One of the great puzzles – and frustrations – of the unfolding mortgage crisis has been the unwillingness of loan servicers to substantially modify mortgages to keep families in their homes, even when it would appear to be in everyone’s economic interest to do so. As Eric Hangen observed in another Open House blog posting, a non-performing loan can be modified into a performing fixed first mortgage at a lower, more affordable level, and a silent second mortgage for the balance of the principal that will be repaid when the home is sold, along with a portion of home price appreciation.
The net return on this model is likely to be much higher than would be realized through a foreclosure fire sale, but due to the fragmented and sometimes conflicting interests of servicers and investors, the unwillingness of some second mortgage lenders to permit modifications, and legal concerns about the pursuit of alternatives to the tried-and-true route of foreclosure, these and other substantial loan modifications are not being made in nearly the kind of volume needed to resolve the crisis.
But now that the Administration has proposed creating a new entity to buy troubled mortgages, there may be an opportunity to fix these problems and ensure that loan modifications occur at a much higher rate. Once the government owns the loans, it should have both the clout and the economic incentive to ensure that sensible modifications are made that both keep families in their homes and maximize returns to the taxpayers.
An article by the Center for American Progress suggests the powers that may be needed to make this happen. Others (see, for example, this piece by the Heritage Foundation) argue that the new entity’s role should be more limited.
The tie-breaker has to be the best interests of the nation, and in my view, it’s clear that loan modifications that maximize the long-term economic return to the taxpayers while keeping families in their homes and minimizing negative spillover effects on communities with large numbers of troubled loans are a win-win for everyone.