by Calculated Risk on 7/11/2009 07:24:00 PM

From Manuel Adelino, Kristopher Gerardi, and Paul S. Willen writing at the Boston Fed: Why Don’t Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures, and Securitization

(ht Holden Lewis, Mortgage Matters at Bankrate.com)

One of the key questions these researchers ask is: Why don't lenders renegotiate¹ with delinquent borrowers more often?

If a lender makes a concession to a borrower by, for example, reducing the principal balance on the loan, it can prevent a foreclosure. This is clearly a good outcome for the borrower, and possibly good for society as well. But the key to the appeal of renegotiation is the belief that it can also benefit the lender, as the lender loses money only if the reduction in the value of the loan exceeds the loss the lender would sustain in a foreclosure.
all emphasis added

Just last week, Gretchen Morgenson at the NY Times made this argument: So Many Foreclosures, So Little Logic

[T]he most fascinating, and frightening, figures in the [subprime loan] data detail how much money is lost when foreclosed homes are sold. In June, the data show almost 32,000 liquidation sales; the average loss on those was 64.7 percent of the original loan balance.

Here are the numbers: the average loan balance began at almost $223,000. But in the liquidation sale, the property sold for $144,000 less, on average. ...

Given losses like these, [Alan M. White, an assistant professor at the Valparaiso University law school in Indiana] said he was perplexed that lenders and their representatives were resisting reducing principal when they modify loans. His data shows how rare it is for lenders to reduce principal. In June, for example, 3,135 loans — just 17.2 percent of the total modified — involved write-downs of principal, interest or fees. The total loss from these write-downs was just $45 million in June.

And yet, the losses incurred in foreclosure sales involving loans in the securitization trusts were a staggering $4.59 billion in June. “There is 100 times as much money lost in foreclosure sales as there was in writing down balances in modifications,” Mr. White said. “That is not rational economic behavior.”

If banks have written down the value of these loans to the 40 cents on the dollar that they are fetching on foreclosures — the only true value for these homes right now — then why don’t they bite the bullet and reduce the loan amount outstanding for the troubled borrowers?

And the Fed economists respond:

We argue for a very mundane explanation: lenders expect to recover more from foreclosure than from a modified loan. This may seem surprising, given the large losses lenders typically incur in foreclosure, which include both the difference between the value of the loan and the collateral, and the substantial legal expenses associated with the conveyance. The problem is that renegotiation exposes lenders to two types of risks that can dramatically increase its cost. The first is what we will call “self-cure” risk. As we mentioned above, more than 30 percent of seriously delinquent borrowers “cure” without receiving a modification; if taken at face value, this means that, in expectation, 30 percent of the money spent on a given modification is wasted. The second cost comes from borrowers who redefault [30 and 45 percent]; our results show that a large fraction of borrowers who receive modifications end up back in serious delinquency within six months. For them, the lender has simply postponed foreclosure; in a world with rapidly falling house prices, the lender will now recover even less in foreclosure. In addition, a borrower who faces a high likelihood of eventually losing the home will do little or nothing to maintain the house or may even contribute to its deterioration, again reducing the expected recovery by the lender.

I'd argue for a third reason: If it became widely known that lenders routinely reduce the principal balance for delinquent borrowers with negative equity, this would be an incentive for a large number of additional homeowners to stop paying their mortgages.

These economists would argue that the lenders are behaving rationally and that foreclosure - when all costs are considered - is frequently the least costly alternative.

¹ The economists define “renegotiation” as "concessionary modifications that serve to reduce a borrower’s monthly payment. These may be reductions in the principal balance or interest rate, extensions of the term, or combinations of all three." Under this definition, they do not include the most common modification: capitalization of late payments and fees.

by Calculated Risk on 7/11/2009 05:50:00 PM

The WSJ Real Time Economics blog mentioned Okun's law yesterday (a relationship between changes in GDP and unemployment): Job Losses Outpace GDP Decline (ht Bob_in_MA)

In a research note, [Alliance Bernstein economist Joseph] Carson says job losses in prior downturns have been roughly proportional to the decline in gross domestic product. But in the current recession, the proportion of jobs lost is running about a third greater than the drop in real GDP.

The correlation between GDP growth and unemployment is called Okun’s Law, after the late economist Arthur Okun who documented it in the 1960s. But the numerical relationship that Okun estimated – and other economists have since refined – has broken down. His original estimate suggested about a 3% decline in GDP for every 1% increase in unemployment. Before joining the Fed, Ben Bernanke, working with Andrew Abel, figured more recent suggested about a 2% decrease in output for every 1% increase in unemployment.

Click on graph for larger image.

This graph shows the quarterly change in real GDP (annualized) vs. the change in unemployment rate. The red markers are for 2008 and Q1 2009.

Usually the trend line is drawn as linear, but I made it a 2nd order polynomial here.

