One of the issues I've written many columns on over the past several years has been the overhang of legacy nonperforming mortgages from the last housing crisis and the loan modification programs that were created to address the problem.
In short, the vast majority of nonperforming residential mortgages have migrated to the balance sheets of the money centers over the past several years. In the past 10 years, only about half of the nonperforming residential mortgages have been resolved.
The reason the process has taken so long is that the banks and servicers have refused, except for a very small portion of mortgages, to include principal forgiveness as part of the loan modification.
The predominant form that modification has taken is of re-amortization over extended terms, with the payment arrearage being added to the principal balance owed by the mortgagor.
For example, a loan that was originated with a $300,000 initial principal balance at a 7% interest rate and amortized over 30 years with monthly principal and interest (P&I) payments of $1,984, but has been in default for two years, would have a payment arrearage of about $50,000.
The loan modification would be a new loan of $360,000, including $10,000 added for refinancing, and amortized over 40 years at around 5%, resulting in monthly P&I payments of $1,729.
The modification is then offered on a take-it-or-leave-it basis. The mortgagors have been accepting them but the 12% reduction in payment is not material and the loans go back into default again within two years, and the process is repeated.
The loan modification programs have become a means through which banks can postpone having to accept losses, mortgagors are locked into loans they'll never be able to repay, and that ultimately increase the losses that will be absorbed by both parties, while reducing the inventory of homes available for resale.
The process has been an utter failure and was scheduled to be terminated at the end of this year, which I wrote about in the January column "Lehman Era's Legacy Issues Leave Hangover for Banks and Builders."
That, however, would have forced the banks into resolving the nonperforming loans through foreclosures, which would have forced losses to be taken, so in April the programs were extended through the end of 2017.
The plan now is to make the loan modification programs a permanent part of the resolution process for mortgagors who have defaulted.
One of the reasons mortgagors have accepted the loan modifications that actually put them deeper into debts they can't afford to repay is because of the fear of mortgagees suing them for the deficiency between what was owed and what a house was either short-sold for or sold after foreclosure for.
The point here is that in the aftermath of the last housing crisis, which was predominantly the result of the degradation of underwriting guidelines by lenders, the institutionalized corrective process at the national level has become the creation of rules that work almost exclusively in favor of the lenders.
Unlike deficiency judgments on student loans, which can't be included in a borrower's bankruptcy proceeding, mortgage debt still can be, but courts are not required to.
Only 17 states have statutes for anti-deficiency judgments or the requirement for residential mortgages to be non-recourse to individuals.
The path of the current of regulatory changes to the treatment of nonperforming mortgages implies that lenders will attempt to have national regulations enacted that will treat mortgage debt similarly to student loan debt.
In response to the stagnation in the housing industry that occurred following the last housing crisis, the money centers and government sponsored enterprises (GSEs) have developed mortgage programs to allow for smaller down payments and lower total costs of acquisition to try to stimulate activity.
That's good for the housing industry, banks, homebuyers and economy, but it also increases the potential for problems for all if home prices fall during a recession again.
The pre-emptive regulatory changes appear to be created to exclusively protect the interest of mortgage lenders in such a situation.
That creates the opportunity for a moral-hazard situation in which lenders again offer mortgages that do not reflect the real risk of default, as was the case with the promotion of the subprime mortgages during the mid-2000s.
The situation is fluid but it bears monitoring by investors in companies associated with housing industry.