FDIC Chair Promotes Increased Incentives for Mortgage Modifications

While the media today focused mostly on the testimony of former Federal Reserve Chairman Alan Greenspan before the Senate Banking Committee, there was other news coming out of the hearing.

Federal Deposit Insurance Corporation Chairperson Sheila Bair told lawmakers about her plans to use methods pioneered by several existing programs to encourage mortgage servicers to increase the pace of loan modifications for homeowners facing foreclosure.

The proposed initiative in which the FDIC is working closely with the Department of the Treasury, will involve the government setting standards for loan modifications and then guaranteeing the resulting modified loans.

Ms. Barr said in her testimony that the bulk of the banking industry is healthy and well capitalized but there is a liquidity problem caused by uncertainty about the value of mortgage assets.  This is making banks reluctant to lend to each other or lend to consumers and businesses.

She recounted recent actions by her agency to increase confidence in the banking system including increasing deposit insurance coverage and providing senior unsecured debt guarantees through the recently announced Temporary Liquidity Guarantee Program.

Ms. Bair said that since the program was unveiled at the beginning of last week, "we have seen steady progress in reducing risk premiums in money and credit markets. Yields on short-term Treasury instruments, which had approached zero in mid-September, have now risen back in line with longer-maturity instruments. Quotes for Libor, the London Interbank Offer Rate, also have declined in relation to Treasury yields - indicating a slow thaw in the interbank lending market. Interest rates on short-term commercial paper have fallen back to their lowest levels since mid-September, indicating that liquidity is also starting to return to that market....  We are making steady progress in returning money and credit markets to a more normal state."

She turned to the current unprecedented wave of foreclosures which she described as "often a very lengthy, costly and destructive process that puts downward pressure on the price of nearby homes. While some level of home price decline is necessary to restore U.S. housing markets to equilibrium, unnecessary foreclosures perpetuate the cycle of financial distress and risk aversion, thus raising the possibility that home prices could overcorrect on the downside.

"The continuing trend of unnecessary foreclosures imposes costs not only on borrowers and lenders, but also on entire communities. Foreclosures may result in vacant homes that may invite crime and create an appearance of market distress, diminishing the market value of other nearby properties. In addition, the direct costs of foreclosure include legal fees, brokers' fees, property management fees, and other holding costs that are avoided in workout scenarios. These costs can total between 20 and 40 percent of the market value of the property. The FDIC has strongly encouraged loan holders and servicers to adopt systematic approaches to loan modifications that result in affordable loans that are sustainable over the long term."

Specifically she suggested that loan guarantees could be used as an incentive for servicers to modify loans with the government establishing standards for loan modifications and providing guarantees for loans meeting those standards.

The Chairperson cited the steps taken by the FDIC following the failure of IndyMac Bancorp as an example of what the government can do to stem the foreclosure tide.  She said that already more than 3,500 borrowers have agreed to loan modifications with the FDIC and these modifications have resulted in lowering monthly payments by over $350 on average.

"By achieving mortgage payments for borrowers that will be both affordable and sustainable, these distressed mortgages will be rehabilitated into performing loans and avoid unnecessary and costly foreclosures. We expect that by taking this approach, future defaults will be reduced, the value of the mortgages will improve, and servicing costs will be cut. The streamlined modification program will achieve the greatest recovery possible on loans in default or danger of default, in keeping with our statutory mandate to minimize impact on the insurance fund and improve the return to uninsured depositors and creditors of the failed institution. At the same time, we can help many troubled borrowers remain in their homes. Under the program, modifications are only being offered where doing so will result in an improved value for IndyMac Federal or for investors in securitized or whole loans, and where consistent with relevant servicing agreements.

She said she hoped that the program will be a catalyst for promoting more loan modifications for borrowers from other banks.

The FDIC has also been playing a role in the implementation of the HOPE for Homeowners Act Ms. Bair said.  The FDIC has joined the Departments of Housing and Urban Development (HUD) and Treasury and the Federal Reserve in establishing requirements and standards for the Program outside those specified in the authorizing legislation, and prescribing necessary regulations and guidance to implement those requirements and standards.

"The HOPE Program incorporates many of the principles the FDIC considers necessary to be effective. It converts current problematic mortgages into loans that should be sustainable over the long-term and subsequently convertible into securities. It also requires that lenders and investors accept significant discounts and prevents borrowers from being unjustly enriched if home prices appreciate. "

She said that the Emergency Economic Stabilization Act (EESE - popularly known as "the bailout,) recently passed by Congress, includes a number of provisions to encourage loan modifications. In particular, EESA addresses the issue of foreclosure mitigation and provides authority that could hold significant promise for future loan modifications. Under EESE, the Secretary of the Treasury is empowered to use loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures.

Chairperson Bair said that "Applying workout procedures for troubled loans in a failed bank scenario is something the FDIC has been doing since the 1980s. Our experience has been that performing loans yield greater returns than non-performing loans. In recent years, we have seen troubled loan portfolios yield about 32 percent of book value compared to our sales of performing loans, which have yielded over 87 percent."

In conclusion Ms. Bair said, "In recent weeks, the FDIC has engaged in unprecedented actions to maintain confidence and stability in the banking system. Although some of these steps have been quite broad, we believe that they were necessary to avoid consequences that could have resulted in sustained and significant harm to the economy. The FDIC remains committed to achieving what has been our core mission for the past 75 years - protecting depositors and maintaining public confidence in the financial system."