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The Biggest Failure of the Year

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Government officials patted themselves on the back last week, announcing that the mortgage modification plan implemented earlier this year through Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) is totally, 100%, killing it.

More than 500,000 mortgages are now in a trial modification plan, one month ahead of the half-a-million goal marker. "We believe we are absolutely moving in the right direction and have reached an important turning point in our modification effort," said Housing and Urban Development Secretary Shaun Donovan.

Great success!
These numbers might look encouraging. Struggling homeowners are getting aid. Expensive mortgages are being reduced. Bubbles are being slain. Help has arrived.

But remember the old saying, Fools: quality over quantity.

One week before the government praised itself for the volume being cranked out, it released a report showing just how these modifications are performing.

As was the case earlier this summer, mortgage modification re-defaults -- modified loans that fall back into default -- are quite high. And not just a little high ... not just annoyingly high ... but horrifyingly high:

Modification Date

30 Days Delinquent,
3 Months After Modification

6 Months After Modification

9 Months After Modification

12 Months After Modification

First Quarter 2008





Second Quarter 2008





Third Quarter 2008





Fourth Quarter 2008





First Quarter 2009





Source: Office of Thrift Supervision, Office of the Comptroller of the Currency, September 2009.

Within three months of modification, more than 40% of borrowers found themselves back in delinquency.

Now, I know what you're thinking: OK, but that's just the 30-day delinquency rate. How about longer-term, actual defaults? It's just as scary:

Modification Date

90 Days Delinquent,
3 Months After Modification

6 Months After Modification

9 Months After Modification

12 Months After Modification

First Quarter 2008





Second Quarter 2008





Third Quarter 2008





Fourth Quarter 2008





First Quarter 2009





One year after modifications, about half of borrowers are more than 90 days past due -- usually the barrier where a lender considers the loan a lost cause. I can't think of many things in life with a 50% failure rate that can be considered anything but failures.

What went wrong?
The reason re-defaults are such a problem is simple: Modifications aren't targeting the right issue.

Continuing with our parade of government reports, the Congressional Oversight Panel just released more data on these modifications. Among its findings: The loan-to-value (LTV) ratio for average modified mortgages actually increased during the modification process. Before modifications, average LTV ratios were 134%. After modifications, the average was 137%.

This is because 64.3% of all modifications simply capitalize late payments and fees onto the existing balance. That's actually a big negative for the one-third of homeowners who are underwater, since the modification actually strengthens the incentive to walk away from their home.

More than 70% of modifications also included interest rate reductions. This is helpful for some with adjustable-rate mortgages, but it doesn't do anything for those whose mortgages aren't just resetting to higher interest rates, but recasting to higher payment schedules. In one extreme example, Bloomberg talks about a borrower whose adjustable-rate mortgage payment could jump from $98 a month to $3,500 a month. Such moves have less to do with higher interest rates than they do with payments resetting to sensible amortization schedules. More specifically, people in these situations bought homes they could never afford, and no modification will really help. That's an unfortunate but realistic truth.

Not biting the bait
If there's one bit of good news, it's that banks haven't been ambitious with modifications:


% of Eligible Mortgages Granted
Trial Modification, as of September

Citigroup (NYSE: C  )


JPMorgan Chase (NYSE: JPM  )


Wells Fargo (NYSE: WFC  )


Bank of America (NYSE: BAC  )


USBancorp (NYSE: USB  )


Source: U.S. Treasury.

This is only encouraging because banks can often recover more money by foreclosing quickly, rather than granting a modification with a 50% failure rate, and inevitably foreclosing on a house that likely lost value during the modification trial period.

I'm all for helping those in need. But the mortgage modification plan helps such a small percentage of those intended that we have to wonder how much help, overall, it's really providing. Especially when you consider that the taxpayers it's designed to help are also footing the bill.

Maybe you disagree. Have a positive mortgage modification story to share? Feel free to share it in the comment section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 12, 2009, at 7:42 PM, xetn wrote:

    This is another example of government stupidity and another theft of the taxpayers. Just how exactly, is this propping up of over-extended house buyers helping the economy? Robbing Peter to pay Paul makes Peter very happy, but I, being Paul, am very angry. At the same time it is not helping the economy to recover because it is taking much needed capital out of the private sector where it could have a chance to be productive; you know, like creating jobs and such.

  • Report this Comment On October 12, 2009, at 8:00 PM, VEttariPEPC wrote:

    I plan on voting against all incumbents, across the board.

    It is time to turn-out the current Congress and see if the next group can do any better. It is hard to imagine that they could do any worse.

