No doubt about it, someone needed to do something to help the mainstream mortgage market improve its loan modifications.
There is a lot of anecdotal evidence that borrowers often have been extremely frustrated with miscommunication and delays on mods. And regulations have helped improve consumer communication to some extent, but mods still aren't working as well as they should.
The number of closed modifications is generally improving, at least at top players. But the redefault rate remains near 30%, according to Ed Fay, CEO of Fay Servicing.
Interestingly, it's the private investor market, not the public one, that's much better at modifications, largely due to a lack of red tape, among other things.
"There is such a huge success rate in private-money modifications. And such a horrible long-term success rate in institutional modifications," said Gordon Albrecht, senior director at the special servicer FCI Lender Services Inc. in Anaheim, Calif.
Borrower notification requirements haven't hurt that so far, he added. But as the public and private mortgage investment markets converge, it's important to remember that regulation is not a panacea, and these requirements shouldn't go too far or in the wrong direction. Procedural delays are of particular concern for mortgage investors, the government and consumers alike.
Part of the problem is that the public tends to view a modification as something with standard terms and as a right — expectations that have undoubtedly been influenced by government mods that are structured this way and are available to those who meet certain criteria.
However, the truth is not everyone can, will or should get a mod, and that creates misunderstandings and moral hazard.
"The biggest four-letter word in servicing is 'hope.' If you give someone false hope, it's unfair to them," said Faye.
Consumer advocates argue that borrowers should all have as much of a chance as possible to avoid foreclosure through modification, and unfairly depict all mortgage companies as opposed to principal reductions and eager to kick borrowers out of homes.
But the reality is that smart mortgage companies as well as consumers want to avoid foreclosures. And companies aren't opposed to principal reduction entirely, just widespread, government-mandated principal forgiveness. Even without regulatory requirements, foreclosure is expensive. It's for that very reason that private investors unhampered by red tape modify, and even reduce principal, much more swiftly than in the public market. They tend to make borrowers happier, too.
"The No. 1 thing we do is principal reduction," said Albrecht.
The problem is, what the private market can do clearly can only go so far.
Modifications can be simple when the maximum loan-to-value ratio is 65% (as it is in the private mortgage market), or if a private investor bought the loan in question at such a deep discount that it can easily give the borrower a 30% to 70% principal reduction without losing money.
But the public market can't do that, and it shouldn't.
"It's got to be a bifurcated process because your private investors are very focused on a specific arena within the market. They don't play cradle-to-grave," said Robert Shiller, senior vice president at special servicer Wingspan Portfolio Advisors (not the Yale economist).
LTVs have been dropping since the 2007-2008 downturn. But LTVs above 80%, never mind 65%, still represent more than half of originations. And both Uncle Sam and the industry think lenders aren't reaching enough first-time homebuyers for whom down-payments are a major hurdle.
Without a discount or enough equity, those who bought, insured or originated loans at "full price" tend to think longer and harder about modification because they have more to lose.
Public market modifications would be more plentiful and resilient if mortgage stakeholders could make quicker and more effective decisions about how much they're willing to cut their losses.
That's easier said than done, given that it's tough to devote resources to actions designed to cut losses rather than generate profit, but clearly better mods should nevertheless be a priority.
Making effective modification decisions at the outset isn't cheap, as it's a "high-IQ servicing, which is frankly different than what we have in a lot of organizations," but it's better than simply generating a high redefault rate that further frustrates borrowers, Fay said.
No one should get in the way of a fast, effective, fair and clearly communicated decision on a mod. And that goes for the government as well as the private sector.
Government and securitization contracts do allow for distressed loans and dwindling loan pools to exit into the private market. But the process includes some red tape that could, and should, be cut back or applied more judiciously so that it leads to more, faster, better modifications for everyone involved.
The government and securitization industry leaders should work on improving that, while mortgage companies must continue to work on improving their communication with distressed borrowers and the speed in which they effectively modify loans.