Why Are Banks Foreclosing?
Mike Konczal makes a familiar point today about the HAMP program, which was supposed to help reduce home foreclosures but, in fact, has accomplished close to nothing:
Obama's Treasury team took a system that had a terrible design and doubled-down on it. Servicers aren't modifying mortgages. There's an active empirical debate we'll cover next week over whether or not servicers are not modifying mortgages because of information problems or becomes of adverse incentive structure — or if you don't speak economics, whether or not the servicers are dumb or corrupt. What was meant to be a passive, thin, pass-through vehicle with obvious conflicts of interest now has to actively manage a giant portfolio of troubled mortgages. And they are either unwilling or incapable of acting as a fiduciary for investors and getting mortgages back to being current and working.
Well, I for one look forward to next week's discussion of this. As I understand it, the basic problem is that loan servicers can make a lot of money by stringing homeowners along, raking in a lot of fees along the way — for insurance, appraisals, title searches, legal services, etc. — and then eventually allowing them to default anyway. The basic story is here. To some extent, then, what's happening is understandable: the incentives are lousy and companies are simply making money on other people's misery. Nothing new about that.
And yet....somehow this has never quite added up. I don't doubt that loan servicers are in business to make money and don't really care if homeowners suffer or not. That's pretty commonplace corporate behavior. But they are in business to make money, and if there's one thing banks are good at, it's figuring all the angles when it comes to making a buck. If, in the long run, principal reductions really, truly were the most profitable way to deal with underwater homeowners, I'd expect that not only would banks figure this out pretty quickly, they'd be figuring out ways to create securitized bundles of principal reductions to sell to gullible German investors. That well can't be completely dry, can it?
So why hasn't this happened? There are a couple of obvious possibilities here. One is that the complicated nature of mortgage securitization simply makes principal reduction too hard. Once the loans have been securitized, tranched, retranched, and re-retranched, there are so many note holders with a legal stake that it's all but impossible to get unanimous agreement to do a principal reduction. Another possibility is that banks are afraid of knock-on effects: once they start reducing principal in a few cases, their entire customer base will find out what's going on and start withholding payment in hopes of getting the same treatment. Reducing principal for 10% of their customers might make sense, but banks might be afraid that there's no way to hold the line there.
However, this is just uninformed speculation, and I await Mike's more informed take on this. One way or another, though, it's hard to believe that banks are really, truly passing up a win-win opportunity here. There has to be more going on.