Underwater and the Strategic Default PR Campaign, 1: Fannie and a 7-year penalty.

Wow. Fannie is jumping ahead of Congress in going after Strategic Defaulters without (a) identifying who they are even quasi-rigorously and (b) identifying how big of a problem this is, and how this isn’t just piling on people experiencing deep income shocks in a major recession. Fannie Mae Increases Penalties for Borrowers Who Walk Away: Seven-Year Lockout Policy for Strategic Defaulters:

WASHINGTON, DC — Fannie Mae (FNM/NYSE) announced today policy changes designed to encourage borrowers to work with their servicers and pursue alternatives to foreclosure. Defaulting borrowers who walk-away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure. Borrowers who have extenuating circumstances may be eligible for new loan in a shorter timeframe….

Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments. In an announcement next month, the company will be instructing its servicers to monitor delinquent loans facing foreclosure and put forth recommendations for cases that warrant the pursuit of deficiency judgments.

Troubled borrowers who work with their servicers, and provide information to help the servicer assess their situation, can be considered for foreclosure alternatives, such as a loan modification, a short sale, or a deed-in-lieu of foreclosure. A borrower with extenuating circumstances who works out one of these options with their servicer could be eligible for a new mortgage loan in three years and in as little as two years depending on the circumstances.

A few initial thoughts with lots of graphs.

1) Why don’t they cramdown these mortgages? Why don’t they do a Right-To-Rent process? “Loan modification” has turned out historically to increase the balance of the loan by capitalizing fees and then just spinning out the length of the loan.

We know from HAMP analysis, specifically carried out by Analysis of Mortgage Servicing Performance, that 70% of modified mortgages have a principal increase (data discussed here):

And that a surprising amount of them redefault a year out:

There is no working definition of predatory lending, but a loan that has a negative amort (increases the balance) and a person is unlikely to be able to pay seems like a good working definition of predatory lending. If the GSEs are going to pressure people into modifications, I wonder what their expectations are of how much principal will be reduced and how likely it is people will immediately redefault. We didn’t do this with HAMP, even though we should have, and HAMP is a disaster nobody will stand by.

Reducing principal, especially cramming it down to the market rate, is a plan to save a mortgage and get homeowners back on track. Modifications have a history of kicking a serious problem 10 yards down the road. And don’t be mad Fannie, but the “we’ll just kick the can for now” solution seems right up your alley.

2) Annie Lowrey has a good catch in When Underwater Homeowners Walk Away, with this Federal Reserve paper The Depth of Negative Equity and Mortgage Default Decisions:

After distinguishing between defaults induced by job losses and other income shocks from those induced purely by negative equity, we find that the median borrower does not strategically default until equity falls to -62 percent of their home’s value. This result suggests that borrowers face high default and transaction costs. Our estimates show that about 80 percent of defaults in our sample are the result of income shocks combined with negative equity. However, when equity falls below -50 percent, half of the defaults are driven purely by negative equity. Therefore, our findings lend support to both the “double-trigger” theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest.

The median 2006 borrower from the four housing disaster states doesn’t strategically default until LTV is at 162, and even then it is mostly from income shocks (unemployment, health care, etc.). For what it is worth, we ran some numbers here:

And if you are an LTV of 160, it will be, under generic estimates, a range of around 8 to 12 years until you are above water. You “own” (and have to upkeep) a place you are a decade out from owning. So a 7 year penalty has to be taken in context.

That paper has issues that could be extrapolated (we don’t need the median borrower to walk away before we have major problems), but it’s important to us to have a clear sense that there is an actual problem here, as opposed to the income shocks of near 20% underemployment.

3) Fannie is saying homeowners should be working with the servicers here. And they should. But it is worth noting that even when we bribe servicers to “nudge” them, as we have done in HAMP, we still don’t actually get principal cuts. Shahien Nasiripour has just found, “As few as 0.1 percent of mortgage modifications initiated under the Obama administration’s signature foreclosure prevention program involve reductions in principal, according to a federal report released Wednesday…A January report by the State Foreclosure Prevention Working Group noted that principal reduction is the best way to stem the foreclosure crisis.” Usually these involve payment increases, unless they lengthen the period of the loan, which means more time underwater.

HAMP, the Obama adminstration’s foreclosure prevention program, has gone from “look busy” to “not working” to utter, complete disaster. A complete waste of time, resources and energy. And Fannie now wants to replicate it. Let’s see how this goes.

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8 Responses to Underwater and the Strategic Default PR Campaign, 1: Fannie and a 7-year penalty.

  1. bdbd says:

    Isn’t a policy to discourage strategic default (if lenders are not particularly helpful) a “You’re screwed? Stay screwed!” policy ?

  2. MNPundit says:

    Essentially, this company which is not really a government entity, is now trying to force homeowners to make their personal finances worse. Scum.

    Fuck ’em.

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  4. ace says:

    I’m all for consumer protection, but I would be inclined to think this type of move will target real estate investors. In the instance where this punishes an actual homeowner who defaults and starts renting as an alternative, they will have done so with the fact in mind that they are no longer interested in owning a house, and may not be 7 years thence.

    A ban on a strategically defaulting real-estate flipper/investor would inspire them to stick it out, or be out of business for nearly a decade. But that’s me being a bit optimistic.

  5. Friedman's Ghost says:

    These type of stories confirm my position of being agains financial literacy educaiton. As financial complexity has increased it has become apparent consumers’ ability to understand it has lead to dire circumstances. In response, we feel education turns consumers into “responsible” and “empowered” market players. They become motivated and competent to make financial decisions. However, this belief lacks empirical support.

    The U.S. Department of Labor’s Taking the Mystery Out of Retirement Planning booklet guides individuals over the course of 62 pages and through eight worksheets to determine how much they need to save monthly to retire in ten years.

    To complete the worksheets, consumers must find over 100 pieces of data from other sources, predict their monthly expenses in retirement, predict rates of return so as to select growth and income conversion factors for each of their assets, and repeatedly add, subtract, and multiply these figures.

    People are often unable to recognize their biases and prevent the effects of these biases on their decisions, even when taught about them.

    American culture has long viewed personal finance decisions as reflecting character traits of responsibility, trustworthiness, self-control, industry, frugality, and wisdom.
    Financial decisions are either “good” or “bad.” Financial behavior is either “responsible” or “irresponsible,” “healthy” or “unhealthy.” Consumers with late payments, like juveniles who commit crimes, are “delinquent.” Poor financial behavior is seen by some as reflecting mental instability.

    Financial literacy education as a policy tool blames the consumer for her own plight, but shifts from an indictment of raw moral character traits to the consumer’s “choice” about whether to attend classes and use the information and skills purportedly taught.

    Sorry for the long post but as someone at a University engaged in financial literacy I cannot help it.

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  7. Pingback: HAMP Comedy: Requiring a Death Certificate for a Modification Edition. « Rortybomb

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