Staff Briefing on Reducing Foreclosures December 4, 2009 Morris A. Davis Chris Foote Eileen Mauskopf University of Wisconsin Federal Reserve Bank of Boston.

Staff BriefingStaff Briefingon Reducing Foreclosureson Reducing Foreclosures

December 4, 2009December 4, 2009

Morris A. Davis Chris Foote Eileen MauskopfMorris A. Davis Chris Foote Eileen MauskopfUniversity of Wisconsin Federal Reserve Bank of Boston Federal Reserve BoardUniversity of Wisconsin Federal Reserve Bank of Boston Federal Reserve Board

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DisclaimerDisclaimer: The views expressed here do not reflect the views of the staff of the Federal : The views expressed here do not reflect the views of the staff of the Federal Reserve Bank of Boston, the Federal Reserve Board, or the Federal Reserve SystemReserve Bank of Boston, the Federal Reserve Board, or the Federal Reserve System

Mortgage Delinquency Rates: 1972:Q1 - 2009:Q3Mortgage Delinquency Rates: 1972:Q1 - 2009:Q3

2Source: Mortgage Bankers Association

Foreclosures, Housing Prices: 1972:Q1 - 2009:Q3Foreclosures, Housing Prices: 1972:Q1 - 2009:Q3

3Source: Mortgage Bankers Association (foreclosures); OFHEO/FHFA (housing prices).

The “Double-Trigger” Model of DefaultThe “Double-Trigger” Model of Default

• Research indicates that foreclosures typically happen when two things occur simultaneously.

– The homeowner is underwater on the mortgage.

– The homeowner suffers an ‘’adverse life event’’ that makes continued payment difficult (e.g., a job loss).

• The double-trigger model explains why foreclosure are a much bigger problem now than in past recessions.

• Double-trigger foreclosures can occur even when unemployment is low, because many people lose jobs even when the economy is booming …

• … but recessions certainly make them worse.

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Empirical Support for Double-Trigger: SurveysEmpirical Support for Double-Trigger: Surveys

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Main Hardship Reason Given by Prime Conforming Borrowers Who Made Successful Contact with Their Servicers

Percent

Unemployment or Curtailment of Income 56.8%

Excessive Obligation 19.3%

Illness or Death in the Family 11.4%

Marital Difficulties 4.7%

Inability to Sell or Rent the Property 2.4%

Property Problem or Casualty Loss 0.9%

Employment Transfer or Military Service 0.2%

Extreme Hardship 0.1%

All Other Reasons 4.2%

Total 100%

Source: Frank E. Nothaft, Chief Economist, Freddie Mac (from presentation dated 11-06-2009).

Empirical Support for Double-Trigger: StatisticsEmpirical Support for Double-Trigger: Statistics

• About 73% of the variation in state-level 90-day delinquency rates is explained by only two factors:

– Change in state’s house prices from 2006:Q2 to 2009:Q2.

– State’s unemployment rate in August 2009.

• Loan-level studies suggest that two factors, falling house prices and unemployment are better predictors of foreclosures that DTI (the payment-to-income ratio).

– A 10-percentage-point increase in DTI

multiplies average 90-day default probabilities by a factor of 1.09.

– A 1-percentage-point increase in the county-level unemployment rate

multiplies default probabilities by a factor of 1.15.

– A 10-percentage-point drop in house-prices

multiplies the probability by about 1.50.

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How does a HAMP modification work?How does a HAMP modification work?

• A HAMP modification reduces the monthly mortgage payment (including principal, interest, and property tax) to no greater than 31 percent of borrower’s monthly gross income.

• Example of HAMP modification:

– “average” household wage income in 2009: $63,118Assumes 1 full-time worker at $48,182 annual salary and 1 worker working 31 percent of full-time job : $5,260 per month.

– “average” monthly mortgage payment (PIT) in 2009 is about $1,550 per month $1,400 is PI, and $150 is property tax.

– Assume the full-time worker loses her job and gets UI benefits worth 50 percent of gross pay. Household wage income drops to $39,027 per year or $3,252 per month (a 38.2 percent drop in income)

– Modified loan requires payments to drop to $1,008 per month (at least for first 5 years)PI at $858 per month

How does a HAMP modification work? (continued)How does a HAMP modification work? (continued)Step 1: Compute the value of a modified loan to investors

• Outstanding loan balance is $209,000, remaining term to maturity is 26 yearsCutting interest rate to 2 percent reduces monthly payment (inclusive of taxes) to $1,008 (exactly 31 percent of current lower income).

• Payment stream of modified loan (incl. property tax): $1,008 per month for 5 years; $1,093 per month in year 6; $1217 in year 7 and thereafter

• Owner/investor gets: $858 a month for 5 years; $943 a month in year 6; $1067 a month starting in year 7.

• Using a discount rate of 5 percent, the present value of the modified loan is: $173,132 .

