One failed bank gets the housing fix right
When the FDIC seized mortgage giant IndyMac it was one of the biggest bank failures ever. Now the troubled lender just may lead us out of the housing mess.
NEW YORK (Money) -- The battered economy is in desperate need of a housing fix, and one failed bank just may have the answer.
On Thursday FDIC Chairwoman Sheila Bair told the Senate Banking Committee about the success her agency has had in helping struggling borrowers at IndyMac, which the FDIC took over this summer.
Bair, the nation's leading bank regulator, thinks this foreclosure prevention program can work for other banks.
"Our hope is that the program we announced at IndyMac Federal will serve as a catalyst to promote more loan modifications for troubled borrowers across the country," she told the committee.
She's not alone. While individual lenders, loan servicers and non-profit foreclosure prevention outfits have been chipping away at the staggering housing crisis on a case by case basis, IndyMac, under the FDIC's leadership, became the first bank to establish a set protocol to modify home loans.
"I think this is an appropriate way to go, and I would hope that more institutions would take it up," said Michael Barr, professor of law at University of Michigan and a senior fellow at the Center for American Progress. "We need a systematic way to do this, we can't continue to do this on a one-by-one basis."
Chris Kukla, senior council for government affairs at the Center for Responsible Lending, points out that this is precisely how Congress approached the recent Wall Street bailout.
"We aren't sitting down on an individual basis and figuring out who needs what," he said. "The government is giving a piece to everyone because there is a recognition that we need to stabilize the financial markets. Well, we need to stabilize the housing market too."
IndyMac services more than 60,000 loans that are either more than 60 days past due, in bankruptcy, in foreclosure or are otherwise not currently being paid. About two-thirds of those customers are eligible for the program, according to Bair, and more than 3,500 IndyMac borrowers have had their loans modified to affordable levels so far. Borrower payments have been cut on average by $380, she said.
Currently most lenders assess each loan on a case-by-case basis, which takes a tremendous amount of time and resources, and can hold up the process for months. Establishing set rules that a lender can apply to thousands of borrowers will speed the process, and help right the housing market more quickly
Under IndyMac's program, the lender modifies a loan so that the borrower's new mortgage payment, including insurance and taxes, eats up no more than 38% of their pre-tax income. This percentage, known as a debt to income ratio, topped 50% for some loans during the boom.
To achieve this lower payment, IndyMac can lower the interest rate, extend the life of the loan to, say, 30 or 40 years, defer some principal to the final years of the loan, or a use a combination of these strategies.
IndyMac is also trying to simplify the process for borrowers. It is overnighting loan forms to eligible customers with a signature required upon receipt. "It doesn't show up with your regular mail, coupons and junk mail, because the key is getting the consumer to open it," said FDIC spokesman David Barr.
The papers clearly spell out a borrower's new loan terms, including the interest rate and monthly payments over the life of the loan. The borrower simply signs and returns the documents with the first lower monthly payment.
Bank of America (BAC, Fortune 500) launched a similarly systematic program earlier in October. That program, scheduled to start in December, came as part of a settlement with state attorney general offices that sued Countrywide, which B of A recently acquired, for predatory lending practices. It's expected to help 400,000 troubled borrowers and is actually slightly more aggressive than IndyMac's plan.
B of A will use a 34% debt-to-income ratio to calculate the affordable monthly payment for its customers, and may also write down the principal balance of some negative amortizing loans. IndyMac will not forgive debt, but instead will add principal to the final years of a loan if necessary.
Additionally, IndyMac's program is now being applied to many delinquent loans owned by Freddie Mac (FRE, Fortune 500), Fannie Mae (FNM, Fortune 500) and other investors, Bair said in her testimony Thursday.
Not everyone is convinced that Bair's brainchild should be the industry-wide template.
Thomas Lawler, a housing economist in Leesburg, Virginia, contends that lenders need to look at a borrower's other assets in addition to their debt to income ratio before working out a loan. "Otherwise, they will include people who shouldn't really qualify, and might exclude people who do," he said. "That is one reason why mortgage lenders don't particularly like to have a very simple systematic streamlined modification, because it doesn't work."
For example, a borrower with substantial additional assets and no other debt may have taken out a big mortgage that eats up 45% of his income. There is a risk that the program will aid this borrower, and not someone with a smaller mortgage and no other assets who also has student and car loans.
But the Center for Responsible Lending's Chris Kukla argues that the crisis is too severe to worry about helping people who don't deserve aid.
Indeed, earlier this month The State Foreclosure Prevention Working Group, a group of state attorneys general and banking regulators, sent a letter to nearly 20 of the largest servicers telling them that they were expected to implement a systematic approach to modify loans similar to IndyMac and Bank of America.
"We aren't getting push back yet, but we haven't gotten any firm commitments yet either," said Iowa Attorney General and task-force chair Tom Miller. "But there is a willingness to talk."