Bankruptcy

21% HAMP First Year Redefault Rate

By Adam Levitin

The Congressional Oversight Panel has a new HAMP report out. Like all COP reports, it's long and chock full o' analysis. There's an executive summary up front, but some of the most important points are only in the report proper (especially pp. 100-111). I think there are three big things to take away from the report:  

• First, 21% of HAMP permanent modifications have redefaulted in their first year. That's ghastly given that HAMP permanent modifications have an additional 3 months of trial seasoning and fairly serious payment reductions. The fact that Treasury hasn't been reporting on this itself, much less analyzing the reasons for the redefaults is disgraceful. 

• Second, if past trends continue, starting this month, there will be more HAMP redefaults each month than new permanent modifications. That means that the total number of active permanent modifications will peak at around 500,000 and decline. 

• Third, it looks as if Treasury will only end up spending $4B for HAMP out of the $75B allocated for homeowner assistance. 

My take: Treasury should shut down the program. At this point all it does it provide political cover for the failure to take meaningful steps to help homeowners and stabilize the housing market. But is anyone really buying it?  

Redefault Rates

Treasury has publicly estimated that the redefault rate on HAMP permanent mods will be 40% over five year. Now, just one year into permanent mods, we have already reached a 21% redefault rate. There is no indication that the redefault rate is plateauing, and no reason to think that it will.

The risk factors for HAMP permanent modifications are not front-loaded. A front-loaded risk would be unaffordable monthly payments. HAMP does a reasonable job on lowering monthly payments. But HAMP permanent modifications have high negative equity, balloon payments, interest rates that will rise over time (often from 2% to 5%, meaning a significant monthly payment increase), and high back-end debt-to-income ratios. These are all time bombs. They come in addition to the typical horsemen of default: death, disability, dismissal, and divorce, to which we can add the amplifier of the worst economy in 70 years.

To be sure, HAMP modifications are performing better than proprietary modifications, but that's not saying a lot, and it's also not an apples-to-apples comparison. Unlike many proprietary modifications, HAMP has a 3 month trial period that screens out the weakest borrowers; HAMP modifications should perform better. The Oversight Panel report notes that if one calculated the HAMP redefault rate including the 146,031 trial modifications that failed to convert to permanent because of a payment default (the others failed to convert because they were not eligible due to loan or borrower characteristics), the real annual redefault rate would be 44% and the 15-month redefault rate would be 50%!

My own personal prediction: over 5 years we will see redefaults in the range of 60-80% on HAMP permanent modifications. I hope I'll be proven wrong. But given the current state of affairs, I think we will see only 100k-200k permanent modifications still performing at the end of 5 years, a far cry from the 4 million homeowners the Administration said the program would help. (Unless by "help" you mean delayed foreclosure by a few months). The number of permanent modifications that do not redefault is the most fundamental metric by which to evaluate HAMP on this metric, it is an epic fail, topped only by Hope 4 Homeowners.

Is HAMP a worthwhile program?

It's hard to say that it is. HAMP will help some homeowners keep their homes and avoid foreclosure. That's always a good thing, even if it helps only say 100k homeowners in the end, instead of 4M. And HAMP has had some benefits in terms of creating standards for non-HAMP modifications. But some of the homeowners who keep their homes with a HAMP modification might have been able to keep those homes without HAMP through a proprietary modification that wasn't subsidized with taxpayer dollars. 

Ultimately, the message to take away from HAMP is that the Obama administration just isn't serious about helping homeowners. The plight of distressed homeowners' is subsidiary to protecting the banks from having to take serious write-downs. There's plenty to say about the politics of that decision, but from an economics perspective, I just think it's short-sighted. The economy will not see a robust recovery until there is serious consumer deleveraging and a stabilization of the housing market. Those two problems go hand in hand, given that mortgage debt is the biggest chunk of consumer leverage. And there really isn't any way to deleverage consumers without there being losses for the financial sector. And that all leads to Figure 14 on p. 58 of the report, which shows the second lien loan exposure of the Big 4 banks relative to their Tier 1 capital. Here are the ratios: 

• BoA: 83%
• JPM: 78%
• Citi: 41%
• Wells: 116%

What this means is that principal reductions on any scale will render the Big 4 (and plenty of smaller banks) seriously undercapitalized, if not outright insolvent. And so the game the Administration has decided to play is extend and pretent. Indeed, HAMP's basic goal was to buy time for the banks while the housing market and economy recovered. The thinking was that if lots of properties went into foreclosure and hit the market in 2009-2010, it would drive housing prices even lower, foreclosures would skyrocket, loss recognition would be unavoidable, the FDIC fund would be overwhelmed, and the economy would go into freefall.

As it turns out, there are system capacity issues that limit the number of properties that can hit the market at any time. The system doesn't seem capable of churning through much more than 2 million foreclosures in a year. HAMP might have bought some time, but the gamble on resurrection clearly hasn't paid off yet, unless one defines resurrection downwards. And we're looking another perhaps 10% drop in home prices this year, which combined with a still fragile financial sector and lots of systemic risk from sovereign debt (European and US states). The danger here is that instead of being a successful bid for time, HAMP will have delayed the necessary reboot of the US, making the economy actually more vulnerable to subsequent shocks. Extend and pretend might be politically expedient today, but let's remember how well it worked with the S&Ls. Maybe it buys the Administration through November 2012. But all that does is tie the Administration's hands for a second term agenda.

Full post as published by Credit Slips on December 14, 2010 (boomark / email).