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Scratch and Dent Expert: Mods Won't Work for Many

While many advocates of streamlined loan modifications are scratching their heads over data showing a high "redefault" rate on modified loans, one industry insider isn't all that surprised.

Some executives, including John Daurio, CEO of Kondaur Capital, are skeptical about the prospects for mass loan modifications. Kondaur, a buyer and servicer of scratch-and-dent loans based in Santa Ana, Calif., pioneered "Combat Loss Mitigators," whereby a single collection specialist handles every stage of the resolution of each loan.

Mr. Daurio is more pessimistic than some about the prospects for a housing market recovery, predicting that nationally home prices will fall another 20% to 30% under pressure from rising unemployment and a weakening economy. He still believes the country faces two to three more years of falling home values before markets stabilize.

Already, he noted that in addition to high "redefault" rates on modified loans, many borrowers are defaulting on products such as pay-option loans before they adjust to become fully amortizing. In other words, they are defaulting before their monthly payment adjusts upward. Rather than ditching the loan contracts and modifying the loans to make them more affordable, he believes refinancing borrowers who can afford to stay in their homes into more affordable loan products is the best solution. And with interest rates on conforming, 30-year fixed-rate home loans falling to levels not seen since before 1970 in late December, many borrowers may be able to reduce their debt burden just by refinancing.

He says actually modifying existing loans only makes sense for a "marginal number of borrowers," not the large volume of borrowers who obtained problematic loan products for homes they couldn't really afford in the first place. In most of those cases, it would be difficult to create a modified loan that the borrower can afford that will exceed the net present value of the recovery from foreclosure to the investor, he said.

"The fallacy of the effort to keep people in their homes is the assumption that people are in homes they should be in," Mr. Daurio said. "I believe that, by far, the vast majority of the horror stories you have been hearing involve people who are in homes that they never should have gotten in first place with loans they never should have gotten."

As for the government's role, Mr. Daurio believes it should buy new mortgage-backed securities to help get capital flowing to the home loan sector again, rather than bailing out investors in existing, troubled MBS.

Saying economic conditions are "horrific," Mr. Daurio said that even efforts to compare the net present value of a foreclosure with a modification may be flawed, because many models used to project future default rates on new or modified loans will not be accurate given the severity of the overall economic downturn.