Those Pesky Second Liens, and an update on HAMP

It’s been a while since we’ve talked about about those second liens and mortgage writedowns (I, II). Since then John Cassidy did some investigating and James Kwak responded to his arguments in language I still find convincing.

To recap: Writing down the second and other junior liens of mortgages, which would allow principal writedowns of underwater mortgages, would expose the stress tests of last year as a joke. There’s probably a hole in the balance sheet of the 4 big banks because they only recorded losses on second/junior liens at 15%. The second/juniors will continue to ‘perform’ because much of it is HELOC debt, which like a credit card you’ll never pay off, can have interest added to principal, without ever a real exit strategy to the debt.

So you have a decade of people underwater in their homes, unable to move to pursue new jobs, with the 1st mortgage owner willing to negotiate new terms but being blocked by the second mortgage owner, in order to pretend that the stress tests weren’t completely invalid. Instead we get the predatory lending shop called HAMP opening up, a failure for consumers and a nice little subsidy to the major banks. Everyone wonders why it isn’t working, and Treasury prays that the forbearance works and housing prices appreciate fast over the next few years and it all goes away.

So two new developments.

1) HAMP is even worse than you thought. Shahien Nasiripour, Watchdog: Obama Foreclosure Program Is Likely To Be A Failure

The most recent data show that on average, homeowners in HAMP owe $1.14 on their mortgage for every $1 in their home’s current market value, according to Treasury Department estimates cited in the report.

Yet the program doesn’t address this problem of negative equity — commonly referred to as being “underwater” — the report notes. The administration’s effort has been touted as a way to stem the rising tide of foreclosures by reducing monthly payments for up to four million troubled borrowers.

But one essential method of helping underwater homeowners — principal reductions — has not been addressed by the program. Mortgage servicers forgave principal on less than two percent of HAMP trial loans, the report notes. But before HAMP, 10 percent of servicer-sponsored mortgage modifications forgave principal, according to the report. Servicers are incentivized to lower monthly payments by getting cash for every sustainable mortgage modification.

“HAMP allows principal reduction, but it is not typically implemented in practice,” the report states.

This data had never been publicly disclosed prior to Tuesday.

The SIGTARP report on the HAMP program finds is that it might actually be reducing the number of principal reductions in the market. The average person applying to HAMP has 114% LTV on their home, so they are approaching the dangerous 120% LTV where strategic defaults skyrocket. And less than 2% of them get principal reductions. 2%! What’s the point of this again? There’s the desire to keep people in their homes, and there’s the desire to keep people in their mortgages. I think we are spending too much time and energy on the second while thinking we are doing the first.

2) I estimated what the stress tests would look like with 40% and 60% junior lien losses, and this is what I found:

A $150bn hole in the balance sheet of the major four players, which would have made the debates of last spring look a lot different. Now here’s housingwire from last week, Second-Lien RMBS Loss Projections Revised:

Moody’s Investors Service revised its loss projections for 2005-2007 second lien, subprime and HELOC-based US residential mortgage backed securities (RMBS).

Moody’s now expects cumulative losses to average approximately 25-55% of outstanding balance for non-subprime closed-end second (CES) pools, 70-85% for subprime CES pools and 40-50% for home equity line of credit (HELOC) pools. The revisions represent more than a 50% increase for expected cumulative losses on non-subprime CES, and nearly a 20% relative increase for subprime CES and HELOC pools.

Following the increased loss expectations, Moody’s placed on review for downgrade 948 tranches of second lien RMBS — representing all vintages — with an original balance of $113bn and an outstanding balance of $35bn.

Check out those numbers! Far worse than experts had thought. Is there still a major difference between retained junior liens on the books of the biggest players and the residential mortgage backed securities market (RMBS)? In the medium term, I bet those numbers are going to converge, and to the extent they don’t I bet it’s because the servicers are sweating the hell out of underwater mortgage holders.

Also Moody’s is going to go in and review around 1,000 second-lien RMBS for downgrade. I hope the quants put on Wagner before they start number crunching, because those RMBS reviews are probably going to look like this:

“Second-liens that started at an LTV of 100, held for 85 cents on the dollar, in a housing market down 30%. The balance sheets will smell like napalm.”

Barry Ritholtz calls for more foreclosures. Indeed I’ve reprinted email where homeowners are desperate to be foreclosed on, but the banks aren’t willing. I think it’s time we move on from this, make the banks eat their losses, let people rent their homes in the short-term and start rebuilding the real economy again.