Consumer Law

Mortgage restructuring and moral hazard

By Alan White

By Alan White

Although moral hazard concerns for banks and securities investors went out the window with the various bailouts and government guarantee schemes, homeowners are not getting their debt written down, paid, insured or assumed by the Treasury. My review of August and September remittance reports found about 7% of mortgage modifications reduced principal, compared with 34% increasing principal and 59% leaving principal the same. The mortgage modification machine is increasing overall mortgage debt for homeowners, not reducing it.

One excuse we hear from mortgage servicers is their worry about moral hazard. Countrywide, for example, included a provision in its deal with state attorneys general giving it an out from loan modification requirements if it detects "material levels of intentional nonperformance by borrowers that appears to be attributable to the introduction (!) of the loan modification program."

I know of no empirical evidence to support the bizarre idea that homeowners who were current on payments and could afford them have decided or will decide to stop paying and risk foreclosure, solely because they thought they could or should get a loan modification. Given the demonstrated psychological importance of homeownership and the ridiculous lengths to which many homeowners in bankruptcy will go to maintain mortgage payments even when they have serious negative equity, this version of moral hazard for mortgage payers seems far-fetched, to say the least.

Consider also that according to the New York Federal Reserve's data, by the end of August, only 57% of subprime mortgage borrowers were still paying on time. The other 43% are already delinquent or in foreclosure. The number of homeowners who could be infected by moral hazard is rapidly dwindling. Consider also the competing moral hazard: the longer we refuse to write down mortgage principal for homeowners who are behind and owe more than their homes are now worth, the greater the chances they will just give up and walk away. At some point, even the most dedicated mortgage payers will realize that their home values will never catch up to their 2006 and 2007 mortgage debts, and they will cease payments. The real moral hazard is that we allow millions of families to be evicted from their homes for the sake of a theoretical construct.

Full post as published by CL&P Blog on October 16, 2008 (boomark / email).