Step 2: Compute the value of home if loan is not modified and home goes to foreclosure

Step 3: Offer a loan modification if it passes the NPV test

• If net take on foreclosure is 65 percent of mortgage: Present value of foreclosure is $134,285. – Since $134,285 < $173,132, investor offers a loan modification to the borrower.

• If net take on foreclosure is 90 percent of mortgage: Present value of foreclosure is $179,140– Since $179,140 > $173,132, investor does not offer a modification.

Problems w/ HAMP modifications for unemployedProblems w/ HAMP modifications for unemployed

• The sharper the drop in your income owing to job loss

the less likely you are to receive a loan modification

• The bigger the decline in the value of your house,

the more likely you are to receive a loan modification

• Those who receive a modification and regain employment quickly receive large windfall gains at the expense of taxpayers (when the loan is GSE-insured or owned)

• In example: borrower receives a windfall gain of $36,000, taxpayer suffers that loss (when loan GSE-insured).

Plans that prevent foreclosures for unemployedPlans that prevent foreclosures for unemployed

• There are 3 plans that can help prevent foreclosures– Wisconsin (WI-FUR): Housing vouchers (grants) to the unemployed

– Boston Fed 1 (BF1): Grants to the unemployed

– Boston Fed 2 (BF2) (similar to HEMAP): Loans to the unemployed

• All 3 plans call for significant but temporary assistance to the unemployed, thus removing the “income” trigger

• None of the 3 plans calls for a loan modification– A loan modification is permanent

– Unemployment is temporary

• Plans differ on a few details:– Who is eligible for help, how much help is given, administration, documentation

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The WI-FUR planThe WI-FUR plan• Who gets assistance:

– Potentially anyone unemployed who has collected UI in the recent past with a mortgage receives a housing voucher

– Note: Some have advocated extending it to renters

• How much assistance:– Voucher computed such that typical household contributes 30% of UI towards mortgage

– Average voucher $900

– Voucher amounts vary by county, fixed within each county

– Suggested maximum voucher of $1,500 (high cost counties)

• Duration of assistance– Suggested maximum number of vouchers: 15 voucher or when re-employment occurs,

whichever occurs first

• Administration:– Plan could be administered by each state’s unemployment office

– Required documentation: Proof of unemployment , Proof of a mortgage, No proof of income

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The Boston Fed planThe Boston Fed plan• Who gets assistance:

– Anyone involuntarily unemployed with demonstrable income loss (with a mortgage)

• How much assistance:– The monthly loan or grant is equal to the percentage loss in household income, multiplied by

the size of the monthly mortgage payment.

– The amount of aid is capped, with a cap that varies by state/county/MSA

• Duration of assistance– The minimum of 2 years or whenever re-employment occurs

• More details on the loan program:– Interest rate and loan repayment schedules are policy choices

• Administration:– Servicers collect documentation on income and possibly assets, determine amount of aid

(loan or grant). Federal government makes aid payments directly to servicers.

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Program OutlaysProgram Outlays

• We expect gross program outlays (WI-FUR or Bos Fed) of $2 - $3 billion per month at current levels of unemployment

• This seems like expensive public policy

• However, since about 50% of all mortgages are government insured, doing nothing and allowing foreclosures to occur is also expensive public policy

• Why? Foreclosures are costly, and in 50% of cases these costs are borne by U.S. taxpayers

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Program Costs per Unemployed HomeownerProgram Costs per Unemployed Homeowner• There is considerable uncertainty, but at one set of

“reasonable” parameters, the least-cost alternative to U.S. taxpayers is the WI-FUR or Boston Fed Plan

• If we do nothing, U.S. taxpayer bill is $6,761– Why? Government guaranteed mortgages: Freddie/Fannie/FHA/VA

• If we administer a HAMP mod to the unemployed,U.S. taxpayer bill could average $18,000 per modification(and likely more)

• If we administer the WI-FUR or Boston Fed grant planU.S. taxpayer bill is about $4,750

– About $3,500 in direct aid to unemployed (depends a bit on the plan)

+ $1,250 in foreclosure costs (some people will receive aid and still go into foreclosure)

– Boston Fed loan program will cost less

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Supplementary SlidesSupplementary Slides

Foreclosures and House Prices in Massachusetts: 1990:Q1 – 2009:Q2Foreclosures and House Prices in Massachusetts: 1990:Q1 – 2009:Q2

Foreclosures and Delinquencies in Massachusetts: 1990:Q1 – 2009:Q2Foreclosures and Delinquencies in Massachusetts: 1990:Q1 – 2009:Q2

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Regression coefficients: Regression coefficients: Constant 0.95 (3.09) Unemp. Rate 0.20 (4.90) HPI Pct. Change -0.05 (-7.34)Constant 0.95 (3.09) Unemp. Rate 0.20 (4.90) HPI Pct. Change -0.05 (-7.34)

Ranges: Delinquency [1.01, 6.49] Unemployment [0.71, 15.20] HPI Pct. Change [-46.1, 10.7]Ranges: Delinquency [1.01, 6.49] Unemployment [0.71, 15.20] HPI Pct. Change [-46.1, 10.7]

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