Tuesday, September 30, 2008

The Sky Is Not Falling, The Sky Is Not Falling


It might be that the sky is not falling, but the financial markets are, and home prices are, and CONFIDENCE IS PLUMMETING. The question is WHY!

Remember the discussion of securitization, and huge pools of mortgages? (If not, read the last post). Each of those bonds, the mortgage-backed securities, has an agreement among the parties that put it together, the investors in it, and the company that actually administers it, known as the "Servicer". This document is called the Pooling and Servicing Agreement and it specifies exactly what each of the parties can and cannot do. Most importantly to individual borrowers/mortgagors, are the terms that may PROHIBIT a modification to specific types of loans or even all loans in the Pool.

As I contact lenders to modify loans, I am too often told, "This loan cannot be modified. We are bound by the pooling agreement". In the past, if a borrower got into trouble and either called the mortgage holder directly, or came to my office for help in negotiating an easing of mortgage rates, or put the arrearages put into the end of the mortgage, we would contact the lender or its legal counsel. The issues discussed would be the borrowers reasons for default, the borrowers ability to make payments in the future, the past history of the loan, and similar matters. No one ever said "Well, everything is fine with the borrower, but the Pooling agreement will not permit a modification". NOW IT HAPPENS.

Investors expect a certain ROI, translated to "Return on Investment", as well they should. But sometimes we cannot get what we expect - life and especially business is not always fair. And most of the time taking a little less is better than getting nothing.

Getting a bit more concrete, let's assume the following which are based on real statistics and real experience: The loans supposedly causing the problems were originated between 2004+/- and a few months ago. This was the period that "Option Adjustable Rate Mortgages" ("Option ARM"s), pick-your-payment ARMs, Negative amortization mortgages, simple interest mortgages etc., etc. became really popularized.


(If you want to skip the numbers, just accept that the real losses to the investment pools, the mortgage backed securities/bonds, containing the so-called subprime or predatory loans, are about 3%-4%).

The Numbers
1. Assume that 75% of these loans made during the 2004-2008 period will never have a default - therefore only 25% will. 2. Assume that of the 25% of the loans that default, 50% of those self-cure, meaning that the borrower fixes the problem him/herself. Most defaults are traditionally the result of a temporary illness, or temporary layoff, or other such short-duration problems. Now, due to the Predatory Lending practices of many mortgage originators, we have a default rate higher because of sub-prime borrowers getting sold a "bill of goods" along with their mortgage 3. Now, we are at 50% of the 25% (the defaulting loans, or 12.5% of the entire portfolio of loans) that are still problems. 4. Assume further that of the 12.5% of that total which do go into foreclosure (not sale, just a term to describe when a lender sends a "Notice of Intent to Foreclose" to the borrower), 50% of those will never go to sale. Borrowers somehow manage to get enough money together to reinstate the loan, or at the last minute get a reprieve from the lender due to a sale of the property. 5. NOW, WE HAVE ONLY 6.25% OF THE TOTAL PORTFOLIO, REMAINING IN FORECLOSURE. THESE ACTUALLY GET SOLD AT FORECLOSURE SALES. 6. Assume additionally that the foreclosing lenders recover only 40% of the value of the loans made, thus losing 60%. THIS LEAVES THE LOSS AT ONLY 3.75% OF THE TOTAL OF ALL OF THE LOANS MADE DURING THIS ENTIRE PERIOD (60% of 6.25%).

At any other time, with all accepted loss ratios, THIS IS NOT A CRISIS. In fact, not even close!!! Unfortunately these are not any other times. The ability to negotiate with lenders is greatly reduced due to the Securitization of Loans. Wall Street took away the risk so no one cared if borrowers could afford their loans, and then severely limited and in many cases took away the ability to try to fix a broken mortgage by making a deal with the lender.

author's copyright by Richard I. Isacoff, Esq. 2008


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