The negative equity problem in America is very real and central to the nation's housing ills. Not only is it drowning hundreds of thousands of homeowners whose housing values are sinking deeper and deeper underwater, but it's killing banks who just can seem to shake their balance sheet ills (aside from life giving support from Washington). The Making Home Affordable programs have pretty much been failures. But that isn't stopping Bank of America from trying get in front of this problem.
BoA said yesterday it was going to reduce mortgage balances for thousands of its troubled borrowers by up to 30 percent. Bank of America will become the largest servicer to begin modifying mortgages, as they collect payments on one in five mortgages in the U.S. Their 2008 purchase of Countrywide Financial is one reason they are so large, and is a primary source of toxic debt. To give you a sense of how bad it is, at the end of 2009, 14.76 percent of BoA's mortgages were at least 30 days delinquent, compared to the industry average of 12.31 percent of homes in delinquency. (Here is a list of all banks modifying mortgages.)
Here is the skinny on what BoA will be doing exactly from WSJ:
Here’s how it works: only borrowers who had loans from Countrywide Financial, which Bank of America acquired in mid-2008, will be eligible. And only the riskiest loans will qualify: subprime loans, “option adjustable-rate” mortgages that have low initial monthly payments but that can adjust sharply higher, and certain prime loans that have a fixed interest rate for the first two years before starting to adjust annually.
The program is also limited to customers who have missed at least two consecutive payments, who can demonstrate that a financial hardship prevents them from making payments at the current level, and whose loan balance is at least 120% of the estimated home value.
Bank of America will go through its loan book to see which loans might qualify for reductions (while checking property values to see which ones are far enough under water), and then the bank will reach out to those who may be eligible. “Our customers do not need to take any actions at this time,” said Jack Schakett, a credit-loss mitigation executive. [...]
Bank of America says that around 45,000 borrowers could see their loan balances reduced with an average reduction of more than $62,000.
... [BoA will be] requiring borrowers to "earn" the lower balances in stages over five years by keeping up on their new, lowered payments. After the third year, the bank could halt principal forgiveness if home values have stabilized enough to provide borrowers with equity.
A couple things to note here. First, some worry that a program like this creates moral hazard, the idea being that if a bank is reducing mortgage balances, why pay now if you can just wait for a modification. While this is not a completely off base thought, as long as the bank is doing this then they are taking on that moral hazard risk. If it's their choice to modify mortgages, then they create hazard for themselves and no others. And that is their own risk prerogative. If homeowners being serviced by other banks default thinking their bank will modify, then that is not the result of moral hazard but unwise homeowners. But in any case, a modification is not a free home. You still have to make payments.
Second, the catch there is that the bank should be doing this on their own. But that isn't the full case here. BoA isn't exactly doing this out of the kindness of its heart or in an attempt to salvage some value from their losses by trying to get more payments out of homeowners rather than try to sell in an over supplied housing market. The plan is a part of a settlement with state attorneys general, led by Massachusetts's Martha "Curt Schilling Played for Who?" Coakley. They were pretty much prodded into this. Not that the modification plan is necessarily the wrong move—it might be the right one, but they shouldn't have been forced into it.
Well, maybe they should. It depends on what went down at Countrywide Financial. That's what this is all about. The settlement is basically BoA's attempt to rid itself of legal troubles targeted at alleged abuses by Countrywide. So if there really was wrong doing, then there would need to be some justice. And perhaps that is what will happen. The banks is going to identify only Countrywide customers in this program.
But there is a third matter to note here: investors. Bank of America only owns between $1.5 billion and $2 billion of the $10 billion or so mortgages estimated to be eligible for modification through this program. The rest were originated by Countrywide and serviced by BoA but owned by mortgage-backed securities investors around the world. The question becomes, is it fair for those investors to take losses through this program.
Herein lies one of the most complicated parts of this whole housing mess. It is almost impossible to adjust mortgages, even if servicers want to or should, because of the lack of transparency and order in the MBS market. How do you get all of the owners of a particular mortgage in an MBS pool to agree to taking a loss by modifying a mortgage in hopes that there might be some value put back into the home by getting it out from underwater or at the very least a reduction in potential losses if the home were instead sold well below the original value in an oversupplied market. You really can't. So BoA is going to do it anyway, under pressure from the AGs.
This is really messy. If investors wind up losing more money than they otherwise would through this modification program they may have a complaint, depending on how the legal agreements were originally structured.