Mar312010

Loan Modifications Succeed by Increasing Borrower Entitlements

Lenders really need to let go. They blew it. It’s over. Just let it die. Both the lender and the borrower pay a price — or at least they are supposed to. Instead, we bail them out, and we pay the price. Don’t forget about us who pay for their mistakes.national_squatters_entitlement

Part of the price we pay is obvious in the accounting for the various bailouts, but much of the price we pay is hidden in higher home prices, greater public indebtedness, and in the subsidized entitlements of borrowers everywhere.

Government backed loan modification attempts are ill-conceived because bailouts create moral hazard. However, the bailouts and the resulting moral hazard can be disguised inside the black box of obfuscation and paperwork of the HAMP program. If the banks and bureaucrats raise the standard of entitlement allowed under the loan modification program, more people will qualify — and more people will be sustaining their indulgences on your tax dollar.

If people are not forced to cut back discretionary spending before they obtain a government bailout, taxpayers are subsidizing their discretionary spending. The standards of what constitutes discretionary spending from essential spending depends greatly on the the spender’s sense of entitlement.

Personally, I really like to play golf. (I am on the course today for “business.”) I don’t spend the $150 per week I would like to on golf because it isn’t an entitlement, and I can’t afford to treat it as one. However, if I owned a house loan, and if my sense of entitlement made it right, I could consider my weekly round of golf an essential. Since this entitlement creates a hardship for me, I can petition my lender for a break on my loan payments. After all, their loan payment is discretionary spending and the US taxpayer is picking up the cost.

Do you see the problem?

Everyone draws their own conclusions about what is essential and what is discretionary. The reviewers of the HAMP programs have broad guidelines and common sense, but they will succumb to the political pressure to get results and push people through the system. The HAMP program reviewers path of least resistance is allow petitioning borrowers their indulgences when borrowers ask for loan modifications. The HAMP program reviewers will achieve great results — at great taxpayer expense.

To understand what is causing this problem, let’s review the HAMP program courtesy of Calculated Risk and his contributor Shnaps:

HAMP applicants tanned and juiced

CR Note: The following is from long time reader Shnaps. Shnaps has been working in the mortgage industry in various capacities “since people were extending the antennas on their mobile phones”. Shnaps currently serves in a key role related to HAMP at one of the largest non-prime mortgage servicers in the Nation.

Shnaps writes:

One aspect of the Making Home Affordable loan modification program known as ‘HAMP’ is almost always taken for granted in its wide reporting – that the borrowers in fact need ‘help’. Moreover, it is generally taken for granted that those seeking modification under HAMP simply cannot afford their monthly mortgage payment. It is assumed that they have made great sacrifices, assumed they have already cut back drastically on discretionary expenses, assumed that they have already gone over their monthly budgets with a fine-toothed comb to eliminate all but the most necessary expenditures in an effort to keep their home. So prepare to be shocked – shocked! – as I share with you that I have seen first-hand that this assumption is oftentimes greatly, seriously flawed.

Since many frugal homeowners and renters, particularly the unemployed or underemployed, have no access to entitlements loan owners take for granted as part of their privileged lives, there is an assumption that the high fliers will have their wings trimmed back to the same standard of living as the workers who are paying the bills.

Since I don’t send my child to a private school, I assume that if my tax dollars are going to subsidize a loan owner’s mortgage, that loan owner would need to take their child out of private school before my subsidy kicks in.

Not so.

At least, not for long. The current standard does require borrowers to demonstrate they have abandoned their entitlements, and big surprise, they are not willing to cut back! People want their loan modification in order to maintain their entitled lives.

Let me begin with a word to the wise for HAMP applicants: unless you believe Snooki is now in charge of approving HAMP applications, it might be a good idea to cut back a bit on some of the creature comforts to which you have become accustomed at least a month before submitting your HAMP modification application.

Allow me to explain. The guidelines for servicers participating in HAMP stipulate that the borrower must submit a “hardship affidavit”. This, ostensibly, is to serve as their sworn testimony that they have been driven into default due to some particular hardship they encountered, and despite making every possible sacrifice, they can no longer “maintain payment on the mortgage and cover basic living expenses at the same time”. (see HAMP Directive)

To demonstrate this, applicants are required to submit recent paystubs and bank statements. The statements are to help further corroborate the income they report (lest they forget to include all of their paystubs) and also to demonstrate that their monthly expenses are as described on their application. Which is to say that they have already ‘cut back to the bone’ and STILL are unable to make ends meet.

