DESERT LAW BLOG

BANKRUPTCY CRAMDOWNS DIE IN SENATE, HARMING ARIZONA LOAN MODIFICATION EFFORT

Under intense pressure from banking lobbyists, the U.S. Senate today voted down adding in bankruptcy "cramdowns" to the bankruptcy reform bill.  The House had previously voted to include this in their version of the bill.  This effectively kills the movement to change the bankruptcy laws to allow judges to write down principal for primary residences of individuals in bankruptcy.  (It should be noted that most other types of debt, including mortgages on second homes, CAN be written down by bankruptcy judges.)

This removes the "stick" part of the equation when dealing with loan modifications and other loan workouts on residential mortgages.  The "carrot" is the payments the federal government is making to entice lenders to participate in the Making Home Affordable Plan.  And that should get some mortgage holders to move more quickly to modify loans.

The main issue, however, with modifying loans using Making Home Affordable (or any previous modification the banks have been doing) is that it is often only a temporary fix (such as temporarily lowering interest rates) and does not forgive much, if any, principal.  For Arizona borrowers who are tens or hundreds of thousands of dollars underwater, the smart financial decision often remains walking away from the home - even at the expense of destroyed credit (which is usually - but not always - the only downside to giving up a home in non-recourse states like Arizona).  It remains likely that a borrower's credit will be repaired long before the home would no longer be underwater.

As I have written before, compounding the issue is that many mortgages are held by investors who are refusing to allow principal to be written-down - thus hindering the efficacy of mortgage modifications for people very far underwater in Arizona.  The bankruptcy cramdown would have been a big stick that borrowers and servicers together could have used to convince these investors that the smart financial decision would be to allow principal write-downs instead of risking a bankruptcy judge doing the same thing (and incurring the additional cost of going through bankruptcy). 

So it seems that we will stay on the same course as before - loan modifications that truly help only a minority of borrowers, and a high re-default rate.  The banks may be happy to have won on this one - but they would still be better off financially conducting voluntary principal write-downs to keep people in their homes and to curb re-defaults.

Update:  Naked Capitalism says about the same as I am saying - in even more blunt terms.

NEW MAKING HOME AFFORDABLE PLAN GUIDELINES FOR SECOND MORTGAGES WILL HELP ARIZONANS

One of the criticisms of the Making Home Affordable Plan unveiled by the Obama administration last month is that it was light on specifics on how to deal with the many homeowners who have second mortgages on their properties.  The second mortgage holders generally have to consent to mortgage modification of the first mortgage (through subordination) or a short sale.  And since they are often completely out of the money due to homes being so far underwater, they can and do hold up any modification or short sale plans by refusing to play along unless they get a pay-off.

This is particularly an important problem in Arizona because so many buyers used second mortgages here.  The price depreciation on homes has been so steep that homes are far enough underwater that the second doesn't expect any payoff.   So they simply refuse to consent to anything unless they get paid some amount of cash by the borrower (who typically don't have it).

Today, the Obama administration put some meat on the bones of the original plan to try to deal with reluctant second mortgage holders.  I wrote back in March about the initial proposal:

A few points that affect many Arizona homeowners are how the modification program deals with junior or second mortgages and provisions for short sales or deeds in lieu of foreclosure (DIL).  The modification program only applies to first mortgages and many (most) Arizonans have a second mortgage on their property.  To deal with this, the modification program allows up to a $1,000 payment to a second lienholder to forgive the debt and $500 to the servicer of the secondary lien.  Alternatively, the second lienholder can simply agree to subordinate to the modified first loan with no payment. 

So the original plan contemplated a pay off of the second mortgage holder by the federal government and a full forgiveness of the debt (essentially a 100% principal write-down on the second).  Or the lender could keep the mortgage and simply subordinate to the modified first loan without any financial benefit.  This was obviously an attempt to get second mortgage holders to take what money they could and forgive the loan (and good thing for borrowers).

