As the next wave of foreclosures gets ready to hit, Congress is on the verge of telling the nation’s mortgage lenders to cram it.
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Democratic leaders on Capitol Hill are warning lenders that unless they step up their efforts to modify troubled home loans, Congress will revive a mortgage cram-down bill that stalled in the House earlier this year. Not surprisingly, the loudest threats have been voiced by House Financial Services Committee Chair Barney Frank (D-Mass).
A cram-down law would give judges, and in particular those sitting in the bankruptcy courts, the authority to modify the terms and conditions of a loan to help borrowers hold on to their homes. With this cram-down authority, judges could lengthen the term of the loan, force lenders to accept lower interest rates or even reduce the loan balance.
A Drastic Potential Change
Under the current bankruptcy scheme, lenders are classified as “secured creditors.” This exempts them from court oversight and jurisdiction.
Once a borrower files for bankruptcy protection, lenders, as a matter of routine course, ask the court to lift the stay on all collection actions so that it can continue its independent foreclosure proceedings. Only in rare instances, will a bankruptcy court deny this lender request.
Since President Obama rolled out his initiative to assist troubled borrowers to hang onto their homes through a program of loan modification, Congress has backed away from enacting cram-down legislation.
In response to good faith representations by members of the banking lobby, Democratic leaders and the President agreed to take a wait-and-see approach. If foreclosures started to tail off in concert with visible progress on the rate of voluntary loan modifications, the need for any new law would become moot.
Although new and existing home sales have climbed in response to falling home prices, the rate of foreclosures has continued at a record pace. There is little evidence that lenders have yet to embrace the virtue of voluntarily modifying their existing loans.
Foreclosures continue to swamp states like California, Nevada and Florida. But now areas that didn't have high rates of sub-prime mortgages are also starting to feel the pain.
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According to Realty Trac, which maintains an online data base of foreclosed properties, places like Boise, Idaho, and Fayetteville, Ark., – areas where defaults have remained low – are now experiencing foreclosures at a new alarming rate. This jump has less to do with the collapse of sub-prime loans than with rising unemployment.
It unemployment continues to climb through the end of this year, or as many analysts have predicted, into the first half of next year, this could lead to a second-wave of heightened foreclosures. Several observers believe that a third wave of housing defaults likely will follow as hundreds of thousands of open adjustable rate mortgages (ARM’s) get ready to re-set to a higher interest scale.
Why Instability Is a Problem
This may be good news for bargain-hunters. But members of Congress and the President fear this continued instability in the housing sector effectively will prevent any prospect for an economic recovery before the end of 2010 or longer.
Through June, more than 1.5 million households have received a default or auction notice. This represents a 15 percent increase over a year earlier.
The administration’s “Making Home Affordable” loan modification program was crafted to help as many as 4 million struggling borrowers who need assistance to keep their home from slipping into foreclosure. Presidential spokespersons are saying that more than 200,000 trial loan modifications already have begun, and that the administration is setting a goal of starting another 500,000 by Nov. 1.
Apparently, someone forgot to tell the lenders; because House members like Barney Frank have been excoriating the banks for dragging their feet.
At the heart of the problem is that most loan servicing companies and their client lenders don’t have any real incentive to modify existing loans. In fact, the opposite may be true.
Even when borrowers stop paying, the mortgage companies that service the loans accumulate fees that ultimately are collected when the foreclosed home is sold. Consequently, the longer borrowers remain delinquent, the greater are the opportunities for these mortgage companies to extract revenue. This multitude of fees includes charges for insurance, appraisals, title searches and legal services.
Because many lenders required borrowers to secure PMI (private mortgage insurance) before extending a loan – especially where the loan was for more than 80 percent of the appraised home value – these lenders also don’t have any real incentive to rework the terms of their loans.
If the loan was conditionally issued with PMI, then even if the home is sold at auction below the original appraised value, the lender is still protected. In these cases, the insurance company that carried the policy is obligated to pay the lender the difference between the price for which the home ultimately was sold and the remaining amount of the loan.
During meetings yesterday with key members of the administration’s housing task force and select Congressional leaders, representatives of the lending industry have said they will redouble their efforts to increase the tempo and volume of modifications.
Their promises may be too little, too late. Time is running out. So is Congressional patience.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