  • Report this Comment On October 13, 2009, at 5:47 AM, loof987 wrote:

    2 + 2 = 4 easy math formula

    Here is the easy formula of how the banks are using modification ploys to defraud borrowers, by intentionally making modifications FAIL ---

    The modifications are failing because the meek, mild and malicious modifications are not Viable or Worthy of being called helpful - The modifications / Restructuring of loans that Bank of America and most other banks LITERALLY FORCE UPON BORROWERS ARE BOGUS !! - The banks barely lower the payments on these Malicious mods and then after 1 to 5 years the loan interest rate goes right back up again to NON affordable rates - AN HONEST, TRUSTWORTHY & TRUTHFUL modification is like an Honest, Trustworthy & Truthful spouse, neither should SCREW YOU OVER EVER ! -- However, at least 90 % of the modifications being Pushed upon naive, innocent & good faith borrowers are SCREWING BORROWERS OVER PERIOD - The banks continue to use their treasonous, terroristic tactics of Pushing NON VIABLE loan Modifications upon distressed and defrauded borrowers.. It's like giving a person 1 gallon of water to last them a 1 month period in the summer heat and telling them that is all they can get, no negotiating and to trust the water giver, as the water giving bank knows best and that 1 gallon of water will be JUST FINE - Of course that person will die of dehydration ! But the banks are 90 % of the time pushing financially Dehydrating Loan Modifications on borrowers, which are meant to Screw the borrowers over, while making the banks Bogus Governement report cards look good - 2 + 2 modifications = Continuing Fraud from the Banks ... Period - These bogus modifications are purposelly structured to fail, not to succeed. When will the government wise up and FORCE THE BANKS to give VIABLE modifications, meant to succeed...

  • Report this Comment On October 14, 2009, at 4:14 AM, Shawnerz wrote:

    "I can't think of many things in life with a 50% failure rate that can be considered anything but failures."

    The national divorce rate hovers just under 50%. Somehow we still make it as a society.

    I'm not pointing to the divorce rate to justify the bad mortgages. I'm just pointing out a statistic.


  • Report this Comment On October 16, 2009, at 1:17 PM, albersdg wrote:

    For some reason that I can't quite put my finger on, I bet most of you capitalists don't go to church much or on a regular basis.

    Because if you did, you would know that when they pass the collection basket and you place your donation in the basket you know it is to help someone else less fortunate and you will never see that money ever again or have any return on your donation (other than the gratitude of the recipient, who you will never know).

    Many people, perhaps most, who are in danger of foreclosure or are in foreclosure were not GREEDY.

    They were foolish, they were uninformed, they were even misled, they were impulsive, they were irresponsible.

    Many were just unlucky. They bought a house believing their employer --- perhaps a bank, investment house, brokerage house, insurer, or realtor --- was a sound company and they could be confident that they had a future at the firm. They put their faith in Corporate America and they were betrayed.

    The company does not have to be a financial, insurance, real estate (FIRE) company it could have been a restaurant, a hotel, a restaurant, or a distributor of auto parts, or of appliance parts.

    Good people making sound decisions are experiencing unimaginable hardship and you aren't making it any easier.

    The chief problem is that the solution (endorsed by Presidents: GW Bush and Obama) is to give the money to the banks and they will fix the problem.

    The banks will only save themselves, and even if they don't they will make sure they are taken care of first not last.

    Don't get angry! Get reform! Change corporate governance to: One shareholder. One vote.

    Mandate that corporate executive pay, in any and all forms, --- including deferred compensation, SHALL NEVER exceed . . .

    Don't reach for "quick fixes" such as a flat tax. Because the rich make exponentially more than almost everyone, a flat tax is really a cap on their liability. Why do you think the rich are all in favor of it?

    Don't be in such to vote out the incumbents. The person who replaces him / her will be just as bad.

    Call, write, show up at office or town meeting and demand that your congressman and senator (at the federal and state level) do his / her job.

    Stop griping and get moving. What do you have to lose?

  • Report this Comment On October 17, 2009, at 10:50 AM, KevinSS13 wrote:

    If you are going to complain about the attempted solution to the problem, then you need to also honestly consider what the alternatives were. Where would we be if this loan modification program were not attempted? What could have been anticipated?

    Clearly it hasn't been as successful as hoped, but there are many reasons why - banks aren't doing realistic modifications - many more people are losing their jobs - and many people are so far under water that no modification makes sense.

    To say that the banks could make more money by foreclosing quickly ignores the impact of dumping a lot of foreclosed homes on the market. Prices would plumet even more quickly than they did last year. Banks know this. Vacant homes still cost money to mantian/secure - and they are more likely to be seriously damaged. Insurance companies know this - just try to insure a vacant home.

    Of all the factors out there causing this high failure rate, the only thing I see that could be changed easily is getting banks to do more realistic modifications. They still would make some money over forclosure.

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