Apparently this was not satisfactory to second mortgage holders who wanted to maintain the lien on the property while still getting a payout.  Second mortgage holders don't want to forgive the debt because they have to then write-down the value of the loan, which hurts their balance sheets.  And many of the largest banks participating in the TARP program have large portfolios of second mortgages - so have a directly line to Treasury Secretary Geithner to request such things.  These banks may also be holding out hope that at least a portion of these distressed borrowers will stay in their homes for the next 30 or 40 years to pay off the loan (and a few might).

So Treasury has devised an additional plan to pay second mortgage holders $500 up front to participate in a modification of the second mortgage at a lower interest rates, with additional payments of $250 per year for up to three years - as long as the borrower does not default.  So the bottom line is that both the first and second mortgage holder will get a cash payout from the federal government for agreeing to modify the loan to a lower interest rate.  But neither will have to actually forgive any portion of the principal.

These payments will hopefully incentivize second mortgage holders to cooperate in the Making Home Affordable modification plan which is being implemented by many of the big banks as we speak.   It's a good step forward to try to find a middle ground with banks that will incentize their cooperation.

Hope for Homeowners Incentive

Additionally, the administration announced that it will give up to $2,500 per loan for mortgage holders to participate in the as-yet-failed "Hope for Homeowners" program. 

The H4H program was originally meant as a way to get banks to write down loans to the market value of the house and then the borrower would share any future increase in equity value with the bank.  Obviously it makes no economic sense for a bank to voluntarily participate in this, since this requires an immediate principal write-down - again doing harm to the balance sheet (which they are trying to avoid at all cost).  And in a market with rapidly falling housing values, it made no sense for a borrower to participate.  They would again be underwater within a month.  Once housing prices hit bottom, it may make more sense for borrowers to pursue this option, but I don't see why banks wouldn't just continue to pursue loan modifications under the Making Home Affordable Plan, instead of writing down principal under the H4H program. 

If the new bankruptcy bill allowing mortgage cramdowns ever gets passed, this program may again be in play as banks choose H4H as an alternative to judicial bankruptcy principal write-downs.

The article from the AP about the actions today can be found here.

MARCH BRINGS RECORD HIGH OF FORECLOSURE NOTICES IN PHOENIX METRO

Not the kind of news people were hoping for, but not surprising either, is that we saw a record high for notice of trustee sales (aka pre-foreclosure notices) in March.  The Republic lays out several of the potential reasons, including more certainty in the market over governmental plans.  Now that banks/servicers know who will and who will not qualify for the Making Home Affordable plans laid out by the Obama administration, they can move forward with a backlog of foreclosures they were holding off on.  So the hope is that March is simply the release of a bottleneck of pre-foreclosure notices and that April will see a drop back down in numbers.

However, as I have been writing, there is another large bubble of negatively amortized option arm mortgages set to recast over the next two years that may exacerbate the problem.  That being said, the new governmental programs will at least give these homeowners an idea of whether they should try to modify now or whether they need to seek other options (short sale or walking away).  Hopefully this increased certainty speeds up the process and allows prices to find a bottom sooner rather than later in the Valley.  That all hinges of course on whether the banks stick to the guidelines of the new plan (certainly not a given).

Note that in Arizona a notice of trustee sale typically indicates that the trustee sale at auction will occur 90 days following the notice (the statutory minimum), so the homeowner has a minimum of 90 days from the date of the notice to find a workout for their home loan.  Not all notices lead to a trustee sale because some homeowners are able to get a loan modification, complete a short sale or catch back up on payments.

ARIZONA AND THE NEW FEDERAL MORTGAGE MODIFICATION GUIDELINES

Much has already been written in the last day about the new guidelines for mortgage refinance and modifications released yesterday by the Obama administration (dubbed "Making Home Affordable").  The Summary of Guidelines can be read here (pdf).  The full Modification Guidelines can be read here (pdf).  A Q&A for loan refinance and modification counselors can be read here (pdf). And a fact sheet on the programs can be found here (pdf).  All this is from the financialstability.gov page.  The Counselor Q&A is the most helpful if you don't have a lot of time to read - skip down to #10 in the Q&A for the loan modification portions.  Then read the Summary more carefully if you think you may qualify.

