Obama administrations loan modification program ‘destined to fail’

Dennis Norman
Dennis Norman

Laurie Goodman, the Senior Managing Director at Amherst Securities, testified today before the House Financial Services Committee hearing on “The Private Sector and Government Response to the Mortgage Foreclosure Crisis“. Amherst Securities specializes in the trading of residential mortgage backed securities and charges Goodman with keeping them and their customers abreast of trends in the market.

Today, in her testimony, Goodman told the committee she hoped to make two primary points in her testimony:
  • “The housing market is fundamentally in very bad shape. The single largest problem is negative equity.”
  • “The current modication program does not address negative equity, and is therefore destined to fail. It must be amended to explicitly address this problem. And there is no single solution; it is a combination of policy measures. Clearly, the arsenal of solutions must include principal reduction and must explicitly address the loss allocation between first lien investors and second lien investors.”

In her testimony Goodman cited some very interesting (albeit it depressing) facts and figures, including:

  • They (Amherst) estimate that approximately 7 million of the 7.9 million homeowners that were reported by the MBA as not making their mortgage payments in 3rd quarter will be forced into vacating their properties.
  • 250,000 New borrowers per month stop making their payments

As a reason for estimating failure on such a large percentage (88.6 percent) of the 7.9 million borrowers that were delinquent, Goodman said;

“The real problem is that default transition rates are high and cure rates are low because the borrower has negative equity in their home. Most borrowers do not default because of negative equity alone. Generally, a borrower experiences a change in financial circumstances. If the home has substantial negative equity, they will choose to walk.”

To prove her point, Goodman cited a study that was done by Amherst which looked at Prime borrowers that were 30 days delinquent on their mortgage 6 months ago. They then sorted the loans by the amount of equity the borrowers had, then came back 6 months later to see which borrowers were at least 60 days delinquent. For borrowers with 20 percent equity, only 38 percent had become 60+ days delinquent. For borrowers with substantial negative equity (owed 41-50 percent more on their homes than the value) 75 percent had become 60+ days delinquent.

During her testimony, Goodman said “there is a substantial group of people who have argued that the primary problem is not negative equity, it is unemployment. This argument is not supported by the evidence. First, the increase in delinquencies for subprime, Alt-A and pay option ARM mortgages began to accelerate in Q2, 2007. By contrast, we did not begin to see large increases in unemployment until Q3, 2008.”

Goodman goes on to point out the results of another study done by Amherst Securities entitled “Negative Equity Trumps Unemployment in Predicting Defaults” which included the following:

  • The combined loan-to-value ratio or CLTV plays a critical role. For prime and Alt-A loans in low unemployment areas the default frequency was at least 4 times greater for borrowers underwater by 20 percent than it was for borrowers with at least a 20 percent equity position.
  • If a borrower has positive equity, unemployment plays a negligible role. We found that all borrowers with positive equity performed similarly no matter the local level of unemployment.
  • If a borrower has substantial negative equity, unemployment plays a role, but less than CLTV. If the borrower has a CLTV greater than 120, the default frequency was 50 percent to 100 percent higher in a high unemployment area versus a low unemployment area.

The evidence is irrefutable. Negative equity is the most important predictor of default,” said Laurie Goodman.

In addition to Laurie Goodman, there was testimony today from Dr. Anthony B. Sanders, Distinguished Professor of Real Estate Finance, Professor of Finance School of Management, George Mason University. Dr. Sanders also paints a pretty dismal picture of the success of the Obama administration loan modification program. Dr. Sanders said “it is a real challenge to servicers to make loan modifications succeed when 70 percent of modifications that have only interest rate cuts have gone into re-default after 12 months.

Dr. Sanders goes on to state that “only 12.5 percent of eligible borrowers receiving permanent loan modifications are able to keep them current. And it is entirely possible that the “success” rate could enve fall below 10 percent of eligible loans.” Dr. Sanders says the reason for this is:

“the degree to which many residential loans in the United States are in a negative equity situation. According to a Deutsche Bank research report, they are expecting 25 million homes to be in negative equity position.”

The second reason Dr. Sanders gave as the cause for such a bleak outlook for successful permanent loan modifications is the unemployment rate. He said “while 10 percent report(ed) unemployment rate is bad enough, the true unemployment rate (including wage and salary curtailment) is closer to 17.5 percent. “

I am glad to see testimony by these two professionals, and others, to help convince Congress that the loan modification plan, in it’s present form, is not effective. I think the evidence is overwhelming that negative equity is the major problem and must addressed in their “stimulus” and “recovery” programs.

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