deal with two banks adding to the confusion.

Anonymous said...

That is my point, there is no "current bank". The bank taking the payments exists only as agents to send the revenue stream along to service the CDOs owned by the investors. They are agents only, and can not and must negotiate anything, they have no legal standing, they are not the owners of the underlying security.

We've long since left the world of "It's a Wonderful Life", what we have is an incredibly complex weave of "stake holders", and no clean, neat path to get from point A (the borrowers) and point B (the owners of the bits and pieces of the mortgage).

No one is talking about this as an issue to any effort to resolve the problems.

Wall Street can't unwind the trades that resulted in the CDOs.

How will they put Humpty Dumpty back together again?

Katherine

Anonymous said...

Hi ya Mike!

Here's more on the abject failure of the O'b modification plan from Politico (h/t Glenn)

http://www.politico.com/news/stories/0709/25095.html

"But other experts say there’s not a whole lot the administration can do directly on the housing front anymore — and that might be the worst news of all for the White House.


Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies, said that while the Obama plan was well-crafted for the issues at hand in February, the cause of foreclosures has changed. Now they are less about the creative, variable-rate loans that buried many homeowners and more about an unemployment rate that has even those with fixed-rate loans struggling to keep up.


“The issues have changed, and in some ways the solutions haven’t kept up with the problems,” Retsinas said. “The most effective intervention would be to put people back to work.”


Best,

wahabicorridor

mike volpe said...

I would disagree with the Harvard Economist slightly. The problems of resetting loans hasn't gone away, it's just been added to by the problems of unemployment. There are still well in excess of one trillion dollars worth of loans to reset over the next couple years. That's still a massive problem.

As to the other point, that's why the president's plan is for Fannie/Freddie only. the government now owns both. He created rules for that Fannie/Freddie would follow.

Home said...

Interesting!

The loan modification process can be frustrating and confusing for many distressed homeowners. But you have to know what exactly is loan modification. A loan modification is a permanent change in one or more terms of a borrower's home loan.

Anonymous said...

This is what I was trying to say, written by two people who are way smarter than I.

From todays WSJ, why the toxic assets are so hard to clean.

http://online.wsj.com/article/SB124804469056163533.html

Katherine

Olique Estefan said...

The key to a successful modification focus on your willingness, you must be willing. Willing to work things out with your lender, willing to continue your payment diligently, willing to take the necessary steps to ensure a successful modification, and most importantly willing to take immediate action.