Essentially, the program has two pieces - helping homeowners refinance and helping homeowners get up to five years of reduced payments through loan modification.  The refinancing part of it, while important, will help very few people in Arizona.  It is meant to assist refinancing for homeowners who have less than 20% equity remaining in their home or who are up to 5% underwater on their mortgage.  Arizona has such a high number of people who are drastically underwater that this will help relatively few people in the state.  Most are just too far underwater to qualify.

The loan modification program, on the other hand, will be able to help many Arizonans.  The program essentially incentivizes servicers and lenders/investors (through payments) to modify loans so that monthly mortgage payments end up being only 31% of a borrower's total income.  In order to qualify, borrowers must show financial hardship, but must be able to document their income showing that they will be able to continue to make payments - thus keeping people from participating who are unable to continue own a home.  If borrowers continue to pay on time over 5 years, they will be eligible for up to $5,000 in principal reduction under the loan modification. The modification program is for mortgages originated before January 1, 2009 and runs until the end of 2012.

So if you are a homeowners, you should check first to see if your monthly mortgage payment (the full PITI) is greater than 31% of all of your sources of income.  And if so, you should read the full qualifications for homeowners summarized in the above links to see if you are eligible.

Read more important details after the jump....

RECORD 12% OF HOMEOWNERS WITH MORTGAGES IN DEFAULT NATIONWIDE

The WSJ reported today that a record 5.4 million U.S. homeowners with a mortgage are behind in payments (i.e., in default) or somewhere further along in the foreclosure process by the end of the 4th quarter.  That's 12% of mortgage loans in the U.S., an incredibly high number.  Here is the press release for the study from the Mortgage Bankers Association.

This number is a leading indicator for a continuing rise in foreclosed homes taken back by banks and then eventually dumped on the market - and highlights how important loan modification efforts are to slowing down the real estate crash.  The press release from the MBA notes that delinquencies from the actual mortgage structure (subprime, alt-A, negative amortization, etc.) is starting to dissipate, while foreclosures are expected to remain high due to job losses and other economic hardships.  In Arizona, I expect it to come from people who are very far underwater on their homes and feel like they have no hope for their home to ever be worth what the loan is worth again - i.e., people who simply decide to walk away.

Interestingly, one of the reasons cited in the article for the increase is that borrowers are deliberately stopping payment on their loans in order to qualify for loan modifications - even if they can pay.  This is because banks refuse to even talk to a borrower about a loan modification unless they are seriously delinquent.  So if a homeowner is diligently making payments, but is barely scraping by due to job loss or other financial hardship, they must intentionally default in order to get the bank's attention.

President Obama's new mortgage modification program guidelines released yesterday attempt to mitigate that problem by incentivizing servicers and lenders/investors to modify loans for people who are in trouble, but who are still current on their payments.   I will write a bit more about the new program later.

This nationwide number comes against the backdrop of the following state by state graphic looking at concentration of foreclosures in the U.S.  Not surprisingly, California, Arizona, Nevada and Florida are all above the national average, while much of the rest of the country is below the national average.  Of course, because the national average is rising rapidly, this doesn't mean there isn't a foreclosure problem in states besides those four.  Nevertheless, the bulk of the problem is concentrated in a few states - Arizona among them.

(click for larger image)

Update:  As I indicated above, the continuing problem in Arizona is that massive devaluation (around 50% in many areas) has caused many borrowers to be way underwater on their loans (i.e., house is worth less than the mortgage) and they are simply walking away.  HousingWire reported yesterday that new data shows 20% of all homes with mortgages nationwide were underwater in December.  And of course that number will rapidly increase as prices decline further as expected.  Noted in the Housingwire article is the same concentration in the four states mentioned above.

FHA LOAN LIMITS IN PHOENIX RISE DUE TO STIMULUS BILL

I noted on Monday that conforming (Fannie/Freddie) limits were raised due to a provision in the stimulus bill, primarily affecting areas that are designated as "high cost" (i.e., not Phoenix).   

Justin McHood over at ArizonaMortgageTeam points out that FHA loan limits also were bumped up by the stimulus bill - and this does affect Phoenix.  The FHA loan limit was raised from $271,000 to $346,250, making many more prospective homebuyers in Phoenix eligible under FHA programs.  It's another minor step to help provide some liquidity to the ailing mortgage market.

