Helping homeowners stay out of foreclosure

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Should the governement give cash incentives to lenders so they’ll lower the mortgage payment of homeowners in trouble, or should that money go to directly to homeowners?

The "Boston Globe" reports on a Boston Reserve Bank study that concludes: cut out the middle man.   Banks don’t want to re-write mortgages because they lose too much money.  That is a direct rebuke of President Obama’s $75 billion plan that encourages banks to lower mortgages for people facing foreclosure.

Paul Willen is senior economist and policy advisor for the Boston Fed.  His study reviewed more than 600,000 mortgages: "We found that lenders were very reluctant to modify loans, specifically to modify loans in such a way that the payment to the borrower was reduced.  We found that about 3 percent of the 600,000 borrowers, we mentioned, that became seriously delinquent, in the year after becoming seriously delinquent, received a modification from their lender which reduced their payment."

Lenders may have a couple of reasons for not adjusting.  Willen says, "Lenders face two different risks when they modify a loan.  The first is re-default risk, which is the possibility that when the lender modifies the loan, the lender changes the terms of the loan to help the borrower, the borrower defaults on the mortgage anyway.  And, in that case, the problem for the lender is that basically all that the modification is doing is delaying the eventual foreclosure.

"The second problem is more subtle; it is what we call self-cure risk.  Self-cure risk is the possibility that the lender is going to make a concession to a borrower which will reduce the amount  that they will eventually recover, to a borrower that would have recovered anyway.  And, in fact, even in this very bad period, through the end of 2008, we still find that a substnatial fraction of the borrowers, in spite of getting no assistance from the lender, manage to become current again a year after becoming seriously delinquent."

Willen says that the banks are doing their best to make a profit.  "The banks are maximizing profits.  Banks are doing what banks do, and in a lot of cases, that means doing nothing to help the borrower."

So far, Obama’s plan has only helped about 50,000 homeowners, though 4 million were expected to take part.  Separately, there has been a proposal made to give the money directly to homeowners.  Willen says that unemployment insurance is a good indicator of those that will need assistance with their mortgages.   His plan is to target those borrowers that have no income due to loss of employment.

"The alternative that we propose is basically to target borrowers who have no income.  And, in that case, the government is either giving or lending money to the borrowers to help them make those payments until they can either get another job or somehow resolve whatever the income disruption is that is preventing them from making their payments."

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