US mortgages

Loan modifications, good; foreclosures, bad. If only life were that simple. The housing market, with new starts on Wednesday at their lowest since 1959, continues to weaken. In response, a bewildering array of programmes, both government and private, has sprung up to change the terms of mortgages. These hope to stave off defaults, enhance values of mortgage-backed securities, reduce writedowns and stem the flood of foreclosed properties on to an oversupplied market – thus saving the world.

That is a tall order. US housing has deteriorated so far and so fast that recovery is a distant prospect. Negative equity, on top of affordability, may now be driving mounting delinquencies. If that is the case, reduction of loan principal – not a feature of most programmes to date – may be needed to keep borrowers on revised payment plans. Furthermore, government efforts fail to reach the 20 per cent of all mortgages held within private-label securitisations, where some 60 per cent of defaults occur. Corralling potentially litigious junior and senior noteholders could prove tricky, even should trustees decide to follow the authorities’ lead.

Modification schemes should tweak only those loans which would have defaulted. In reality, some homeowners capable of paying their bills will sneak a free ride. Picking between the haves and the have-nots becomes more difficult the lower quality the loans, where borrowers struggle with higher overall debt levels, lower incomes and, now, rising unemployment. Helping borrowers with debts beyond a set proportion of income is too crude a tool. A successful programme, in theory, means total writedowns of less than the total cost of defaults that would have occurred. It helps MBS values, down sharply since the Treasury abandoned plans to buy troubled assets, only if those expected defaults are fully discounted. Those choosing to buy now, such as hedge fund manager John Paulson, must be brave of heart and deep of pocket.

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