Friday, February 13, 2009

Loan Servicers and the Credit Crunch

This link to Reich's blog, What Geithner Needs to Do, is for those who want to peek behind the curtain at what the Wizard of Oz is trying to do. This is a cheap shot, but as I read this post that image came up because Reich is literally a little man compared with the image he controls, just like the character in the Wizard of Oz.

Most members of Congress and 99.9 percent of the public are unaware that the Fed has already committed over $2.5 trillion to the financial system, in order to get credit markets moving again -- but with limited results so far. It's easy to do things through the Fed because there's scant political oversight of it, and the Fed's dealings don't show up as additions to the federal budget deficit. (Yes, we live in a democracy, but not when it comes to the Fed.)

There's more, but that's the nub of it. And he concludes that Geitner's challenge is to raise confidence in two groups: the public and investors. Given the complexity of the challenge, making the public feel better is a more realistic outcome than building confidence in investors.

This comment by Reich impressed the Roubini people enough to link it in their weekly newsletter and blog, a treasure trove of reading for those who enjoy contemplating the dismal science, where Reich is a regular contributor.

But unfortunately that is not the focus of this post. I begin with that to illustrate how high-profile people are talking in public. It is my sincere hope that in private they know better. At the heart of any remedy are details too tedious to imagine. But those details don't make for dramatic news so we have to listen to chatter in the news cycles while those with longer attention spans toil away trying to resolve the mess.

And this leads to the reason I'm still hopeful that Obama can get a handle on this thing.

Buried deep within this crisis, far from the gasbags, serious talented people are doing the boring work of figuring out what to do. I can't find it now, but I'm certain that during one of Obama's cheerleading speeches I heard him make reference to "funds to pay loan servicers" (or words to that effect) to help unravel the mess created by the securitization of mortgages. As every schoolboy knows by now, that was the pebble that started the avalanche but most of us cannot imagine how the details work.

In simple terms, if no one ever defaulted on a securitized mortgage the system would be working smoothly to this moment and everyone would be unaware that an accounting ticking bomb was waiting to explode. At the core of the challenge is how best to deal with a mortgage in crisis.

We are hearing a lot about "foreclosures" but between that worst-case scenario and an occasional late monthly payment lie a variety of possibilities. Listen closely to the chatter and you will hear the phrase "work out the mortgage" which is code language for modifying the terms of the original loan so that interest rates, terms or (heaven forbid) adjusting the outstanding principal. Listen for the buzzword workout.

The "workout" part of this deal is the sticking point. At the heart of that mess is a class of professionals known as "loan servicers." Apart from the other parties to the arrangement (lender, borrower, lending institution, and the many subsequent sliced up places where monthly payments must be sent) those whose mission is to track the process have an unbelievably complicated task. As long as there are no defaults, everything runs smoothly. (Ain't technology great?) But the moment conditions change they have to do the financial equivalent of neurosurgery on the mortgage, tracing all the little pathways connecting the single payment nerve to its many waiting destinations.

Who pays the loan servicers?

As long as all they do is routine work, they probably collect a modest charge from both ends of the transaction, depending on which end needs attention. If those receiving little snips of the revenue are traded, all they have to do is change mailing addresses on a list. If the loan gets sold to a different place at the originating end, they change the address on another list. But if the loan gets changed, this is where it gets messy.

Basically, there are two easy changes. Either the loan gets paid off early and vanishes. Or it gets foreclosed and vanishes. A bit of a problem, maybe, and a little out of the ordinary, but like swatting a fly, either change is swift and simple.

But if the terms of the original loan get changed but not stopped, this is where the time-consuming part starts. There are no shortcuts. Someone at a desk with a keyboard must comb through several haystacks looking for the magic needle in each one, keeping track of the trail. Think of the phone man looking at a bundle of tiny colored wires in that cable box finding the one leading to your house out of hundreds, thousands of others going Lord knows where.

This comment was in a comment thread at a Times article about the problem last year.

I believe the loan modification problem has less to do with potential liability than a staggering lack of human resources at the servicers.

As an auctioneer, I am regularly contacted by borrowers in default. In my efforts to assist these borrowers, I have contacted a number ofloan servicers to attempt to “work out” a sale of the property in question. Without exception, the servicers are unable to evaluate, much less comply with, any of the requests to deviate from the typical foreclosure track that I have made so far.

I get the distinct impression that the servicers are so understaffed that they are barely managing to feed all the defaults they are managing to the “foreclosure mill” law firms in their employ.

Asking a servicer to do actually think about what would be in the best interest of the owner of the RMBS, including options other than foreclosure, would be incredibly time consuming and would require an extremely large staff of highly trained and hopefully experienced case workers. It would be incredibly expensive.

For the servicer and for the servicer alone, It is much cheaper to foreclose. For every other party to the transaction, including the owner of the RMBS, it is much more expensive to foreclose.

For those entities who are not parties to the transaction, specifically including owners of neighboring properties, owners of other RMBS secured by neighboring properties, and municipal governments dependent on tax revenue from neighboring properties, the servicer’s decision to foreclose when a workout was possible has a particularly negative impact.

— Will McLemore (comment #37)

Mr. McLemore is not part of the crisis. He's part of the solution. As an auctioneer he has no skin in the game unless he makes a sale. If he does, he gets paid. If he doesn't, he won't.

If you are a lender, you know that it's quicker and cheaper to foreclose than to do a workout because whoever services the loan either won't or can't because the details are too complicated. It's more expeditious in the long run to cut the loss altogether instead of settling for a smaller amount, even though settling for a smaller amount would make more sense.After all, this is a business and losses can be "written off."

(If this were a small landlord negotiating with a renter who may have been faithful to his monthly payment for years, he would be more amenable to negotiation. He would know that vacant property is a lot more expensive than property bringing in less than expected. Something really is better than nothing. But corporations are not prone to think in those terms.)

The clearest explanation of the banking and credit mess I have heard to date is by Elizabeth Warren in a Terry Gross interview in December. She simplifies in easy to grasp language the outline of where we are and what must be done to begin digging out.

A few environmental realities have changed since December 10, but the overall shape of the crunch remains unchanged.
Readers are urged to set aside half an hour to listen to Elizabeth Warren explaining what she calls "a frozen market that is freezing poeple's lives."

Bankruptcy and commercial law expert Elizabeth Warren explains how taxpayer money is being spent in the financial bailout program. A professor at Harvard Law School, Warren chairs the oversight panel appointed by Congress to monitor the spending of the $700 billion bailout money.

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