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.

To e-mail the Lex team confidentially click here
To post public comments click here

Lex is the FT’s agenda-setting column, giving an authoritative view on corporate and financial matters. It is also one of the few parts of available only to Premium subscribers. This article is provided for free as an example. A Premium subscription gives you unlimited access to all FT content, including all Lex articles and the FT mobile Newsreader.

Subscribe now

If you have questions or comments, please e-mail or call:

US and Canada: +1 800 628 8088
Asia: +852 2905 5555
UK, Europe and rest of the world: +44 (0)20 7775 6248

Get alerts on US when a new story is published

Copyright The Financial Times Limited 2021. All rights reserved.
Reuse this content (opens in new window) CommentsJump to comments section

Comments have not been enabled for this article.

Follow the topics in this article