The Mortgagee Letter from HUD announcing the new limits can be viewed here (Word doc).  And a county by county look-up of the new limits is here.

CONFORMING LOAN LIMITS RISE DUE TO STIMULUS BILL

Housing Wire points out today that the recently passed stimulus bill (American Recovery and Reinvestment Act of 2009) re-raises the conforming loan limitations for many markets back up to late-2008 level.  The Economic Stimulus Act of 2008 had temporarily raised the conforming loan lmitations for the last six months of 2008.

The conforming loan limitations (capping loan amounts that Fannie and Freddie are allowed to purchase/guarantee) for 2009 were set under the Housing and Economic Recovey Act of 2008, meaning they dropped back to lower levels starting January 1, 2009.  The new provision in the latest stimulus bills sets the limitation back to the higher late-2008 levels (or the 2009 levels calculated under HERA - whichever is higher).

This is obviously important in providing liquidity to the mortgage markets as Fannie and Freddie are currently operating as one of the only remaining secondary market buyer of newly originated mortgages.  This will give them freedom to purchase/guarantee a wider range of mortgages.

The new limits vary by housing market and can be found here.  They generally help areas designated as "high cost" - which does not include Phoenix.  That means that the one-unit conforming loan limit for Maricopa County will remain $417,000 for loans originated in 2009.  Two years ago, there were a lot of sales/loans in Phoenix metro that were exceeding that limit, but with the severe devaluation we have seen, the bulk of the new mortgages in Maricopa County should come in well under this limit.

OBAMA ANNOUNCES NEW HOUSING PLAN IN PHOENIX

The news of the day today was President Obama's visit to the Phoenix area (Mesa to be exact) to announce the details of his plan to stem home foreclosures.  Reaction to the plan has been generally positive around the blogosphere, with many of the complaints centering around it not going quite far enough yet or there not being enough details yet (full specifications on the plan are to come in a few weeks).  The administration published an executive summary of the plan in advance of Obama's speech that can be found here (pdf).  Additional details can be found here.

Cribbing from Economist.com's Free Exchange:

Very generally speaking, there are three parts.

First, the administration will increase the number of homeowners able to refinance at current, low mortgage rates. Borrowers whose mortgages are owned or guaranteed by Fannie Mae or Freddie Mac will be able to refinance a loan up to 105% of the home's value (up from 80%, previously). This is expected to help about 4 to 5 million households who owe nearly as much or more than the value of their homes.

Note that this is for people who are not yet underwater or just a little underwater, but who have less than 20% equity left in their home due to devaluation.  Due to very strict lending standards now, unless a borrower has at least 20% equity (and often 30%), they are unable to refinance.

The second part is the one that's grabbed headlines; the president has dedicated $75 billion toward efforts to prevent foreclosures. Chief among these efforts is a plan to reduce monthly payments for troubled borrowers. For those spending greater than 38% of their income on mortgage payments, up to 43%, the government will ask lenders to reduce interest rates to bring payments down to the 38% level. The government will then match lender dollars, one-for-one, in bringing down interest payments until the borrower is only spending 31% of income. Both borrower and lender will be eligible for $1000 payments when payments are reworked, and if the planned payments are made. If it's necessary to reduce principle, then Treasury will provide assistance with this, as well.

Note that principal reduction is up to $1,000 per year over five years if a borrower continues to pay on time - only a $5,000 principal write-down and nothing to write home about for Arizonans who are way underwater.  The reduced monthly payments are also for five years and then regular payments can be phased back in.

The final portion of the plan involves measures to "strengthen" Fannie and Freddie and to keep mortgage credit available and fairly cheap.

The plan uses various fees for servicers and mortgage holders as carrots to induce them into modifying loans instead of going through typically more expensive foreclosures.

Of note is the explicit support of the administration for a change in the bankruptcy laws to allow for mortgage cramdowns.  Obama emphasized this in his speech today (full text here). 

