Nationalization is scary, but so is the alternative: The malaise and mismanagement we have witnessed since the financial system started breaking down last summer.  US Government looks to quell nationalization fears; FDIC says additional mortgage relief and financing aid will hinge on stress test without nationalization yet taxpayers have invested billions bailing out subprime lenders and banks, with precious little to show for it.

Can nationalization be much worse?  Granted, there are great risks to nationalization. For starters, there is the basic philosophical quandary. It’s tough for a country to take over a large swath of its banking sector and still tout itself as the first, best bastion of capitalism.  Execution risks abound too. University of Chicago business school professor Raghuram Rajan notes that nationalized banks would be subject to political pressures. They might weaken the economy by keeping failing companies alive. And nationalization would amount to a government rescue of bank bondholders, who don’t deserve the help.  The economic arguments are persuasive. But they ignore policy realities that indicate a well-managed and limited nationalization effort could be a net benefit. Nationalized banks could serve broader interests, such as increasing lending and providing mortgage relief.  The effort to spur mortgage lending has had little discernible effect on private-sector banks.

Taxpayers have invested $350 billion in the bank bailout so far, with $350 billion more on the way. The money has not had the intended effect of spurring lending or eliminating so-called toxic assets. One sign of how this could be different came from Great Britain. Northern Rock, a bank nationalized last year by the British government, on Monday announced a plan to write $7 billion in new mortgage loans this year and nearly double that next year.  Read complete article by David Greising. 

Servicer reporting is woefully inadequate, both with respect to servicer performance in general and modifications in particular. Servicers, like any other business, face a budget constraint. Servicers are either paid set fees to service large portfolios of mortgages on behalf of investors or they operate as a subsidiary of a mortgage underwriter servicing the underwriter’s own portfolio. Most servicers do both. The point in either case, therefore, is that the interest rate of the loan includes some amount set aside to cover the cost of servicing.

When mortgage loan performance sours, servicing costs rise substantially. Not only do servicers face increased costs arising from the need to contact borrowers via additional mailings, telephone calls, and legal filings to extract payments, but servicers also must pass along payments to investors as if they are made in full until the property is seized in foreclosure and sold. Hence, as I presented in my October 2007 white paper, servicing costs on a typical $144,000 loan can rise from roughly $50 per year to over $1,000 per year while the loan is in delinquency and over $2,000 per year when the loan enters the foreclosure process.

The problem is that as the servicer is forced to spend more servicing delinquent and foreclosed loans, it has less money to spend on servicing performing loans. When servicers do not have sufficient funds to cover the costs of promptly pursuing new delinquencies, those new delinquencies have a greater probability of rolling into foreclosure. When servicers face budget shortfalls, they cannot follow up promptly on contacting borrowers who are late making payments for the first time. Lags of even a few days in such follow-up have been shown to make a big difference in the propensity for the borrower to become more delinquent, rolling from 30-days to 60-days delinquent, and then 90-days and into foreclosure.

Costs increase further because servicers must “advance” delinquent borrower payments to investors “as if” the money was received from those loans and only recovers that money upon foreclosure and sale of the property. Modification expenses add unknown magnitudes to those costs.

A big question on RMBS and mortgage bank investors’ minds these days, therefore, is whether servicers have sufficient cash flow to maintain servicing quality. If RMBS investors judge servicers cannot perform adequately, investors have the right to sell servicing rights to a servicer that does have such resources. As I pointed out in my September 18, 2008 testimony before the Senate Committee on Banking, Housing, and Urban Affairs, investors must make that replacement before a servicer enters bankruptcy, since a bankruptcy laws may not allow replacement of the servicer because servicer rights can be considered part of the debtor’s estate.

But servicers do not routinely and systematically report roll rates, advance rates (the money the servicer has to pay to investors “as if” it had been received from loans in delinquency) or modifications and related costs to either RMBS or mortgage bank investors, nor to regulators. Worse yet, as the crisis had deepened servicers who do produce such reports for their own use have become more reluctant to share their internally-generated reports with outside parties. Hence, investors and regulators alike have almost no means of judging whether modification programs are beneficial to borrowers or lenders. Investors are therefore reluctant to buy new RMBS and have little ability to judge the impact of servicer performance on the value of existing RMBS, while mortgage bank investors and regulators similarly have little means of judging bank safety and soundness and bank performance.

