Previously, I posted an article which discussed stresses upon the housing market, current and future, and how the stresses were going to interplay with the housing recovery. Items were discussed in a very general nature, but no actual attempts to suggest how to resolve such issues were presented. Now, it is time to begin to address such issues.

To suggest solutions, the problem must be adequately defined. It is not enough to say we must stop foreclosures, or that homes are overvalued, or that banks are not lending. The root causes of such must be identified, accepted, and solutions built around those root causes.

To recap, the basic challenges, though not all, are:

• Homes are still overvalued in most areas of the country.
• People are defaulting from not being able to make payments.
• Wages are not increasing, and in fact, when inflation is factored in, real wages are falling.
• Few people can qualify for loans.
• Investors and lenders are afraid to loan money.
• The economy is not getting better.
• Demographic changes.

There is no “one size fits all” solution. Each problem will require several different approaches to meet the challenges of all parties involved. Some problems can be met with “short term” fixes, but in far too many cases, the fixes will be long term, if not generational in nature. In fact, many of the problems will likely involve a major restructuring of how housing and economic factors are viewed, and addressed.

There are two points that I must make now: (1) I will not be going into detail about how we got to this point in time. Many books have been written about where housing went wrong in the 1990’s and the 2000’s. A rehash of the details is not germane for the article. (2) There is no point in what I write to laying blame to individuals or entities involved in what went wrong with housing. What is important is to begin laying the foundation for the recovery of housing and the economy as a whole.

To correct the problems related to overvalued homes and to the inability of the people to afford homes, we first need to address how to deal with the foreclosure crisis, and also how to restart lending for home purchases. Though these are symptoms of the underlying problems, they form the basis for resolving current pressing issues that can help achieve some stability in the market.

To date, it is believed that there are 6.5 million homes delinquent in their mortgage payments and it is believed that another seven million are potentially at risk. 90% of the homes that are delinquent will end up in foreclosure. Efforts to resolve the issue so far have ended in either dismal results or abject failure. What can be done is the pertinent question?

No one or two policies or programs will solve this issue. What must be taken as a variety of steps are different programs to address the various issues that are related to being able to do a modification of a loan. One cannot just simply say “let us modify the loan and go on our merry way”. Too many complicating factors exist to prevent such a simple solution. So to attack the issue of foreclosures, we must first outlined the parameters that need to be considered to doing any modification. These parameters will determine the types of programs that may be implemented with success.

The first parameter is to determine the conditions and restrictions that allow for any modification to occur. Investor servicing agreements may allow for modifications, principle reductions, or may not allow for in any modification. These terms must be strictly adhered to contractually, unless negotiations can offer other terms.

The second parameter is to understand that portfolio lenders are under different constraints. They must maintain profitability and adequate liquidity for continued operations. Profitability means earning enough to income to keep the doors open. Liquidity means having enough cash reserves to meet losses and other expenses. Herein lies the problem for lenders doing principle reductions. If a principal reduction is granted, the reduction must be treated as a loan loss, and liquidity reserves are thereby affected. Do enough principle reductions, the lender opens the door for the FDIC or other regulatory agency to walk in and shut them down.

The third major parameter is whether or not a borrower can qualify for a loan modification. A true financial analysis must be done on each borrower. This analysis must determine the overall financial condition of the borrower, and not just focus on the mortgage debt ratio. Additionally, the property and the local housing market must be thoroughly evaluated to determine true home value, as well as what can be expected in the market in the near and intermediate future. One must reasonably forecast whether or not home values will fall further and by how much. This is because it is well known that with loans at 125% or greater loan to value, the likelihood of default increases greatly, and therefore to modify to fair market value when home values will continue to fall only puts off the problem for a period of time.

Prior to the housing crisis, it was typical that if a homeowner was in trouble, he would default on the credit cards and other debt but would continue to make the housing payment. This scenario is no longer the norm. Today, it is much more likely that the homeowner will continue to pay the credit cards and not the mortgage. So a careful evaluation of other debt and its effects must be done. What must happen is to develop a reasonable conclusion as to the likelihood of default of a borrower based upon any modification scenario. At that point, the decision can be made on what, if any, modification and/or principal reduction is to occur. If none can be done, then other alternatives must be considered.

The final parameter is strictly for the homeowner to decide. In the U.S., There is a love-love relationship with regards to homeownership. This is the modern “American dream.” However, if the homeowner was take a realistic look at whether it makes sense or not to attempt to hang onto a home when in default, a different picture would often emerge.