But the best part of the plan that shows someone in the administration has actually listened to borrowers is that a homeowner does not have to be delinquent or in default on their loan payments in order to be eligible.  I have people call me all the time who are exasperated after being told by their lenders that they won't even talk to them about modification until they are at least 3 months behind in payments.  Often these homeowners have been struggling mightily to come up with their payments (including using credit cards - a no-no) and wonder why they even bothered.  So hopefully this will encourage lenders to do some legwork to talk to consumers who legitimately are unable to pay, but who have nevertheless tried to hold up their end of the bargain.

My view of the plan overall is that it at least shows that the government is starting to recognize the roots of the problem and are working to correct them.  Showing some competence and putting together a comprehensive plan like this will help boost confidence and certainty in the market and may actually slow down foreclosures to the point where buyers sitting on the sideline feel it is time to get into the market - thus further stabilizing prices.  The $8,000 first-time buyer tax credit in the stimulus package just passed will also help with this.

As for residents of Arizona, I still think that without larger principal write-downs (which this does not do), many homeowners are in trouble and will remain in trouble for years to come. I'm afraid that Arizonans will continue to look to the anti-deficiency statutes to "walk away" from their homes that are tens or hundreds of thousands of dollars underwater - even if they are able to pay.  But at least this plan will go a certain distance towards easing the short-term payment difficulties for people who want or need to stay in their homes, but no longer have the means to pay the full amount.

I will be interested to see the full details of the plan when they are introduced in the coming weeks.

BIG BANK MORATORIUM ON FORECLOSURES PENDING GOVERNMENT ACTION

Following getting roasted on Capitol Hill this week, JP Morgan Chase and Citigroup announced today that they are temporarily halting foreclosures for at least the next three weeks to wait for guidance from the federal government on their proposed plan to subsidize loan modifications.  The proposed federal program is meant to try to keep people from initially defaulting as one of the big problems with the loan modification process right now is that people have to stop making payments and default before the banks will even consider talking to them about a modification.

FED ADOPTS PRINCIPAL REDUCTION PROGRAM FOR HOME LOANS

The Federal Reserve picked up a major portfolio of home loans when it bailed out Bear Stearns and AIG.  The Washington Post writes that they are now initiating a new home loan modification program for those loans that focuses on principal reduction - a tactic many (including me) feel is the best way to stem the tide of foreclosures.

The Fed is emphasizing reducing the amount of principal owed by people at risk of foreclosure, particularly those with a loan balance that is more than 125 percent of the estimated value of their property. Private lenders have been reluctant to renegotiate loans that way, as some of the institutions that own those loans, in the form of mortgage-backed securities, stand to lose money and therefore object.

This gets to the heart of the matter - banks (and investors in mortgage-backed securities) lose money if they write down principal and have to recognize that loss on their books - which further hurts their capital positions.  So instead they try to do as little as possible in a modification and often only delay the inevitable foreclosure - costing the bank or investor even more money than if they had just written down the principal.  Furthermore, as the article points out, investors in MBS typically need to approve principal write-downs, so mortgage servicers often are not allowed to modify loans in a way that would prevent foreclosure.

For example, the Federal Deposit Insurance Corp. has tried to use its control of California bank IndyMac, which it seized last summer, to do loan modifications, but has been frustrated by investors in those loans being unwilling to reduce the amount of principal owed.

To remedy this problem, bankruptcy cramdowns are now being considered in new legislation circulating in Congress.  This would put principal write-downs in the hands of judges, not the banks - and the banks (and MBS investors) are generally not happy with that idea.  The alternative, of course, is for banks and investors to undertake principal reductions voluntarily, which they do not yet seem willing to do.  Perhaps the threat of bankruptcy cramdowns will incentivize them to do this.

Still, the amount of home loans owned by the Fed is only a small fraction of the amount of total loans outstanding and, according to the article, homeowners typically will not know whether their loan has been acquired by the Fed and is eligible for this new program.  But the hope is that by initiating a true principal write-down strategy, it will provide some empirical evidence of whether principal write-downs will be effective and will serve as a model for other government programs and the private sector.

Update:  More coverage and commentary from HousingWire, including the letter from Bernanke, can be found here.

