Principal forgiveness may not be the silver bullet for housing: S&P
The attorneys general settlement proposal to major servicers includes a push for more principal forgiveness on delinquent mortgages. But it may be one of the initiatives cut when banks decide to push back. Following an investigation into foreclosure practices, the 50 state AGs submitted their "opening bid" in settlement discussions, which includes a slew of new requirements. Dual-track loss mitigation — pursuing a foreclosure case at the same time as a loan modification — would end, and modification attempts would be mandatory, among other new rules. Analysts at Standard & Poor's sounded off on the proposal in a report released Friday. While many of the proposals would obviously benefit delinquent homeowners, investors and servicers in the short-term at least would see losses mount as the foreclosure process extends even further. "Servicing costs and workloads may significantly increase at a time when servicers are inundated and operating under cost constraints," S&P said. "Many servicers/originators may attempt to pass an increase in costs to borrowers through higher mortgage rates." Analysts said principal forgiveness could reduce those losses for investors if the borrower remains current afterward. And home prices, too, could begin to rebound if there are fewer foreclosures entering the shadow inventory supply. However, the obstacles to such an initiative may prove too daunting. But not everyone agrees. Laurie Goodman, senior managing director at Amherst Securities, has long said principal forgiveness would be more effective for underwhelming modification initiatives such as the Home Affordable Modification Program. In October, Goodman said a principal reduction effort could "re-equify" roughly 11 million borrowers in imminent default. She said as long as servicers make clear the consequences of strategic default, this "moral hazard" could be thwarted. "The moral hazard (strategic default issue) must be addressed by first recognizing it as an economic issue, not a moral one," S&P analysts wrote in a research note issued Friday. "The costs of default must be made explicit." However, Standard & Poor's said too many homeowners may be too far underwater. In order to bring more borrowers in negative equity – meaning they owe more on the mortgage than the home is worth – back to the surface could require a reduction between 25% and 30%. In some markets where home prices have been cut in half, like Las Vegas, reductions may need to be in the 50% to 70% range. "The amount of principal forgiveness needed to re-equitize borrowers and/or lower their monthly payments to an affordable level may be beyond the currently contemplated principal forgiveness amounts," S&P said. Such an offer could induce more borrowers to strategically default, and there is also the challenge of reducing a first-lien balance while a second-lien remains with another lender. S&P added that if a borrower redefaults after the principal forgiveness, the losses to the investor would be even harsher than if the servicer had foreclosed in the first place. Four of the state AGs don't agree on these points. In a letter written to the lead investigator, Iowa AG Tom Miller, they point out the proposal may overstep the boundaries of the investigation. Republicans in Congress, too, have complained the proposal goes too far. Other lawmakers, including Rep. Maxine Waters (D-Calif.) said it doesn’t go far enough, and the $20 billion penalty floated by some would be too little. "Market participants have debated the value of principal forgiveness. Some cite concerns such as moral hazard, while others believe it's a necessary step toward overcoming the housing crisis," S&P said. "However, we also believe there may be a number of obstacles that may prevent principal forgiveness modifications from having a significant positive impact on the housing market and for RMBS investors." Write to Jon Prior. Follow him on Twitter @JonAPrior.