If a home is seriously underwater, by 125% or more, a true and realistic evaluation of homeownership must be made. For large numbers, it will be decades, if at all, that a homeowner will be back to 100% loan to value. And it is not reasonable to expect that home values will increase to what they were prior to the housing crash. As a result, one must take a look at whether it makes sense to give up the home in foreclosure, wait 4 to 5 years, paying less in rent, and then buying a home again after the market has stabilized.

At a certain point and, homeownership must be viewed as a financial decision. As with stocks, if you have lost money on a stock, and you know it’s going to drop further, if you do not hang on to the stock. Instead, the sell the stock, take the losses, and by another stock or investment. At some point, that is how you must look at housing.

The most immediate concerns now are the actual foreclosure crisis. What can be done to resolve the issues? As indicated before there is no one answer. Instead a multitude of approaches must be considered, and the individual decision made based upon the borrower and housing market characteristics. Anything else will not work.

We have seen several different programs advanced by the government to promote resolution of the crisis. The programs have usually met with dismal failure, or at the minimum very poor results. The programs are rife with controversy, and many of the same programs are now seeing litigation against servicers for claims of poor performance when in fact it was standards by which the programs were set up by the government which has led to the poor performance. What must be done is for private industry to develop a true working relationship with the lenders and servicers for a common good. Instead of coming at the problem with an adversarial relationship, and homeowners, their attorneys, and modification companies, must seek to provide a “win-win” scenario for all.

(At this time, a significant point must be made. Homeowners, attorneys and loan modification companies all generally gather paperwork and then submit the paperwork for a lender’s evaluation. This does not help the homeowner, because the decision is left to the lender, and the lender’s proclivity is to say no. Instead, the homeowner or his representative must develop a plan to counter this tendency. Offer different scenarios that would be acceptable to the homeowner, and would also benefit the lender. Make the scenarios realistic. Create a “win/win” situation for all involved. Do not create an adversarial relationship. Give the lenders a reason to say “Yes”, and not to say “No”.)

Now, we can consider programs to alleviate some of the stresses of housing.

Foreclosure Relief Through Modification of Investor-Owned Loans

Two factors are the immediate key to lessening the foreclosure crisis for homeowners. They are (1) the ability to repay the loan, and (2) negative equity. Each contributes to foreclosures, together or separately. But, these factors are not the only factors that must be considered. Servicing Agreements, liquidity issues, litigation, and other factors will weigh greatly on individual decisions. Any solution will need to take into consideration all relevant factors.

Ability to repay the mortgage loan can no longer consist of just achieving a 31% Housing Debt Ratio for a homeowner. Studies have shown that homeowners will still default in great numbers, unless all other debt is subjected to “resolution services”. Simply put, at a certain point, if the homeowner cannot service all debts, he simply “gives up” and walks away. Additionally, underwater loans, especially above 125% loan to value, show significantly increased likelihood of default. So, foreclosure resolution must address these key issues.

Lenders and investor issues must also be taken into consideration with individual loans. The conditions that determine the terms allowing for loan modification must be considered and incorporated into any individual decision as well.

To meet the conditions for ensuring successful loan modifications, the following steps need to be taken. (Note that for many, there will be no available solution, and those situations require different tactics, including allowing the foreclosure to occur.)

A comprehensive plan to restore a homeowner to financial stability must be developed and executed. This plan will not only reduce the Housing Debt Ratio to 31%, but it will also seek to either lower or eliminate the Second Mortgage, and will also involve “Debt Resolution” services to reduce or to eliminate revolving debt. A trial modification will be started on the first mortgage with the understanding that certain goals for second mortgages and revolving debt must be achieved for the trial modification to be made permanent. (It is possible to determine the typical outcome of most second mortgages and revolving debt settlement prior to entering into negotiation, and those outcomes should form the basis of the trial modification.)

The terms for the first mortgage modification must be reasonable for all parties. The terms must offer favorable outcomes for the lender/investor, as well as the borrower. The key is to make it a “win/win” scenario for all.

Terms considered must include principal reduction, principal forbearance, interest rate reduction, extensions of payment, re-capitalization of delinquent payments, and other factors. Nothing should be automatically excluded, unless restricted by contractual agreements. (Principal reduction requests should not be an automatic demand for Fair Market Value. Reductions should be carefully considered to benefit all parties, and to lessen default risk.)

Attorneys and legitimate loan modification companies will need to be “front and center” with this program. They can properly evaluate the client, and determine what outcome is reasonable for both the client and the lender, if they take the time to do so. They prepare the paperwork fully, including reasonable terms, and turn the “adversarial relationship” to a “mutually beneficial relationship”.