MORTGAGE CRAMDOWN LEGISLATION NOW UP IN THE AIR

The Hill is reporting today that President Obama has indicated that he opposes including the cramdown legislation I previously wrote about (here and here) in the stimulus package over concerns it will cost Republican votes.  It sounds like Obama is trying to get as many Republicans on board to vote for the stimulus package and putting anything too controversial in there is being reconsidered (although no doubt there will be a lot that Republicans don't like in the bill).

It sounds like there is some disagreement between the President and Senate Democrats on this according to the article - so stay tuned to see if the legislation is included...

HOWELL JACKSON SUPPORTS EMINENT DOMAIN FOR BAD MORTGAGES

Dean of Harvard Law School, Elena Kagan, has been nominated to be solicitor general by President-elect Obama, leaving the spot open at my alma mater.  Today, HLS Professor Howell Jackson was named Acting Dean there. 

I did not have Professor Jackson for any classes when I was there, so I don't know him personally.  But interestingly, he is a person cited by the NCRC as lending support to using eminent domain to take over bad mortgages on the cheap - a topic I wrote about yesterday.

From the press release:

As Harvard Law Professor Howell Jackson points out, eminent domain can solve the barriers related to first and second liens by directly purchasing all mortgages on targeted properties.

Somehow I don't think the step up in titles for soon-to-be-acting Dean Jackson is going to convince Congress to go through with the idea.

Update:  Here (RealPlayer) is a webcast of a panel discussion moderated by Dean Kagan and involving Professor Jackson, among others, discussing the economic crisis and bailout.

GOVERNMENT TAKING OF BAD MORTGAGES USING EMINENT DOMAIN?

Here's a new idea proposed to Congress yesterday by the National Community Reinvestment Coalition (NCRC): have the U.S. Government essentially condemn bad mortgages and take them using their power of eminent domain (paying a severely discounted market rate to their owners).  Then the government could modify the mortgages however they wanted - most likely reducing principal amounts down to fair market value and allowing homeowners to stay in their home with a less burdensome loan. 

This proposal is part of NCRC's "Help Now" solution to the foreclosure crisis.  Under the original Help Now proposal (pdf), the government would simply buy these bad loans at a big discount from banks and holders of mortgage backed securities.  Then they would modify the loans - writing down principal and solving a lot of problems.  This plan would get around the current problem of investors in mortgage backed securities withholding consent to loan modifications, since the government would now own the loans.

But to get this done, of course, the banks and MBS investors would have to be willing to sell their mortgage portfolios at a steep discount and recognize losses.  I'm guessing that wouldn't be a popular option for investors in MBS or banks with loan portfolios - who figure that the government should buy the mortgages at higher prices and the government/taxpayer should shoulder potential losses when writing down principal.  (A variation of this asset pricing problem was the fatal flaw in the original TARP plan to buy bad assets.)

So enter the eminent domain idea from NCRC - a stick used to threaten banks and holders of MBS to sell at a low price or the government would just use eminent domain and determine what the fair market price of the portfolio of loans actually is (obviously they would say it's very low).  No doubt this would lead to lots of lawsuits over the fair market value, etc. 

The other challenge made of course would be whether the taking was for public use as required by the U.S. Constitution. (Note that the taking addressed is of "private property" and isn't limited to real estate.)  This is usually the crux of eminent domain disputes and a source of a long line of property law precedent in the courts.  The most recent U.S. Supreme Court decision was in 2005, which endorsed a fairly expansive interpretation of "public use" as set forth in the U.S. Constitution.  They said that use of eminent domain is permissible even if the taking of property was used for private economic development by private developers - as long as there was a public benefit (in this case urban revitalization).  So the question would turn on whether the U.S. Government taking these mortgages (private property) using eminent domain would be for the public use or benefit.  An argument could be made for that fairly easily I would argue, but it certainly isn't a clear cut case.

I won't get deeper into the history of eminent domain, but it is a fairly controversial power used by governments and often disputed in court.  Which leads me to believe that while the plan may theoretically work, it would probably get bogged down in the court systems long enough for it not to be effective in time to help stem the foreclosure tide.  But I guess it would keep the bankruptcy judges out of the process...

