Avoiding Future Meltdowns

This is the last in a series of articles (the first of which was posted on December 9th) to discuss current problems with business practices in the home loan industry, especially with regard to loss mitigation activities.

As noted, the current home loan system appears to incentivizes loan servicers to foreclose on properties for their own benefit rather than pursue loan modifications and short sales that would benefit their clients as well as the borrowers on these loans and society at large. I believe that the system also encouranges both loan servicers and loan originators to take excessive and dangerous risks that put our entire enconomy in jeopardy.

 Accordingly, I believe the rules of the game need to be changed.  Below are some additional and/or expanded suggestions to avoid a repeat of the situation we are currently still experiencing:

1.  Avoiding Irresponsible Lending: In the conclusions of the NCLC report, they suggest that there be  additional regulations of loan products to avoid irresponsible lending.  However, regulations frequently have loopholes (both unintended and intended, and the banking industry does have a very strong lobby.)  What I believe is really needed to address this problem is the disbanding of Fannie Mae and Freddie Mac, the government sponsored agencies that guarantee home loans made by loan originators. In my opinion, these guarantees effectively eliminate most of the risk of loss to lenders from making bad loans (and that certainly encourages irresponsible lending.) At a minimum, no guarantees should be provided for non-traditional high risk loans (e.g, no doc, alternate-ARMs, etc.)
2. Not allowing loans to be “sliced and diced” to create New Securities: The creation of asset-backed securities out of risky loans that have been split and then assembled into portfolios of different risk classes can actually create more uncertainly about the value of the underlying assets (rather than reducing risk by diversification).  As a result, investors can be easliy misled as to the true risks involved. The existence of these assets accelerated the financial collapse that occurred when the housing bubble burst.
3.  Not allowing lenders to delegate the decisions on short sale or loan modifications to loan servicers: While previously mentioned, this bears repeating.  Since loan servicers generallystand to make more money in a foreclosure than in a loan modification or short sale, their interests are contrary to the best interests of the investors they represent and society as a whole. In addition, loan servicers frequently seem to be concerned with punishing defaulting homeowners even if that reduces the recovery that can be realized on the loan, and that is likely to be contrary to the interests or concerns of the investors..These conflicts of interest are best avoided by not giving loan servicers the authority to make loss mitigation decisions regarding these loans, and requiring them to submit all offers to the investors for consideration.
4. Regulate default fees reasonably related to the costs incurred (so they do not become an additional profit center for loan servicers):  As noted by the NCLC, these fees can increase the cost of curing a default to homeowners to the point where a loan modification is no longer possible. They also encourage servicers to place homeowners into foreclosure.
5. Make Retail Lending to Consumers An Activity Of Only Local Banks: The major national banks have become so large that they were “too big to allow to fail” when this problem started.  As a result we have had to subsidize them to the tume of billions of dollars, even though they shared a good portion of the fault for  many of these losses. With those subsidies (and the assumption of the losses by Fannie Mae and Freddie Mac through loan guarantees) the banks are now very profitable again while others are losing their homes and their jobs,  In addition, Fannie and Freddie are being subsidized by taxpayers (for the banks losses that they had to backstop) to the tune of $135 Billion or more currently (depending on which of the reported numbers you believe). And that number could more than double before its all over. I believe that is not something we, as taxpayers, should be paying for. Local lenders are likely to be more responsive to their clients and less likely to take unreasonable risks. In addition, to the extent that they do make mistakes, they can be left to suffer the consequences of their actions without jeopardizing the entire U.S. economy.
6.  Mandating a Modification Before a Foreclosure: As suggested by the NCLC, laws should be passed requiring that loan modifications should be considered before any foreclosure actions are started, and loan modifications should be required where they are more profitable to investors. I believe that makes a lot of sence. It reduces the damage to the economy (and to homeowners), and it ultimately allows for a recovery of some or all of the loss over time. That is, the loan modification could include a provision for a sharing of equity gains as home prices go back up (which is what usually happens over time.)
7.  Providing for Principal Reductions in the Government’s Making Home Affordable programs (and also in Bankruptcy proceedings): This is another NCLC recommendation that I agree with. They note that principal foregiveness is frequently necessary to make modifications affordable, and that they may well be justified in cases of improper underwritiing.
8. Speeding Up the Processing of Foreclosure Alternatives: It currently takes far too long for these alternatives to be concluded, which puts further strain on our economy and increases the losses being incurred. With regard to modifications, NCLC suggests that borrowers be given standardized offers (based, e.g, on their income at the time of origination and current default status) without the need for detailed underwriting. Only if the offered modification is rejected by the homeowner (e.g., due to a decline in income or other hardship), or if an initial modification fails, would detailed underwriting then be needed. The idea would be to introduce speed and uniformity, but with the opportunity for a subsequent review if the standard program is inadequate and if a further loan modification would save investors money (and, if a modification were possible, preserve home ownership.) With regard to short sales, the delay likely increases the failure rate  – i.e., most buyers are not willing to wait six to 6 to 9 months or more  to purchase a property with no assurnace that the transaction wll ever be approved. 

That’s my opinion.  What’s yours?

If you would like to add any additional suggestions or comments, please do so below.

Arthur Chatroo, Realtor®, specializes in loan modification assistance and short sales in North San Diego County California. North San Diego County Loan Modification Help, North San Diego County Short Sales, North San Diego County Short Sale Real Estate Agent, Short Sale Real Estate Agent. North San Diego County CA Short Sales. North San Diego County Real Estate Agent..]

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