Bankruptcy

Will the Mortgage Industry Fix the Mortgage Mess Itself? A Look at Project Lifeline

By Adam Levitin

The mortgage industry has been arguing against bankruptcy reform legislation that would permit the court-supervised modification of single-family principal home mortgages in bankruptcy. The industry argues that permitting mortgage modification in bankruptcy would result in higher interest rates and that its private efforts will solve the problem. In an earlier post and in a working paper, I have shown that we are unlikely to see higher interest rates as a result of allowing bankruptcy modification. Here, though, I want to take issue with the mortgage industry?s claim that its private efforts will solve the problem.

Hopefully the mortgage industry is correct about this. But there is good reason to doubt the efficacy of the industry?s efforts. To date, the mortgage industry?s efforts to fix the foreclosure crisis have been a lot of sizzle, but not much steak. Unfortunately, this seems to be the case with Project Lifeline, the latest half-measure to come out of the mortgage industry. As I explain below, the very structure of Project Lifeline means that homeowners in a significant number of states will be unable to take advantage of Project Lifeline's meager offering because it will kick in only after their homes have been sold in foreclosure.

The mortgage industry?s efforts at cleaning up the foreclosure mess have been coordinated through a private consortium of the largest mortgage servicers, called the HOPE NOW Alliance, which provides a clearing house for homeowners to reach servicers to attempt to work out deals on troubled mortgages. The HOPE NOW Alliance?s most recent effort, called Project Lifeline, was rolled out today with much hoopla. Project Lifeline is likely to have have very little impact. Despite its endorsement by the Treasury and HUD Secretaries, Project Lifeline is a voluntary private program of the six largest mortgage servicers under which they will pause foreclosure proceedings for up to 30 days for a certain limited group of homeowners who contact them and provide updated financial information. In order to qualify for the Project Lifeline pause, a loan must (among other things) be 90-days delinquent and not have a foreclosure sale scheduled within 30 days. That means that there cannot be a sale scheduled within 120 days of the first missed payment. The problem is that many foreclosures are completed within this 120-window.

By the time a homeowner can qualify for Project Lifeline, there may be no home left to save. Are mortgage servicers this clueless about foreclosure law or is the point of Project Lifeline simply to sandbag other reform efforts?

Most servicers start foreclosure proceedings when mortgage loans are 60-days delinquent. The time it takes from the beginning of foreclosure proceedings to a sale varies significantly from state to state, but in many states, it can easily be completed within another 60 days. For example, in Maryland, my state of residence, it takes a minimum of 16 days. If I read Michigan law correctly, the sale can occur within 22 days. In Texas the foreclosure sale can be accomplished in 42 days. If servicers are efficient about foreclosures, there are many states (at least 17 and quite possibly more) in which no homeowners would be able to qualify for the Project Lifeline pause.

For those homeowners who do qualify for the pause, it?s worth noting that it is not a guaranteed 30-day pause, but a pause of up to 30 days, during which the servicer is not obliged to do anything. Assuming servicers attempt to work out the loan in good faith, we still shouldn?t be particularly optimistic about the outcomes given the past track record of mortgage servicers and the HOPE NOW Alliance. In the last half of 2007 some 869,000 workouts occurred. But 75% of those were repayment plans. Repayment plans just mean that arrearage is allowed to be paid out over time going forward. But there is no change to the terms of the mortgage. The monthly payments actually go up because in addition to the usual monthly payment, there is also the arrearage to be repaid. If the monthly payment was unaffordable before, a repayment plan actually makes things worse.

Even of the 25% of workouts that resulted in modifications of loan terms, we have no way of knowing whether these modifications were qualitatively sufficient to provide long-term solutions. Given the large number of mortgages in foreclosure from failed workouts (29% of foreclosures nationally!), it would appear that many were insufficient. It tells a lot about the HOPE NOW Alliance members? mindset that they entitled their statistics on the number of mortgage modifications and repayment plans as ?mortgage loss mitigation statistics.? (See pp. 12-16). Servicers are likely to lowball loan modification offers. As long as this happens, we are unlikely to see the mortgage industry fix the mess it wrought.

So let?s consider a few possibilities. If the mortgage industry?s efforts are unsuccessful, then we really need to have a fallback plan or else we?re looking at a foreclosure epidemic of unprecedented proportions. Permitting mortgage modification in bankruptcy would provide such a fallback.

On the other hand, if the industry's efforts are successful, then what harm is there in permitting modification of mortgages in bankruptcy? No one files a Chapter 13 petition for fun--that's 3 or 5 years of living on a court-supervised, IRS-devised budget. There simply is no moral hazard issue here.

Finally, permitting modification of mortgages in bankruptcy might actually facilitate the private work outs of delinquent mortgages because it would push servicers to offer modification terms closer to what a homeowner could get in bankruptcy. It?s hard to see what the possible downside is to permitting mortgage modification in bankruptcy?it would make bankruptcy treatment of mortgages like all other secured debts (at least pre-BAPCPA), would have little or no effect on interest rates, would not create moral hazard problems, and might facilitate private deal-making. We should see bankruptcy reform as a counterpart, rather than an alternative, to private mortgage loan workouts.

Full post as published by Credit Slips on February 12, 2008 (boomark / email).