The absolute key to accomplishing this program will involve being factually correct and honest with the lender. It will require a true “default risk analysis” of the loan at origination, at the current moment in time, and finally, based upon the terms of the trial modification offer. The “Default Risk Analysis” must show that the default risk has been greatly reduced.

When the Homeowner Does Not Qualify for Modification

When accessing a homeowner for modification, we must be honest. There will be far too many times that a homeowner will not qualify for a modification no matter what terms are offered. This may be simply for employment reasons, medical, or any number of other reasons.

The attorney or loan modification who is reputable knows when there is no likelihood of modification. For these clients, they should not submit modification requests that have no likelihood of success. Instead, they must prepare the client for the inevitable loss of the home, and take steps to help the homeowner achieve this result with the least stress and humiliation possible.

There are many different methods that can be utilized for effective relief. We have all heard of these methods, so I shall not endeavor to discuss them. What is important is that the homeowner be steered into these legitimate and effective solutions.

A Program for Portfolio Lenders

Portfolio lenders and investors are faced with particular issues. Usually, the portfolio lender is a bank or other similar institution that is subject to government regulations, including liquidity requirements. Because of liquidity issues, it is not possible to engage in large scale principal reductions. To do so would destroy liquidity requirements and could “invite” the FDIC or OCC in to review the books, and either force a buyout of the lender, take over by the FDIC, or closure. Since many of these lenders are “local or regional” banks, this is not an outcome to be desired. There is a potential solution.

There are many groups of investors present with substantial money available to purchase “distressed properties” whereby the homeowners are in default. Usually, they partake in FDIC auctions or similar actions. Other groups of investors are present who are looking to invest money in different entities to generate income and Return on Investment. It is time to bring these parties together with the portfolio lenders.

The purpose of bringing all parties together is to create the “good bank – bad bank scenario”. Individual mortgage loans will be evaluated to determine the default risk of any one loan. Depending upon the risk level, the loan will be identified and placed into a separate category. Once all loans have been evaluated, a true value can be established for selling the loans to the “purchase investor”. At the same time, the “income investor” is included to determine what capital infusion will be needed to support the lender when the loans are sold. An agreement is reached whereby the loans are sold and the new capital is brought into the lender, to keep the lender afloat and also strengthen the loan portfolio.
The homeowner will receive significant benefit with this program. The “purchase investor” should have bought the loans for between 25 and 40 cents on the dollar. They can then negotiate with the homeowner, offering them significant principal reductions and lowered payments, while still having loans with positive equity. Default risk will have been greatly reduced, and all parties will have experienced a “win-win” scenario.

Bank Purchases with Shared-Loss Agreements

Banks that failed and were purchased by other banks pose a completely different issue. The terms of the purchase include what is commonly known as “Shared Loss Agreements”, whereby the purchaser and the FDIC share in any losses caused through foreclosures. I have been a vocal critic of these agreements in that they favored immediate foreclosures over loan modifications.

It is now time to consider enacting programs with the purchasing banks to make it more favorable to provide loan modifications to qualified homeowners. This would mean governmental financial incentives that would essentially match or exceed the loss sharing agreements, so that the lender finds it beneficial to modify loans, and not foreclose.

Now, this “recommendation” is sure to raise a furor over just the thought of providing such incentives, but it must be done. Here is the reasoning behind my thoughts.

By now, most of the lenders are being reimbursed at a 95% loss rate for each foreclosure. This amount is far greater than what is achieved through the modification process. Since the taxpayer is taking the losses anyway, why not use the “loss money” and create a program that will keep the benefit to the lender equal to foreclosure, but it allows the homeowner to stay in the home? It is the same money, whether it is a loss by foreclosure, or by modification.

The effects of such a program would be to allow many homeowners to stay in their homes with affordable payments and loan balances. It would reduce the number of foreclosures, which would provide less stress on the housing market. Home values would continue to fall, but that is going to happen no matter how many loans are modified.

Summary

I have tried to present a “balanced” and “effective” methodology to treat the foreclosure symptoms of the housing crisis, covering the next few years. The methods and programs would serve to lessen the severity of the foreclosures, now and in the near future.

Much of what I suggest will be found to be very controversial by many, but that is because the focus for many is to “punish” the perpetrators, without regard for the consequences to the entire U.S as a whole. It is time to move beyond “anger” and “punishment” and instead to focus on how to resolve the problems in an effective manner, with the least disruption to the economy.

My next piece will go into trying to stimulate lending, and the steps that must be taken to restore investor confidence in lending.