Laurie Goodman, veteran MBS analyst and now a senior managing director at Amherst Securities,
served up painful facts about mortgage defaults at a House Financial Services Committee hearing last week concerning "The Private Sector and Government Response to the Mortgage Foreclosure Crisis," Available here.
An ace HousingWire
reporter already scooped this story,
but I've been itching to comment since I watched the hearing. Goodman brought facts and a spirit of inquiry to the policy discussion that bear celebrating. As a matter of fact, when the Committee released the names of witnesses the night before the Hearing, I'd felt the kind of hope for Congress I hadn't felt in months. Someone without a political or corporate agenda, having detailed data on mortgages and years of professional experience interpreting it, was going to testify. Psych!
Goodman is a real mortgage analyst. Not an staff economist for a regulator justifying its performance (or existence) or a university professor opining from 30,000 feet (typically with an ideological predilection for the right or the left side of the issue), but someone who had their arms up to the elbow in actual loan level performance, who knew how to look in the weeds for evidence of borrower motives, servicer performance, the determinants of trends.
It's not just Goodman (though for years she has been recognized by investor surveys etc. as a premier analyst and strategist). There's a number of other disciplined and creative analysts on both the buy and sell sides of the MBS and ABS markets that the Congress and the Administration ought to have been listening to while dreaming up their schemes to heal the mortgage and housing markets, save financial markets from themselves, and put financial institutions back on the straight and narrow. So indulge my enthusiasm and let me highlight some key points in her testimony.
First, Goodman demonstrates how strong a driver of defaults negative equity is. Her testimony is based on a study of loans that were 30 days delinquent 6 months earlier. Then, Goodman looked forward 6 months, for loans that had gone on to be at least 60 days delinquent. Out of prime borrowers originally 30 days delinquent with 20% equity, 38% were 60 or more days delinquent. Borrowers with less equity performed worse. For example, a full 75% of the prime borrowers originally 30 days delinquent with significant negative equity (141% - 150% loan to value) were 60+ days delinquent.
Why does Goodman study borrowers 30 days delinquent (rather than currrent, for instance)? To demonstrate how important a factor negative equity is in the borrower's decision to default. In addition, this approach keys on the fact that cure rates are much lower and transition rates into successively worse delinquency rates are much higher than in previous credit downturns.
Here's how Goodman narrates current events: "Most borrowers do not default because of negative equity alone. Generally a borrower experiences a change in financial circumstances, misses a payment on their mortgage and then re-evaluates ... If the home has substantial negative equity, they chose to walk."
By focusing on the transition from 30 days delinquent to seriously delinquent, the testimony underscores something else Goodman and her fellow MBS analysts have pointed out for a while: time is on the side of defaults, and waiting for a delinquent mortgage to self cure in this housing market is a losing game.
Goodman also took on the widespread, but mistaken notion that unemployment is the primary driver of delinquency, default and home loss. (Indeed, a committee member set her up for a dunk ball, by stating "there is no better foreclosure mitigation plan than a job." I should clarify, he was using his three minutes to grandstand against the Administration's stimulus, spending and tax programs as "job crushing" disincentives to job providers, not demonstrating his - or even his staff's - understanding of the dimensions of the foreclosure crisis.)
Drawing on her recent report, "Negative Equity Trumps Unemployment in Predicting Defaults," (covered by HousingWire.com
at publication: Read here
), Goodman made three key points:
1. The total ratio of mortgage debt to home value (CLTV) is critical. In areas with low unemployment, defaults rates of Prime and Alt-A loans were at least 4 times greater for borrowers underwater by 20% than for borrowers with at least 20% equity in their homes.
2. Comparing loan performance and unemployment rates at the local level (as can be done with loan level data), Goodman found all borrowers with positive equity performed similarly regardless of the local rate of unemployment.
3. When borrowers have negative equity - as measured by CLTV, to include second mortgages - unemployment plays a role, but a minor one compared to negative equity. For example, borrowers with CLTV greater than 120%, default rates were 50% to 100% higher in a high unemployment area than in a low unemployment area.
Summing it up, unemployment may be a catalyst, but it is not a driver of defaults.
Based on this research and a lot more like it, Goodman is comfortable telling the government that if they want to improve the success of HAMP, they need to move principal reduction higher in the modification waterfall and relax the focus on payment reduction.
Furthermore, to design a successful principal reduction program, "the Administration has to address the second lien problem head on" and provide for extinguishing the second lien. A couple of approaches could work, including "paying an extinguishment fee" or allowing banks holding second liens to take the loss over time rather than all at once.
Let me explain. The second lien is an obstacle to modification because it jumps to first position when the first mortgage is modified. This is a disincentive for the second lien holder to cooperate with the first lien holder in a modification and agree to re-subordinate their loan or reduce the principal amount and re-subordinate. The HAMP second lien program, 2MP, introduced in August, addresses some of these problems but does not yet seem to be operational. Unfortunately, as Goodman pointed out in her testimony, when it does come online, "it will merely make the second lien pari passu to the first lien."
This obstacle is not reduced by the fact that the four largest servicers (BofA, Wells Fargo, Chase and Citi) are also the largest holders of second lien residential loans. According to data compiled by Goodman last March, they own $94 billion closed-end seconds, $397 billion home equity lines of credit, and about $653 billion in first lien loans. (The report wasn't cited in testimony, but I relied on it in my November 2009 Housingwire Magazine article, "Modify Me: A Review of Loan Modification Efforts.")
At first glance, these concentrations seem to raise the odds that the first lien servicer is owned by the bank that holds the second lien. However, in March Goodman calculated that, even if every first lien was accompanied by a 25% second lien, only about $163 billion of the top servicing banks' second liens would be accounted for.
Goodman acknowledged that her testimony had been focused exclusively on mortgage modifications. But she offered to return to work with the committee on mortgage modification as well as the broader set of measures that must be taken if the capital markets are to function efficiently again.
That was a good offer, one other congressional committees noodling the financial markets debacle should take up as well. And if they do, they should invite investment analysts and strategists from other investment firms. Having come up through the ranks of mortgage research myself, I am willing to vouch they are far less likely than the usual suspects at hearings to serve up a dish of cant and self-justification.
(Important disclosures: Linda Lowell is a stakeholder in the US housing market and a taxpayer. She worked for Laurie Goodman more than once in her decades as a security analyst, and may have been biased by that experience.)