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Monday, November 30, 2009

Soon The Banks Will Be Between a Rock and a Hard Place

The White House is concerned that their loan modification program is floundering and so they're about to put more pressure on the banks.

The Obama administration will crack down on mortgage companies that are failing to do enough to help borrowers at risk of foreclosure, as part of a broad effort to boost participation in its mortgage assistance program.

The Treasury Department said Monday it will withhold payments from mortgage companies that aren't doing enough to make the changes permanent. Officials will monitor the largest of the 71 participating mortgage companies via daily progress reports.

The goal is to increase the rate at which troubled home loans are converted into new loans with lower monthly payments. At the end of October, more than 650,000 borrowers, or 20 percent of those eligible, had signed up for trials lasting up to five months.

To understand just how dangerous this and how much unnecessary pressure this will put on banks first you should understand the process by which banks approve loan modifications. Loan modifications require most of the same paperwork as a regular loan: pay stubs, bank statements, w2's, etc. It also requires a full budget filled out by the borrower and it requires a letter explaining why the current mortgage payment is too high. (I often refer to this as the sob story) This may not seem like a lot but a file that is appoved is often the size of one section of an encyclopedia by the time it's done.

Second, you must all understand that the approval for a loan modification is nearly the exact opposite of the approval for a regular loan. Whereas on a regular loan, you want everything from income to credit to assets to be maximized, you want that to be minimized in a loan modification. At the same time, you don't want a totally hopeless situation since that's a sign of someone totally irresponsible and unfit for a loan modification. At the same time, the government has created its own rules. For instance, the modified loan can't go below 2% and still has a front end ratio of 31%. (by this I mean the housing payment, mortgage taxes and insurance) So, for a bank, figuring out if a loan should be approved is a delicate process.

Finally, loan modifications, on this scale, are totally new. Banks have no bureaucracies for them. They are creating them as they try to approve these loans. At the same time, they are working closely with the federal government and Fannie/Freddie for the first time on this issue. As such, you are asking multiple bureaucracies to work together. We can all imagine the bureaucratic nightmare that creates.

I'm not here to defend the banks. I have no use for banks. I don't care how difficult it is when it takes six months and more, as it often does, there's no excuse. Still, these banks are dealing with a brand new process, that's very complicated, and involves multiple new bureaucracies. Most importantly, it goes against every business instinct for banks to approve a loan modification. After all, you're approving someone entirely based on their current inability to pay.

Now, the White House will try and embarrass all those banks that aren't approving enough. Those banks will be put on some list for all to see. It's sort of like being put in the middle of the town square during the Middle Ages. Banks will want to do everything to avoid being on this list. Doing this means approving more loan modifications.

Now, think about the difficult, confusing, and new process I just described. Add to this directives from banks to the people in charge of processing these loan modifications to get more of them done. What you'll have carelessness and speed into a process that complicated and chaotic. That will mean a lot of people that shouldn't be approved will be approved. This will expose the process to a great deal of fraud. If banks are fixated on approving as many as possible, they will be extremely susceptible to being taken advantage of.

It remains to be seen if the White House will be effective in intimidating the banks. If they are, however, you can bet that will be a decision that we will all regret. That will unleash a terror in the loan modification market that we will all regret. I was always against the proliferation of loan modifications. They have an inherent moral hazard. They are wraught with potential fraud. Now, the administration is determined to make sure that all my worst loan modification nightmares come true.

1 comment:

Anonymous said...

I am on the inside of the title insurance industry. The word we are getting is that the new HUD disclosure has so much compliance risk that some of the lenders we deal with have told us their legal department won't let them lend under those circumstances. This means that at least some banks will only be lending in order to hold the loan themselves. This will really limit the amount of money they lend.