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Sep 16 2012

Banks Responsible for 800,000 Unnecessary Foreclosures

A new study by the Federal Reserve Bank of Chicago and several academics has concluded that banks that were poorly staffed and whose employees were inadequately trained were responsible for 800,000 foreclosures that were unnecessary and could have been avoided with loan modifications through a federal program.

The study’s authors — from the Federal Reserve Bank of Chicago, the government’s Office of the Comptroller of the Currency (OCC), Ohio State University, Columbia Business School, and the University of Chicago — arrived at this conclusion by analyzing a vast data set available to the OCC. They wanted to measure the impact of HAMP, the government’s main foreclosure prevention program.

What they found was that certain banks were far better at modifying loans than others. The reasons for the difference, they established, were pretty predictable: The banks that were better at helping homeowners avoid foreclosure had staff who were both more numerous and better trained.

Unfortunately for homeowners, most mortgages are handled by banks that haven’t been properly staffed and thus have modified far fewer loans. If these worse-performing banks had simply modified loans at the same pace as their better performing peers, then HAMP would have produced about 800,000 more modifications. Instead of about 1.2 million modifications by the end of this year, HAMP would have resulted in about 2 million.

HAMP is the Home Affordable Modification Program, a federal program that provided subsidies to encourage banks to modify mortgages for certain borrowers rather than foreclose on the homes. Many critics at the time said the program would fail because the modifications are voluntary and built on encouraging banks to modify loans rather than forcing them to do so. This study would seem to back that up.

If 800,000 fewer homes had been foreclosed on, the impact on the economy, and on tax revenue at the state and local level, would have been pretty significant.

13 comments

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  1. 1
    Michael Heath

    Ed writes:

    If 800,000 fewer homes had been foreclosed on, the impact on the economy, and on tax revenue at the state and local level, would have been pretty significant.

    Starting in 2007 I repeatedly observed banking officers making traditional decisions which in the context of what was obviously going on in the housing industry at that time, was both irrational and harmful to the interests of their own employer. By 2009 that observation was convincingly validated as true.

    Lenders would not work with borrowers to keep them in possession of the property, both residential but also commercial. Doing so would have better minimized price drops and minimized the number distressed properties for sale; the latter which provides an amplifying feedback to price drops which led to the near-total destruction of the new housing sector and all its attendant jobs (and in some areas like mine, the total destruction of that sector now for five years where it’s only now starting to come back). Instead these bankers stuck by the old paradigm that moved these properties into foreclosures and therefore repossession. The old paradigm only worked when a relative few homes went under, so few it had no significant impact on either market pricing and more importantly, market liquidity. Bankers validated the old truism they’re stodgy and incapable of change.

    One possible defense of their behavior was that when they merely identify borrowers in trouble, federal regulations require them to reclassify those loans to being a riskier class of loan, which in turn requires the banks to increase the amount of reserves held against these loans (normally customer deposits, CDs, and savings). I’m not sure if they were unable to sufficiently increase deposits to more aggressively identify and work with troubled borrowers; savers in recessions typically move more towards safer investments like those offered by banks anyways. But perhaps the number of savers moving into such investment vehicles was more than offset by other people holding less money in the bank because they were having financial difficulty.

  2. 2
    D. C. Sessions

    “Unnecessary” is such a loaded word. Bear in mind that at least one of the Presidential tickets this year openly proclaims a von Hayek position (that interfering with “the work of the recession”) is destructive.

    On the other hand, all of those foreclosures have been great investment opportunities for those of us who were liquid enough to buy them up at bargain prices. Their former owners couldn’t get principal reductions, but after foreclosure the banks were quite willing to sell them at steep discounts. In a couple of years they’ll have appreciated quite a bit, and in the meantime the rental market is starved for properties.

  3. 3
    carlie

    On the other hand, all of those foreclosures have been great investment opportunities for those of us who were liquid enough to buy them up at bargain prices. Their former owners couldn’t get principal reductions, but after foreclosure the banks were quite willing to sell them at steep discounts. In a couple of years they’ll have appreciated quite a bit, and in the meantime the rental market is starved for properties.

    Really. Nice for you. Too bad about all those people who ended up homeless, because the banks weren’t willing to basically resell to them at the exact same price they later sold them for to other people.

  4. 4
    D. C. Sessions

    Really. Nice for you.

    I suspect you misunderstood my “those of us,” but let that slide.

    The key point is that it’s an ill wind that does nobody good, and there’s money to be made from a crap economy. Conveniently, this time around those best positioned to make out are also politically influential.

    With any luck, they’ll get a Government that can really work the pump to strip the middle class of what they still have.

  5. 5
    Modusoperandi

    HAMP is the Home Affordable Modification Program, a federal program that provided subsidies to encourage banks to modify mortgages for certain borrowers rather than foreclose on the homes.

    /me puts on tri-corne hat with tea bags attached to it.

  6. 6
    Michael Heath

    D.C. Sessions writes:

    “Unnecessary” is such a loaded word. Bear in mind that at least one of the Presidential tickets this year openly proclaims a von Hayek position (that interfering with “the work of the recession”) is destructive.

    True but the Romney/Ryan ticket is also falsely arguing their results will not be destructive but instead stimulate the economy faster than the president’s policies would. Where it’s critical realizing the president’s policies have mostly not been passed given an obstructionist caucus of Republican Senators. So when we flesh out the stated objectives, even Romney and Ryan effectively concede what is necessary since they claim to aspire to very same results the president asserts.