But the situation is worse than that. Monitoring servicer performance requires – at the least – defining what a modification is and the procedural means by which it is to be administered. The first hurdle faced by Hope Now and OCC reporting on modifications was the mere definition of a modification, and that hurdle has still not been overcome. Recall that lenders have already accommodated many borrowers through “repayment programs.” Some observers say that repayment programs are not modifications, while others maintain they are. We still don’t have an answer to that most basic question, nor do we have systematic reporting to track modification activity and subsequent performance.  > Read Complete Article by Joseph Mason

Faced with the 90-day freeze on foreclosures, lenders will be more inclined to provide loan work-outs with delinquent borrowers, California Department of Corporations Director Preston DuFauchard said during an afternoon teleconference with reporters.  The proposed freeze “is designed to be a stick to get people to have a more aggressive modification program,” DuFauchard said. “ . . . The time value of money creates a real strong incentive to take this modification approach.”

Highlights  Foreclosures: Impose a 90-day stay for owner-occupied homes on which a notice of default has been filed.  Loan modifications: Exempt lenders from the 90-day stay if they have an “aggressive” program to ease mortgage terms for distressed homeowners.  New loans: Implement various steps to prevent lenders from making unsustainable loans in the future.  While many lenders already are doing voluntary loan modifications, they aren’t being nearly aggressive enough to resolve the foreclosure problem, said David Crane, the governor’s special adviser for jobs and economic growth.  Paul Leonard, director of the California office of the Center for Responsible Lending, noted that an increase in loan modification efforts nationwide began over the summer, when the Federal Deposit Insurance Corp. took over failed lender IndyMac Bancorp. The governor’s plan follows that example.  “The goal is to encourage loan servicers to adopt a more streamlined, systematic approach to mortgage  loan modifications,” Leonard said. “The governor is trying to use leverage to move servicers in a positive direction.” 

Mark Goldman, a real estate finance instructor at San Diego State University, said the 90-day stay may give delinquent borrowers more time to remain in their homes, but ultimately it will place greater financial pressures on lending companies and banks.  “The lender is going to just have to wait that much longer to get the collateral, and that may have some negative impacts on the pricing of loans,” Goldman said.  A new California law that requires mortgage lenders to work harder to help distressed borrowers led to a steep drop in September default notices in San Diego County, and foreclosures also declined. In many instances, Senate Bill 1137 calls for lenders to try to contact distressed homeowners then wait 30 days before filing a default notice.

A total of 1,206 county homes received notices of default, which mark the beginning of the foreclosure process. That marked a 58 percent decline from August and a 35 percent drop from September 2007. Around the state, mortgage servicers recorded 94,240 notices of default on homes during the third quarter. That was down 23 percent from a record of 121,673 in the second quarter and up 30 percent from third-quarter 2007, according to the MDA DataQuick research firm.

In his proposal to help distressed borrowers, Schwarzenegger suggested that loan modifications be based on a 38 percent monthly housing debt payment-to-income ratio, so that revamped loans are more sustainable. To achieve that, he suggested that lenders temporarily reduce interest rates, increase loan repayment periods, or defer part of the unpaid principal balance to the end of the loan term.

He called for the Department of Real Estate and Department of Corporations to enforce federal laws and regulations, such as the Truth in Lending Act, and discipline real estate licensees who violate such laws and regulations.  To avoid future mortgage market meltdowns, lending practices should be reformed to protect borrowers by expanding fiduciary responsibilities for mortgage brokers, Schwarzenegger said. He also called for increasing and standardizing licensing requirements for loan originators. Counseling may be desirable for borrowers entering into risky mortgages, to make sure they understand terms and obligations, he said.

Turning to underwriting, the governor urged the federal government to require loan originators to retain a portion of their loan risks to encourage better practices. Kevin Stein, associate director of the California Reinvestment Coalition, said the success of the plan will depend on the details of implementation.  “It is good that the governor is engaged, good that he has called for a special session,” Stein said. “We don’t want it to be another good-sounding program that doesn’t meaningfully help people stop foreclosure.”