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Commentary on the Real Estate Market - July 2009
by Peter L. Zachary, MAI, MRICS

On July 11, 2009, the Business Day section of the New York Times had a front page article, "A Trip to the Woodshed for Biggest US Mortgage Services". A mortgage service is the company that you mail your mortgage interest checks to. They are in charge of collecting your mortgage payments and foreclosing upon you if you fail to do so. The Times article states that the US Treasury Secretary as well as the Secretary of Housing and Urban Development (HUD) have demanded that representatives of the top 25 mortgage services assemble in Washington on July 28, 2009. The Times states that the subject of the meetings is loan modifications "specifically, the government is going to be asking - in none too friendly fashion - why the nation's big services aren't doing more to modify loans for homeowner's who are in danger of defaulting on their mortgages." The Times continues, "Back in the spring, after all, they all signed onto the administration's new Making Home Affordable program, which uses a series of incentives - not the least of which is $1,000 to the service for every mortgage they modify, to help keep people in their homes and prevent foreclosures." The Times continues: "And yet, five months later - and two years into the housing bust - the rising tide of foreclosures remains the single biggest threat to economic recovery. In 2005, at the height of the bubble, there were some 800,000 foreclosures. This year, sadly, we are on pace to see 3.5 million foreclosures with no end in sight. 'On Main Street, the recovery will begin when foreclosures stop,' said Senator Jack Reed of Rhode Island, who has been pushing the Treasury Department to get mortgage relief more quickly to homeowners at risk of foreclosure."

The Times article states: "It's not just California and Florida anymore," said Mark Zandi of Moody's Economy.com. "Foreclosures are taking place coast to coast. They're high-end homes, low-end homes, primes mortgages, jumbo loans, you name it. Foreclosure mitigation needs to be front and center." As of March, according to Mr. Zandi, some 15 million homes were 'under water', meaning that their owners' mortgage balance was higher - often considerably higher - than the value of the homes. Not all of those people will default on their mortgages. But many will. "We believe there is a general need for servicers to devote substantially more resources to this program for it to fully succeed and achieve the objectives we all share," wrote Mr. Geithner and Mr. Donovan in their letter."

However, the Times cites William Kelvie, the chief executive of Overture Technologies who said, "servicers are just not equipped to do this". The Time states, "For most of its history, the mortgage servicing industry - which is dominated by big banks like Bank of America, Wells Fargo and JPMorgan Chase - did relatively simple tasks: it collected mortgage payments, paid taxes on the properties and so on. Yes, it dealt with borrowers who were in arrears - which usually amounted to no more than 2 or 3 percent of their portfolio at any one time - but mainly it either prodded people to get current on their payments or initiated foreclosure proceedings."

The Times article continues: "Modifying loans - thousands upon thousands of loans, amounting to as much as 25 percent of a servicer's portfolio - is a much more complex task. For some servicers, the sheer numbers can 'overwhelm the system,' said Larry B. Litton Jr., the chief executive of Litton Loan Servicing, which is owned by Goldman Sachs - and which has long specialized in loan modifications. That is at least part of the reason why borrowers are having so much trouble getting their servicers to take their calls: many servicers can't cope with the volume. 'Servicers have to become full-blown underwriting shops,' said Mr. Litton. Alas, most of them so far are not."

The Times states that Mr. Litton continues: "I wish I could say that was the only reason the loan modification machinery is grinding so slowly. But the more I looked into it, the more I began to suspect there is another, darker reason. Although it would seem obvious that mortgage relief makes more sense than foreclosure for everyone concerned, the holders of the loans don't always see it that way. Many banks have less incentive than you'd think to sign off on large-scale loan modifications. For instance, many times, when a mortgage holder falls behind, he will 'self-cure' (as it's called in the trade) - and eventually get current with his mortgage. So the bank, or the servicer, often has a reason to simply wait him out. In addition, the rate of re-default on modified mortgages can be as high as 50 percent, especially if the modification is not underwritten carefully. In which case, the servicer hasn't avoided a foreclosure, but merely postponed it."

The Times stated: "Many institutions also are reluctant to do large-scale mortgage modifications because they will hurt the balance sheets. After all, once a loan is modified, the bank has to take a write-down on the portion of the loan it is swallowing. If lots of loans are modified, that means a lot of write-downs. Sure, foreclosure ultimately costs the bank more money than a modification would. But foreclosures these days take a long time - as much as 18 months in some states. And all that time the banks can keep the loans on their books at inflated values. Daniel Alpert, the managing partner of Westwood Capital, calls this practice 'extend and pretend,' In fact, he said, he has been hearing that banks aren't even willing to conduct so-called short sales anymore. Those are sales where the borrower asks the bank to sell the house for whatever it can get, and the bank in turn lets the borrower walk away from the loss that results from the sale."

"Banks are saying no because they don't want to take the loss," said Mr. Alpert. "They would rather foreclose. That is just wrong."

The Times concludes: "Starting next month, the government plans to begin publishing data showing which servicers are doing well and which are doing poorly, thus trying to shame them into doing the right thing. And, of course, there is that July 28 meeting, in which all these points will be made, I suspect, rather forcefully. Apparently, the only incentive left is a good swift kick in the rear."

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