JUDGES SUPPORT MORTGAGE CRAMDOWN LEGISLATION

The Wall Street Journal has a follow-up on the topic I posted about late last week - mortgage "cramdown" legislation.  That is legislation giving the power to bankruptcy judges to modify terms of mortgages on primary residences - including principal write-downs.

The WSJ talked to judges, who - not surprisingly - are in support of having the power to alter primary residence mortgages.  They cite one of the reasons I brought up in my earlier post:

Allowing a judge to modify loans gets around the problem that many mortgages have been turned into securities and sold to multiple investors. "The bankruptcy system depends on people making deals, but the deal-making piece of it has disappeared when it comes to mortgages because of the way mortgages were sold and packaged," Judge Bufford said. "There's nobody on the lender side to do the deal unless you [get permission] from investors, and that's impossible."

The full article can be read here.

MORTGAGE CRAMDOWNS ON PRIMARY RESIDENCES MAY SOON BE A REALITY

Percolating behind the scenes during the transition period for the new administration is President-elect Obama's support and Democratic Senators' support for a change in bankruptcy law that allows bankruptcy judges to modify the terms of mortgages on primary residences.  Currently bankruptcy judges can modify various loans, including on secondary/vacation homes and investment property, but cannot modify loans on primary residences.

That may be coming to an end soon as the new Congress is considering a change in the bankruptcy laws to allow judges to modify loans, including principal reductions (sometimes known as "cramdowns").  The financial services industry has, of course, been very wary of allowing this to happen since it will potentially lead to many homeowners seeking the protection of bankruptcy to obtain home loan modification to a level they can afford.  But today according to an article in the Wall Street Journal, in a major reversal, Citigroup expressed support for the Senators' plans to modify the laws to allow principal reduction by bankruptcy judges. 

More after the jump...

LOAN MODIFICATION DIFFICULTIES CROPPING UP DUE TO UNDERSTAFFING

The NYTimes had a good article last week about some of the difficulties in actually completing loan modifications.  One of the major hurdles is that loan servicers are not staffed to handle the labor intensive work of loan modifications.  One of the main complaints by consumers in attempting to complete a loan modification or get approval for a short sale is the many months it often takes for the loan servicer and bank to sign off.  As the article points out, most loan servicers are lightly staffed and only equipped to collect checks and send out statements.  Adding loan modification services includes hiring people to negotiate and draft loan modification documents, getting approvals from whomever actually owns the loans (another complication as the article points out) and the work it takes to follow up with the borrowers or their lawyers.

Loan modifications and short sales aren't profitable practices either - as banks are losing money in the process.  But foreclosures usually cost even more, so banks are willing to foot the bills for additional staff.  Nevertheless, it stands to reason that loan servicers aren't eager to hire a lot of extra staff to speed up a process that is ultimately a money-losing operation.

When representing clients in my law practice for loan modification services or providing legal assistance getting approval for a short sale, I am always confronted with the question of how long will this take.  And because of the staffing issues and the wide variety of work-outs between lenders/loan servicers, my only answer can be "It depends."

WE'RE #1...

...in housing price decline - according to the latest Case Shiller Housing Price Index released today for October 2008.  Nationwide, housing prices fell in the 20-city index for the 22nd consecutive month and set a year over year record decline in October of 18%.  Phoenix metro leads the way with the steepest decline, however, just edging out Las Vegas with a 32.7% annual decline.  Las Vegas is at 31.7%.  And of course one year ago wasn't the peak of our market.  So total declines have been much greater.  According to John Wake, over at ArizonaRealEstateNotebook.com, total price declines from peak are about 41%.  He has some more thoughts on the index on his blog here.

I'm not as optimistic as John about us finding a bottom in early to mid-2009 for a variety of reasons, including continuing and worsening job loss in Phoenix, the tepid efforts at loan modification so far by banks and the the incentives I wrote about a couple of weeks ago for people in Arizona to simply walk away from their homes, thus exacerbating the price declines.  Hopefully John is right and I'm wrong in this case.