The red markers are above the trend line, but within the normal scatter.

For Q2 the unemployment rate increased 1.2% (from Q1, quarterly average), and the annualized real GDP change will probably be in the -1% to -2% range - so that is also above the trend (a larger than expected change in unemployment based on the change in real GDP).

Okun's law is just a general relationship, and the relationship appears to have changed over time (as mentioned in the WSJ).

Note: the graph shows the quarterly change in real GDP annualized (the way it is reported by the BEA each quarter). In the WSJ post, they mentioned "a 2% [or 3%] decrease in output for every 1% increase in unemployment". A 2% decrease in quarterly output would be reported by the BEA as over 8% annualized for the quarter.

by Calculated Risk on 7/11/2009 01:41:00 PM

From the SF Gate: State leaders talking again - budget woes go on

California's fiscal crisis continued unabated Friday with most major banks refusing to cash the state's IOUs starting today, the state controller delaying $4 billion in payments to public schools ...

State Controller John Chiang and state Superintendent of Instruction Jack O'Connell said $4 billion in payments to local school districts that were supposed to go out on Friday will be delayed until July 30. The move will conserve cash for the state, which has been issuing IOUs since July 2. ...

As of Friday morning, the state controller had mailed 101,930 IOUs covering more than $389 million in payments, said Hallye Jordan, a spokeswoman for Chiang.

And despite a plea from state Treasurer Bill Lockyer that banks extend their Friday deadline to accept the IOUs, most refused to do so.

Citibank agreed to a one-week extension, while Bank of the West said it will accept IOUs until further notice. The banks that rejected extension requests include Bank of America, Wells Fargo, JPMorgan Chase and Union Bank ...

And Felix Salmon has a nice chart on who gets paid cash, and who gets IOUs: California: The haves and have-nots

And from Controller John Chiang yesterday: Controller Releases Year-End Cash Figures

“California continues to pay for its history of unbalanced budgets. The State spent $10.4 billion more than it collected last year alone, and is now without enough cash to cover all of its payment obligations,” said Chiang.

“Our major sources of revenue have continued their trend downward, leaving no viable option but to craft a new budget that recognizes California’s recovery has yet to begin.”

Personal income taxes in June were $987 million below (-18.0%) estimates in the May Revision, and sales taxes were short by $154 million (-5.8%). Corporate taxes were $1.31 billion above estimates (41.2%). Corporate taxes in May and June were boosted by a surge of payments from corporate taxpayers hoping to avoid a new State penalty.

The State started the fiscal year with a $1.45 billion cash deficit, which grew to $11.9 billion on June 30, 2009. Borrowed money from special funds provided enough cash to fund State operations through June 30. The Controller faced a large cash shortfall at the end of July, forcing his office to begin issuing registered warrants or “IOUs” to any General Fund payment that was not protected by the State Constitution, federal law, or court decision. Without IOUs, the State would have run out of cash and begun missing those protected payments at the end of July.

While updated cash projections show that IOUs will preserve enough cash to make those protected payments through September, the cash shortfall in October will endanger the State’s ability to make those payments.

Many other states have serious budget problems too.

by Calculated Risk on 7/11/2009 09:03:00 AM

A little Saturday morning video ... offered without comment.

Bloomberg - Roubini Says U.S. Recession Will Last Six More Months (Click here for full video)

00:00 Outlook for the U.S. economy, recession
07:07 Reasons for current economic condition
11:50 Unemployment rate; fiscal consolidation
18:29 Case-Shiller Index; green shoots in housing
30:05 Second stimulus package; consumer spending
34:43 Roubini, Shiller respond to questions.

Here is a short preview ...

by Calculated Risk on 7/11/2009 01:09:00 AM

CIT Group (no relation to Citigroup) is like GE Capital. They provide financing for almost 1 million businesses and had about 76 billion in assets as of March 31st.

From the WSJ: Major Lender Faces Crunch

CIT Group Inc ... is preparing for a possible bankruptcy filing ... CIT has retained the law firm of Skadden, Arps, Slate, Meagher & Flom LLP, ...
...
CIT has a $1 billion payment due in mid-August and it is unclear the company "will be able to handle that," said this person. The company will give more guidance when it discusses second quarter earnings in two weeks.
...
A bankruptcy filing by CIT could affect thousands of small borrowers, from Dunkin' Donuts franchisees to restaurant owners and clothing retailers.

... the government has made it clear it doesn't see the company as a systemic risk to the financial system. The people familiar with the matter said the government feels that other lenders, such as J.P. Morgan Chase & Co. or Deutsche Bank AG, can handle many of the same loans that CIT specializes in, such as loans to small retailers or rail-car leasing firms.

Meanwhile, competitors like GE Capital Corp. and GMAC LLC have been able to sell debt with the backing of the government's top credit rating.

Apparently the government thinks CIT's competitors could pick up most or all of their business.