Time to shift to explore causes of mortgage default

Today, once again, a New York Times editiorial lodged a complaint about the Administration's signature mortgage modification program. The program essentially pays mortgage lenders and servicers to reduce the borrower's loan payments in an attempt to prevent or forestall defaults. The Times's complaint, in a nutshell, is: "It's not working!"  We've heard it regularly since 2008.

President Obama's loan modification program has been the centerpiece of the Administration's efforts to stabilize the mortgage market.  But it is time to shift focus.  It is time to focus on fixing what went wrong at the loan level.

Even in this depressed market, approximately $1 trillion dollars in new mortgage loans are expected to be made in 2011, and more than $1 trillion dollars in new mortgages are expected in 2012.   Most of these loans will be insured or guaranteed by the US government -- directly or indirectly -- through Fannie Mae, Freddie Mac, or FHA. 

It's shocking, but true, that these trillions of dollars in new mortgages are, in many important ways, being made with the same policies, same systems, same underwriting approach as the mortgages that failed so spectacularly.  There have been some changes, to be sure, such as removal from the market of lenders with eligibility criteria that could be gamed, and higher down payments.  But there has been far too little inquiry into how conforming, conventional loans could and should be improved.

It's time to ask and address these questions:

-  What changes are needed so that this new generation of mortgage loans will be better than the set that crumbled between 2008 and 2011?  

-  How do we better determine whether a loan applicant can afford a mortgage and withstand a minor income shock without going into default?

-  How do lenders measure the loan applicant's income and expenses to determine if he or she can afford the new loan?

-  Are there patterns in current delinquencies and defaults that are instructive about making new loans better? 

In the coming days, I'll provide here in this space more about a central aspect of the mortgage process -- how lenders determine whether a loan applicant can be expected to afford a loan -- and what we've learned in our research on homeowner energy and transportation expenses.