Saturday, December 1, 2007

Subprime Borrower: No Modification for You! Part I

There are a lot of reasons why few borrowers are going to get modifications of their subprime loans. Although Friday's Wall Street Journal (U.S., Banks Near a Plan to Freeze Subprime Rates 11/30/07) has a front page article reporting that the Treasury Department and a number of large residential mortgage servicers are close to agreeing on a plan to freeze subprime home loans, the truth is more along the lines that they are agreeing on how to look like they're doing something to address the problem.

Problem I: Logistics. The Journal quotes Treasury Secretary Henry Paulson as saying [That it would be impossible to] "process the number of workouts and modifications that are going to be necessary doing it just sort of one-off." He's right, for reasons eloquently outlined by others (for example, Tanta: "Dear Mr. Paulson"). But, since they're working on a plan anyway, he must be thinking there's a way to modify loans in bulk. According to the Journal, the plan will be to divide the modification candidates into three groups:

1) Those who can make their payments when their rates go up. This group would not get modifications, presumably because they don't need a modification.
2) Those who can't make their payments even if their rate doesn't go up. No modifications for this group either, presumably because it wouldn't do them any good.
3) Those who can make their payments if their rate doesn't go up. These folks would get their rates frozen for a period to be determined by criteria to be worked out.

That's all well and good, except I think maybe we should exclude from Group 3 the borrowers who committed fraud to get their loans in the first place. It's hard to know exactly how big this group is, but apparently there could be quite a few members and the original loan files helpfully already identify many of them (Tanta again). Culling out these borrowers will spare Mr. Paulsen the embarrassment of the inevitable Wall Street Journal follow up story, "Treasury Secretary's Plan Aids and Abets Subprime Fraudsters."

My question is, how do you sort borrowers into these groups without resorting to "sort of one-off" analysis? By relying on the same crappy data tapes used to securitize the loans in the first place? Doing the modifications requires reunderwriting the borrowers, and the servicers don't have and are not likely to hire the people necessary to do that.