There was an interesting article in last week’s Wall Street Journal about the success a hedge fund is having in modifying mortgages and keeping homeowners in their homes. The point of the article was to highlight a successful private market example of mortgage modifications, in this case a distressed investment fund, as compared to the highly publicized Federal programs like the Home Affordable Modification Program (HAMP).
A key difference between the hedge fund’s strategy and HAMP seems to be the willingness to reduce the principal owed on the loans. The hedge fund forgives a portion of the principal in 90% of their modifications. Federally regulated banks subject to HAMP, according to the article, are more likely to lower interest rates, give homeowners time to catch up on late payments, and extend the length of the loan. They only forgive a portion of the principal in 2% of their modifications.
Despite the strong case that the article makes for the private market strategy over government involvement, it identifies two critical factors that limit the hedge fund’s effectiveness:
1. Many mortgages have thousands of owners. Because mortgages were packaged into securities for resale, the infamous Residential Mortgage Backed Securities (RMBS) that were part of the credit crisis, it is often impossible to buy (and therefore modify) individual mortgages – they have thousands of owners.
2. Banks don’t want to recognize losses. If a mortgage does have a single owner, like a bank, then that owner has to be willing to sell the loan at a steep discount in order for it to be attractive to the hedge fund. After all, they’re doing this to make money. The strategy banks currently employ of lowering rates and extending the term allows them to push any losses into the future.
In the end there is no suggested way forward, though presumably the author would hold up the private market model as the ideal. Reports from the government itself seem to show that the Federal programs are not working for everyone either. For many homeowners, the end result is likely to be foreclosure unless the economy and housing markets bounce back quickly.
Check out the full article for an interesting story, and by all accounts a successful mortgage modification strategy for certain homeowners.
It seems the article isn’t making a strong case for private sector solutions so much as it’s arguing that loan modifications are the best way to resolve the mortgage crisis
HAMP is a flawed policy (even folks clamoring for more government involvement were criticizing it when Obama announced it), but that doesn’t mean that government intervention is always wrong. For example, there was a cramdown bill that would allow judges in bankruptcy proceedings to use principle adjustments to keep people in their homes. It was defeated after vigorous lobbying by the banks.
More here: http://online.wsj.com/article/NA_WSJ_PUB:SB124112073490174169.html
and here: http://seekingalpha.com/article/134636-another-happy-day-for-banks-cramdown-bill-fails
Ultimately the problem lies with the two issues you identified which are themselves private sector creations. The only reason this little hedge fund can do what it can is because it owns the full note on the loan.
The regulatory burden of treating mortgages like securities was a risk these private sector actors took on. Perhaps if the government had been a better referee and stepped in earlier, we wouldn’t have been in this situation…
Sujal
Thanks for the comment, Sujal. You’re right, of course, that the data in the article draws a clear distinction between modifications that include principal reductions and those that don’t. I would agree that’s the strongest case made. My (intended) point was that even the “success” the hedge fund is having is nowhere close to a universal solution because of the two highlighted limitations. Upside down homeowners are a tough challenge, and I’m not especially optimistic that we’ll find a solution that is palatable to everyone.