Mortgage Loan Modification Unprofitable and Not Being Done

The Obama administration gave the mortgage industry $75 billion to rewrite delinquent loans and prevent additional foreclosures. According to the plan mortgage holders in financial trouble might find any one of a variety of remedies including interest reduction, principle reduction, or other term modifications aimed at reducing the monthly payment. The goal was giving people a real chance to stay in their homes and prevent the rash of foreclosures we are seeing these days.

The process is failing. The basic reason for failure is found in the lack of profit for the lenders. Mortgage modification is not a money making proposition. Therefore such modifications will not happen no matter how much money the government pumps into the system.

A study (PDF) released by the Federal Reserve Bank of Boston tells the sad tale.

The problem is that renegotiation exposes lenders to two types of risks that can dramatically increase its cost. The first is what we will call “self-cure” risk. As we mentioned above, more than 30 percent of seriously delinquent borrowers “cure” without receiving a modification; if taken at face value, this means that, in expectation, 30 percent of the money spent on a given modification is wasted. The second cost comes from borrowers who redefault; our results show that a large fraction of borrowers who receive modifications end up back in serious delinquency within six months. For them, the lender has simply postponed foreclosure; in a world with rapidly falling house prices, the lender will now recover even less in foreclosure. In addition, a borrower who faces a high likelihood of eventually losing the home will do little or nothing to maintain the house or may even contribute to its deterioration, again reducing the expected recovery by the lender.

The writers conclude the infusion of money is going to the wrong place. Instead of giving money to the financial institutions holding the mortgages

Large financial incentives to investors or even to borrowers to continue payment could mitigate this problem.

In other words, give money to the very people in need of aid. I second that motion. Putting money directly into the hands of people likely to spend those dollars is the best way to stimulate the economy. Putting money in the hands of people in danger of losing their home to foreclosure may be the very best way available to both stimulate the economy and keep people in their homes. The more money we see poured into the financial industry the less benefit we seem to see other than in maintaining their CEO salaries.

Peace.