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24 Jan 2009
A friend asked:
Apparently the mortgage holders today are not the loan originators and therefore have little incentive to deal, or should I say workout, one-one with consumers. Can [someone] provide some comments on workout to help clarify the concept?
Workouts are a normal part of bank lending, because foreclosing (or the equivalent) is very expensive, and the bank is often better off agreeing to a smaller or longer loan and actually getting paid.
Back in ye olden days, like 10 years ago, you normally got a mortgage directly from a bank, and that bank then either held the mortgage or sold it to Fanny or Freddie. If you came in and asked for a modification, which is what it's called with a mortgage, the bank could either decide themselves whether to do it, or they had only to ask Fanny, who understands how to deal with such questions.
You can still do it that way, but the bubbilicious way to get a mortgage is to go to a broker who just arranges the paperwork who hands it off to the actual bank. The bank then took a whole bunch of mortgages and sliced them up (the slices are called tranches, because French is more elegant than English), with the slices being paid in order. As the money came in, first they'd pay the most senior tranche, then the next most senior, all the way down to the most toxic bottom tranches who get what, if anything, is left. Each tranche was supposed to be priced to reflect its risk of not getting paid, although we have seen that the pricing models were bogus. Since the originating bank never expects to see those mortgages again, it also became common to sell the servicing, collecting each month's payment, to someone else.
This has produced utterly perverse incentives. The brokers get paid their commission so long as the borrower makes the first six months' payments, and the commission depends on how profitable the loan is to the bank, so their incentive was to sell people high-rate loans, even if they qualified for lower rates, and to sell loans with low teaser rates that didn't increase for at least six months. The servicing companies get paid by the transaction, they get paid more for a foreclosure than a modification, so why not just ignore your calls and letters asking for modification since if they wait, they'll get to foreclose.
Even if you get through the servicing company to someone who will talk to you about modifications, now you have to get the separate permission of the owners of each tranche. The holders of the most senior tranche have no incentive to agree, since they'll probably get paid anyway and would get paid less if they agreed to your modification. The holders of the most toxic tranche have no incentive to agree since their share will be wiped out. The middle tranches will get more, but even though the total amount paid to all of the tranches would be more with a modification than a foreclosure, tough noogies. Just to add one final problem, the paperwork on many of these things was incredibly sloppy, so it's quite possible that nobody knows who owns your loan! I have read reports of judges turning down foreclosures because the party trying to foreclose couldn't show that they actually owned the mortgage.
One of the things that desperately needs to go into the next bailout-like law is one that allows or even requires banks to modify mortgages if it would be good for the bondholders overall, even if the top and bottom tranches don't like it. Republicans hate that (sanctity of contracts, you know, and you wouldn't want to give a break to Those People who greedily signed loans with terms they didn't understand) but the new Congress may be able to pass it.
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