So how do these look in practice? The very first ‘HAMPlication’ that your correspondent pulled up recently showed a wanton disregard for minimizing spending. On the contrary, it looked like “cutting back” for this applicant does not involve such Draconian cuts as eliminating:

• visits to the tanning salon
• the nail spa
• some kind of gourmet produce market (have you seen the price of arugula?)
• various liquor stores
• A DirecTV bill that must involve some serious premium programming or pay-per-view events (or both?).
• And over $1,700 in retail purchases, including: Best Buy, Baby Gap, Brookstone, Old Navy, Bed, Bath & Beyond, Home Depot, Macy’s, Pac Sun, Urban Behavior, Sears, Staples, and Footlocker.

And that was just in one month! They were seeking to reduce a $1,880 mortgage payment that had just gotten to be a real cramp to their ability to keep a roof over their heads.

This woman could stock Mariah Carey’s closet….

I have documented hundreds of cases of HELOC abuse and borrower entitlement. We know many people took on Option ARMs as a way to reduce their housing cost below rental parity, and most of these people would take out another if they were still offered. Between the payment savings and the HELOC abuse, many borrowers built lives of luxury and entitlement that they don’t want to give up. They are owed it; it is their borrower’s birthright.

I’d like to say this is the exception, but it’s much closer to the norm. Many people who request HAMP modifications submit bank statements that demonstrate little if any “belt-tightening” going on.

Somehow, we now expect the same people who asked for ‘liar’s loans’ to be truthful on when it comes to ‘hardship affidavits’?

I discussed that phenomenon in Reverse Liar Loans. The incentive to lie is huge, and now it is on the other side of the ledger.

Success of HAMP depends on expanding entitlement

The success if HAMP is hampered by the standard of entitlement. The only way to increase the effectiveness of HAMP is to increase the lifestyle entitlement allowed under the system; otherwise, borrowers are going to walk away.

Let’s say the woman in the above example told the lender, “No, I refuse to give up the spending. If you don’t modify my mortgage, I will continue to squat until you foreclose.” Some borrowers are using attorneys to send this message right now. The banks are too overwhelmed with foreclosures to bargain so they amend-pretend-extend until such time they can force the borrowers out.

HAMP must succeed

In any negotiation, you must know your next-best alternative to a negotiated agreement. For lenders, they have two options: (1) allow the borrower to squat in the home, or (2) foreclose and take the losses. Option one is appealing if they can get the borrower to agree to repay later — empty though that promise may be. Borrowers know this, so they use it to game the system. Option two used to be unavailable because of depleted capital ratios and government moratoria. It is still not desirable, but now lenders are strong enough to foreclose if they determine the borrower is truly a deadbeat.

If you assume straight-line increase in the foreclosure rate, they will foreclose on less than 300,000 borrowers. They currently have 1,200,000 in default, and that number is growing daily.

7,500 — January, 2010
10,375 — February, 2010
13,250 — March, 2010
16,125 — April, 2010
19,000 — May, 2010
21,875 — June, 2010
24,750 — July, 2010
27,625 — August, 2010
30,500 — September, 2010
33,375 — October, 2010
36,250 — November, 2010
42,000 — December, 2010
282,625 — Total 2010 BofA foreclosures

When you consider the math, Bank of America — and this goes for the other lenders who are all in the same difficult spot — must have the HAMP program succeed. If they have to foreclose on all their delinquent borrowers, prices will be crushed — along with the entitled dreams of their owners.

 

This is particularly true in the yet-to-be-deflated markets like Orange County or the Bay area. Prices in those markets were inflated by debt, and they will be deflated by its removal. By delaying the removal, lenders hope to keep prices high and prevent the downward spiral of strategic defaults sure to accompany a price collapse.

Making HAMP work

Making HAMP succeed requires one simple thing: allow borrowers to keep more of their entitlements. Fewer borrowers qualify when the program qualifications are onerous, and the only way to reduce the burden on borrowers and qualify more for the program is to let borrowers keep their lifestyles.

We are establishing a multi-year entitlement for over-extended homeowners paid for by frugal homeowners and renters. You won’t see it — except maybe here — because the terms will be buried in some obscure HAMP agreement we needed to save the us from the second Great Depression, right?

We will let the woman in the example above keep her $1,700 a month for buying consumer goods because it stimulates the economy. We will continue to let loan owners send their children to private schools and take big vacations — live an entitled life well beyond the people who are actually working to pay for it — to stimulate the economy or some other bullshit reason.

The moral hazard we are creating is huge. Lenders know they can do whatever they want, and now borrowers know they can overextend themselves and the government will bail them out too. What incentive is there for prudent lending and restrained borrowing? None.

The rich bankers get richer; the entitled loan owners keep their indulgences; the frugal who might want to have the same lifestyles are being burdened with taxes and debt to pay for the entitled, and in paying, they deny themselves the very things the government bailouts are providing to others.

I think that is wrong.

I also think that is how this problem gets resolved.