    If we consider the elementary structure of an argument, assumptions (here objectives like more economic growth), premises, and conclusions; Republican conclusions is not the right place to start when it comes to understanding the defectiveness of their arguments. And stated Republican assumptions are near-equivalent to what the Democrats argue they want – economic growth, less federal debt, and less un- and under-employment. Instead it’s Republican premises that are fatally defective, either because they’re presently knowingly false premises and/or because the results of those premises have historically returned a result opposite of what they claim and/or experts exclaim the same now.

    Because the root cause defect in Republican arguments lies within their set of core premises, a functioning journalism sector is imperative when it comes to optimal results – to always fact-check and never allow politicians to misinform the public without an immediate clarification from those journalists. Which Anderson Cooper is proving can effectively be done very well, even in real time.

  7. 7
    unbound

    800,000 unnecessary foreclosures is nice evidence how much more efficient the private sector is. And then I laugh until I cry at people thinking that the private sector will magically make everything better.

    Like any other corporation, many banks are short-cutting training and staffing so they can improve their quarterly bottom line. And what was the punishment for the 800,000 unnecessary foreclosures? Therefore, expect this number to grow.

  8. 8
    Ben P

    Starting in 2007 I repeatedly observed banking officers making traditional decisions which in the context of what was obviously going on in the housing industry at that time, was both irrational and harmful to the interests of their own employer. By 2009 that observation was convincingly validated as true.

    I mostly agree with what you say with one important distinction. Are you sure you’re talking about banking officers, or are you talking about loan serviers?

    In my experience if you’re lucky enough to have a mortgage where you are actually paying to a bank and have a specific loan officers at that bank who is handling your mortgage, the bank is actually reasonably responsive and willing to work with people. However, this situation is exceedingly rare, the only time it really ever happens these days is with credit unions and often not even then.

    The reason for this $800,000 figure is partially staffing I’m sure, but is also in a major part due to perverse incentives.

    Most mortages are sold off to investors, and the “customer” part of the mortgage is sold to a servicing company. They have the right to collect payments to the loan. THe servicers don’t answer to the borrowers, they answer to the investors who have purchased the loans, if at all.

    THe reason servicers are often so intransigent in agreeing to workouts to the point of it being kafka-esque, is that they often make as much or more money themselves from a loan in foreclosure as they do from a painless collection. They have virtually no economic incentive to work with borrowers or to hire staff whose job it is to work with borrwers beyond the absolute minimum necessary to ensure they get their RESPA paperwork out in time.

  9. 9
    raven

    “Unnecessary” is such a loaded word. Bear in mind that at least one of the Presidential tickets this year openly proclaims a von Hayek position (that interfering with “the work of the recession”) is destructive.

    That sounds like pseudoscience economics.

    1. It didn’t work in Japan which has gone nowhere for two decades.

    2. It didn’t work during the US Great Depression either.

    One of the key measures for a housing/financial depression is simply time. The fed is predicting it will be over in 2018.

  10. 10
    Didaktylos

    Mercantile capitalism is rather like a house of cards – it stays up when things are going well because there isn’t enough room for all the bits to fall down at the same time. But it doesn’t take much to get one bit falling out of phase with the rest …

  11. 11
    baal

    FWIW – my wife and I recently changed houses. We managed to get the bank to allow a “NO MERS” clause to be added to our mortgage. I’ll be shocked if they actually stick to the term but encourage anyone who can to do so.

    MERS is the electronic system that was put in place to allow the packaging and commoditization of mortgages. It’s lack of decent design is part of the overall mess of the housing sector.

  12. 12
    Worldtraveller

    baal, we didn’t go so far as to have it put in the mortgage clause of our last house, but we were told that the mortgage company we went through ‘never’ bundles and sells mortgages, that they manage all of their financed homes directly.

    We were rather surprised a few years later when we were attempting to refinance, to discover that not only had it been sold, it had been sold to a repo agency. It took at least an extra week to get the refi done simply becuase the agency didn’t want to give up the paperwork to our mortgage.

  13. 13
    Michael Heath

    fastlane writes:

    we were told that the mortgage company we went through ‘never’ bundles and sells mortgages, that they manage all of their financed homes directly.

    We were rather surprised a few years later when we were attempting to refinance, to discover that not only had it been sold, it had been sold to a repo agency.

    This may have been communicated to you correctly where you misunderstood, understandable since we don’t do mortgages much unless we’re in a relevant industry, or the lending officer misinformed you or was sloppy in how he communicated your type of loan when it came to its marketability.

    What’s I’m guessing happened is that you purchased a non-conforming loan. “Conforming loans” meet certain criteria established by Fannie Mae or Freddie Mac who also purchase these loans (where the lender usually continues to service them). Instead your loan probably stayed with your lender on his balance sheet as an asset; often these non-conforming loans are called “portfolio” or “boutique” loans. However these non-conforming loans can still be sold to other companies, just not Fannie or Freddie. They can be sold as an individual loan, as a package of loans, or if the company is sold. That’s because they are in fact an asset. And there are times when banks balance sheets get weak and they can’t secure enough deposits, so they sell loans to get cash to maintain a certain amount of reserves to hedge their bets on the loans they underwrote and carry on their balance sheet. The federal government sets the reserve rates for banks who write residential and commercial loans where it’s a law to follow these ratios, where banks are also audited to see if they’re doing so.

    So your bank probably had to increase its reserves of cash by selling “performing” loans (loans whose customers were current on their payments), in order to get their reserve rate in compliance with the risk they’re taking on as reported on their balance sheet. Or they sold non-performing loans to reduce the amount of reserves they needed to hold by reducing the risk on their balance sheet. These two types of sales has been very common over the past several years given how poorly the commercial banks have performed since the housing crash.

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