Over the past few years, it has been pretty easy to shrug off banks' and servicers' decision to foreclose as their default behavior, instead of providing struggling homeowners with mortgage modifications. After all, in most cases a deep principal loss would be necessary to make the home affordable, since many of these borrowers probably shouldn't have been provided their mortgages in the first place. Banks and servicers were just working in the best interest of the investors who owned these mortgages, right? Investors are now saying that this generally accepted logic is incorrect.
Let's back up for a moment. It's pretty easy to see why investors became angry with banks over the past few years. The banks sold them securities full of toxic mortgages. As a result, these investors are incurring billions of dollars in losses as homeowners default and foreclose. And to the extent that they can force banks to buy back these mortgages, they are trying to do so. That's the source of the ongoing foreclosure put-back crisis.
But last week, the Association of Mortgage Investors ("AMI") produced a White Paper (.pdf) that produced a very different criticism of banks. It turns out that investors feel that banks' aggressive foreclosure tactics are not in their best interest. Investors would prefer banks to take more care to work with borrowers to perform mortgage modifications in many cases.
This is a pretty big deal, because it turns banks' often cited rationale for foreclosing on its head. If investors prefer modification in most cases where banks are foreclosing, then the financial benefit of modification is actually generally greater than that of foreclosure. In those cases, modification would be a win-win situation for investors and home owners, while foreclosure would make everyone worse off.
"We're in favor of keeping people in their homes and paying their mortgage whenever humanly feasible," says Chris Katopis, executive director of AMI. And the extent to which investors believe modifications may be the best answer even extends into to the territory of banks' worst nightmare: principal reduction. "Investors are far more inclined to want people in their homes, even if it means writing down a mortgage, than seeing a foreclosure," explains Katopis. He says that "in the vast number of cases" modifications can work.
So what's the problem? Why aren't banks modifying more mortgages? Katopis would not speculate, as he cannot speak for banks. But it's easy to develop a plausible theory. Modifications are harder to make than stamping "foreclosure" across a mortgage note. Big servicers are drowning a flood of bad loans, and there's little doubt that they would have to hire a huge number of additional workers to process modifications if that strategy were more common. In fact, it costs banks less money to just foreclose; ultimately, investors will bear the loss, and any loss avoided through modification will not be shared by the banks. Banks and servicers have little incentive to modify.
Unfortunately, investors do not always have the ability to do much about this, which is why they're trying to work with state attorney generals to hold banks accountable for their foreclosure practices. According to Katopis, in a majority of cases, mortgage investors do not have "control rights" over servicing. So they can't simply fire a bank that forecloses too often without strongly considering modification and hire a more modification-friendly servicer instead.
This is an interesting development. Securitization has been criticized for eliminating the community bank flavor of having a mortgage. Struggling homeowners feel that their house is owned by a faceless investor who doesn't really care about them. But that might not be entirely accurate. Instead, the bigger problem might be that investors have too weak control over loan servicers. A different weakness in the securitization process creates a situation where those who actually own a mortgage have little power to act in their own best interest to help borrowers keep their homes. That's a different criticism of securitization, and arguably even worse from an economic perspective.