Here (pdf) is the full release from S&P with the Case Shiller index today.  It has some nice charts and graphs to give you a better idea of the declines over the past year.   Here is the NYTimes' take on the index.

MORE ON THE COMING OPTION ARM BUBBLE

Following up on my post the other day about the massive Alt-A and Option ARM reset/recast bubble coming over the next several years - Dr. Housing Bubble has a lengthy post explaining more about Option ARMs.  Pretty interesting discussion about why borrowers are thought to be helped by lower index interest rates - but negative amortization is having the effect of still raising the monthly mortgage payments for many.   In some cases, these "recasts" that add accrued interest into principal - thus increasing the size of the loan - are causing some drasting jumps in monthly payments.

As I wrote in my previous post, an increasing percentage of these Options ARM borrowers are already defaulting on their mortgages because they are very far underwater and see the writing on the wall (or they lost their job, etc.).  This is particularly bad in Arizona, Nevada and California where significant percentages of homeowners took out these types of loans and are now way underwater.

DISCUSSION OF PRINCIPAL WRITE-DOWN DURING LOAN MODIFICATION

An interesting post on Friday by John Wake over at Arizona Real Estate Notebook regarding principal write-down during loan modification.  His post with ensuing comments and discussion can be read here.  John's comments were in response to thoughts published by Anthony Sanders of the W.P. Carey School of Business at ASU.

Essentially by not writing down principal during loan modification, banks are just deferring foreclosure to some point in the future (often only 3 to 6 months in the future).   Diana Golobay writes about many of the same issues related to loan modification on Housingwire.com here.

My response to John's post is on his site and can also be read below the jump.

MORTGAGE MARKET TROUBLES TO CONTINUE IN ARIZONA AND NATIONWIDE

60 Minutes did a report this week on what many of us who are following the mortgage market mess have known for awhile - there is still a big second bubble of "exotic" mortgage loans out there that are just starting to hit the market - and are expected to default in big numbers.  The adjustable rate subprime loans have for the most part reset, causing massive defaults and foreclosures, but the Alt-A loans and the Option ARM loans are just starting to reset.

Alt-A loans are loans made to people with good credit histories (so not subprime by definition), but who could not provide verification of income or assets.  They are usually interest-only, adjustable rate loans.  Option ARM loans are typically negative amoritzation or interest-only loans with low teaser rates that will eventually reset to higher monthly payment amounts.  The following chart from Credit Suisse shows how we are currently in a trough between the end of subprime adjustable rate resets and the beginning of the Option ARM/Alt-A resets (click for a larger chart):

 
As you can see by the chart, the bulk of the resets are yet to come over the next three years - causing many mortgages to reset with higher interest and therefore higher monthly payments.  With home prices already very depressed, the question becomes whether homeowners with these types of mortgages will stick it out and continue to pay the higher monthly amount - or give up and walk away from their homes because of how far underwater they are on their loan.  As I wrote earlier this week, Arizona is particularly susceptible to the "walk away" effect because of the current consumer protection laws in place.

Credit Suisse revised their predictions earlier this month to predict that 8.1 million homes will go through foreclosure in the next four years (approximately 16% of all home mortgages).  Currently about 1 in 10 home mortgages are in default or in foreclosure.

LOAN MODIFICATIONS & SHORT SALES IN ARIZONA – PART ONE OF MANY

One of the matters I have been helping some clients with are issues relating to their residential loan workouts. There is a lot to be said about the topic, so I just want to give some very general comments in this first post about the current incentive structures in place for homeowners in Arizona. In short, much of what has occurred in the last two years encourages homeowners to walk away from their home loans – which is unfortunate for the Arizona market as a whole as it creates a continuing downward push on home values.

In Arizona, property values are down an average of 35% since last November – and by as much as 50% from the peak of values (See John Wake's blog for some stats on this). Once we finally hit a bottom in the market (hopefully before the end of 2009), most experts don’t expect any sort of bounce in values. More likely we will bump along the bottom for a few years with flat or minimal appreciation before beginning to slowly start recovering value. And even then, annual appreciation won’t be anything like the last four years. It is more likely to be between three and five percent appreciation for quite awhile.