The Housing Death Spiral

In fairness, the new Obama Administration housing policy has not had the time to work. But judging on past performance, and based on the fact that principal reductions aren't really part of the Obama plan, I would expect the same results:

Mortgages modified in the third quarter failed at a faster pace than those revised in the first, and the delinquency rate on the least risky loans doubled, signs of deteriorating credit quality, U.S. regulators said.

Loans modified in the first quarter to help borrowers keep their homes fell delinquent 41 percent of the time after eight months, and second-quarter loans had a 46 percent default rate, the Office of the Comptroller of the Currency and Office of Thrift Supervision said in a report today. Third-quarter trends “are worsening,” the agencies said.

“For the year and this quarter, we saw the same trend that we saw last time: quite high re-default rates, no matter how we measured them,” John Dugan, the U.S. Comptroller of the Currency, said in a conference call with reporters.

Lenders including Citigroup Inc. and loan-servicing companies are adjusting mortgages by lowering interest rates or crafting longer-term payment plans. The Obama administration is acting to help as many as 9 million struggling homeowners by using taxpayer funds to pay lenders such as bond investors, mortgage servicers for reworking the mortgages.

Dugan said higher re-default rates are likely related to stressful economic conditions and new loan plans are not producing significant reductions to make mortgages sustainable.

It's frustrating, considering that banks aren't even acting in their own best financial interest. Given the falloff in the market, foreclosing a home and reselling it would return less money than reducing principal and letting the homeowner stay in the home. But the loan servicers don't seem to want to deal with unwinding the securitization of the loans, and deal with potential lawsuits from writing down their security.

Why isn't that happening? Ah, those pesky securitizations. Although investors litigating to block mods is the oft-given reason for not taking this course of action (a presumed to be high number of securitizations either bar or restrict mods), my impression is servicers simply have not wanted to fight this fight (they have clearly defined compensation in the case of foreclosure versus no rewards for mods, save the fees under new government programs). Paying legal fees to fight investors is an even more dubious business proposition (it's a near certainty they can't charge those expenses to the securitization trust, and it would thus come out of their bottom line).

That is a long winded way of saying I doubt that there has been much study by legal talent as to how to overcome mod restrictions in servicing agreements. Given the high level of fraud (in a small sample, Fitch found evidence of fraud in every loan file it examined), there might be ways to persuade investors they have more to lose than gain by pursuing this line of legal action.

Major banks and financial firms won't even work with mortgage brokers anymore, suggesting that the entire market is hopelessly broken. New rules and standards for loans going forward are on the way, but that does nothing for those struggling to make payments right now.

The answer is, and has always been, to allow bankruptcy judges to modify the terms of the loan, which would encourage the loan holders to work out a deal. But while that passed the House, the Senate "moderates" have refused to move forward because the corporate interests holding the strings on them have refused to allow it.