foreclosures, better for the banks too!

WASHINGTON - Government initiatives to stem the country's mounting foreclosures are hampered because banks and other lenders in many cases have more financial incentive to let borrowers lose their homes than to work out settlements, some economists have concluded.

Policymakers often say it's a good deal for lenders to cut borrowers a break on mortgage payments to keep them in their homes. But, according to researchers and industry experts, foreclosing can be more profitable.

The problem is that modifying mortgages is profitable to banks for only one set of distressed borrowers, while lenders are actually dealing with three very different types. Modification makes economic sense for a bank or other lender only if the borrower can't sustain payments without it yet will be able to keep up with new, more modest terms.

A second set are those who are likely to fall behind on their payments again even after receiving a modified loan and are likely to lose their homes one way or another. Lenders don't want to help these borrowers because waiting to foreclose can be costly.

Finally, there are those delinquent borrowers who can somehow, even at great sacrifice, catch up without a modification. Lenders have little financial incentive to help them.

Analysis downbeat on modifications
A study released last month by the Federal Reserve Bank of Boston was downbeat on the prospects for widespread modifications. The analysis, which looked at the performance of loans in 2007 and 2008, found that lenders lowered the monthly payments of only 3 percent of delinquent borrowers, those who had missed at least two payments. Lenders tried to avoid modifying the loans of borrowers who could "self-cure," or catch up on their payments without help, and those who would fall behind again even after receiving help, the study found.

"If the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily 'preventable' foreclosures may be far smaller than many commentators believe," the report said.

Nearly a third of the borrowers who miss two payments are able to self-cure without help from their lender, according to the Boston Fed study. Separately, Moody's Economy.com, a research firm, estimated that about a fifth of those who miss three payments will self-cure.

Lenders also worry that borrowers may re-default even after receiving a loan modification. This only delays foreclosure, which can be costly to the lender because housing prices are falling throughout the country and the home's condition may deteriorate if the owner isn't maintaining it. In some cases, lenders lose twice as much foreclosing on a home as they did two years ago, said Laurie Goodman, senior managing director at Amherst Securities.

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The failure of the modification programs isn't really news to us. We know the modification programs are just to extend the defaults over a long enough period so that the banks can absorb the losses. But this brings up the interesting point that doing so almost ensures the banks will lose even more in the long run. Of course if we assume that the majority of the price declines are behind us then the banks may not see any additional losses by foreclosing 2 years from now versus foreclosing today.