Four years after the housing bubble popped, 11 million homeowners owe more on their mortgages than their houses are worth.
On the theory that easing the debt burden for those underwater borrowers would boost consumer spending and lift the overall economy, the U.S. government is experimenting with a program to sell delinquent loans to investors at a discount that encourages them to lower the mortgage principal.
The Federal Housing Administration is auctioning thousands of defaulted mortgages at prices marked down by as much as 65 percent. If the pilot works as planned, the government mortgage insurer will cut its losses by avoiding foreclosures while giving borrowers a better chance of remaining in their homes.
“This pilot program is a potential win-win-win,” Acting FHA Commissioner Carol Galante said in an e-mail.
Still, as the program joins other small-scale government housing initiatives, it illustrates the challenges policy makers face as they try to revive the housing market. So far, investors in the loans are scratch-and-dent specialists who buy less-than-perfect debt and try to squeeze a profit out of it. In the long run, they might have little interest in continuing to work to keep troubled borrowers from losing their homes.
In some cases, the investors are the same people who originated subprime loans in the run-up to the 2008 credit collapse or later ran afoul of regulators.
The FHA so far has acquired and sold about 2,500 loans on properties across the U.S. under the program, with a total unpaid principal balance of $446.8 million. More than a year into the project, most of the notes are still delinquent, according to data provided in a briefing by FHA officials.
The program is one of several avenues being pursued by the regulators and President Barack Obama. One of those, the Home Affordable Refinance Program or HARP, is being expanded to include more borrowers. The Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, said today it will allow qualified borrowers to refinance into current low interest rates no matter how underwater they are on their mortgages.
Like HARP, the FHA pilot program -- known as the Mortgage Acquisition and Disposition Initiative -- is aimed at the problem of underwater homeowners, who are at increased risk of walking away from their mortgages. Lenders and investors have been reluctant to take the losses associated with writing down principal even when it might prevent a costly foreclosure.
One aim of the FHA initiative is to prove to the housing market that writing down negative equity can be less costly than foreclosing, said Pete Mills, managing director of the Community Mortgage Banking Project and co-author of a widely circulated paper that makes the case for such writedowns.
$750 Billion Underwater
U.S. homeowners now owe $750 billion more in mortgage debt than their homes are worth. Up to $200 billion of those mortgages are both in default and underwater. If past patterns persist, almost all of them will go into foreclosure, Mills said. Principal writedowns can encourage homeowners to stay and pay.
“It’s a tool for the toughest loans out there. They’re at the doorstep of foreclosure,” Mills said. “Even if we can save 20 or 30 percent of them, it’s great.”
By giving investors a chance to make money, the FHA program provides market incentives to begin to overcome lenders’ reluctance to reduce principal, Mills added. “The principal reduction comes via market factors versus political factors.”
Winning bidders agree not to foreclose on borrowers for six months while they work to modify the terms of the loan including writing down the principal. After six months, however, anything goes.
Loans For Sale
Beyond the FHA program, distressed debt investors have also been buying delinquent mortgages directly from banks. Every month, banks put an estimated $1 billion worth of distressed loans up for sale, according to California-based Private National Mortgage Acceptance Co., which acquires mortgages.
Whether the FHA program ultimately helps current homeowners, it is in the government’s interest to keep foreclosures off its books. The agency pays an average of $28.78 every day to maintain and market each of the tens of thousands of repossessed properties that it has received in exchange for insurance payouts to loan servicers.
The agency, an arm of the U.S. Department of Housing and Urban Development, has insured more than 34 million mortgages since it was created in 1934 to encourage lenders to offer credit to homebuyers who might not otherwise qualify for prime loans.
The FHA is financed by the mortgage insurance premiums it charges to lenders and historically has not required a taxpayer subsidy. That could change if its losses from the housing crash continue to mount.
Traditionally, FHA takes ownership of a property after it has gone into foreclosure and the servicer has received the insurance payout. The pilot program instead allows servicers to transfer delinquent FHA-insured loans to the agency before foreclosure -- but only after the servicer has worked with the borrower to make the loan current.
Selling troubled loans in bulk aligns the profit-driven motives of investors with the needs of distressed borrowers, according to Stan Humphries, chief economist at Zillow Inc., a real estate information service. Buyers of the notes stand to profit when the borrower makes full, on-time payments.
“They’re going to make it work and they’re going to do it quickly,” Humphries said. “It’s market-driven.”
Some investors said they see things differently. Jon Daurio, founder of Kondaur Capital Corp., a San Diego company that successfully bid on some of the notes, said his firm’s goal was to get properties on the market as quickly as possible because it believed home prices would continue to plummet. In most cases, the company tried to persuade borrowers to give up the home in exchange for cash.
Even at a 65 percent discount, “you’re not buying the loans cheaply enough” to cut the principal, said Daurio, a former executive at now-defunct subprime lender Ameriquest Mortgage Co. Daurio left Kondaur in May and is planning to start another investment company.
Borrower advocates say they are troubled by the participation of companies whose principals were subprime lenders or who have drawn scrutiny from regulators in the past.
The FHA program “is a way to continue to line the pockets of the predators who created this mortgage crisis,” said Bruce Marks, chief executive officer of the Neighborhood Assistance Corporation of America, a Boston-based non-profit that aids and counsels troubled borrowers.
One of the four firms that have bought notes through the program is Bethesda, Maryland-based MCM Capital LLC. MCM Capital employs Steven Trowern, a former director of Dynamic Capital Mortgage Inc. in Brookline, Massachusetts. According to a 2009 consent order and state officials, Dynamic was found to have falsified loan documents and misled borrowers. Without admitting wrongdoing, Trowern signed an agreement that he wouldn’t own or manage a mortgage company in the state for three years.
“There has been no violation of the Massachusetts no-fault consent order regarding former directors of Dynamic Capital Mortgage, nor has there been any violation of representations and warranties provided to HUD,” MCM Capital President Michael Niccolini said in an e-mail.
FHA spokesman Lemar Wooley praised MCM and described Trowern’s involvement as “minimal.”
“MCM has been a very good partner,” Wooley said in an e-mail. “We are confident that they met our requirements at the time they submitted their bid and we are confident that they will continue to meet our requirements and qualifications. We are satisfied that Mr. Trowern’s level of participation was minimal.”
Wooley described all four companies that won bids as “excellent partners.”
Skeptics of principal writedowns include Fannie Mae and Freddie Mac, the government-controlled mortgage companies that together own about 200,000 foreclosed homes. They have resisted pressure from the White House and Congress to allow loan servicers to cut principal on mortgages the companies own and guarantee, citing their fiduciary duty to taxpayers. So far, neither has experimented with selling delinquent notes.
FHA is still collecting and reviewing the data on its first four loan sales. If all goes well, the agency early next year will take a step toward making the program permanent by proposing regulations to implement it on a wider scale.
“We have over 1,600 borrowers whose loans have gone through the program and have received no complaints,” Wooley said.