I spoke with FDIC Chairman Sheila Bair on Wednesday about her efforts to prevent foreclosures. Here's what she had to say:
Why have you been pushing so hard for increased foreclosure mitigation?
"Our view is that there are a lot of unnecessary foreclosures going on that are creating further downward pressure on home prices. Distressed foreclosure sales really are the market in several areas of the country. So you already have an overbuilt market, you are adding a lot more inventory through unnecessary foreclosures, you are dislocating people, you are creating vacant properties and eroding tax bases and there are a lot of other external costs involved with that. So, we really think that preventing unnecessary foreclosures has got to be a top priority. It's not by itself going to solve the problem, and loan modifications by themselves are not a silver bullet—it's hard work to get these loans modified. But that underscores even more why you need a systematic process to do it and you need some financial incentives to get it done quickly.
Can you walk me through your plan?
Basically the idea is to do some loss sharing. There are two components. One is to provide a $1,000 per modification payment to the servicers to help cover their administrative costs if they do a long-term sustainable loan, which we define as at least getting down to 31 percent debt-to-income ratio and documenting income. The approach we are using at IndyMac [Federal Bank] would be the most suitable way to get to that long-term sustainable loan modification. If the loan redefaults and they have losses, our proposal would be for the government to share those losses 50-50 with investors. With our plan, of those loans that would go seriously delinquent in 2009, we think we can reduce by 1.5 million those that would otherwise become foreclosures eventually.
How would your plan be more effective than others that are out there?
At the FDIC, that's what we do. When a bank fails, we cover the deposits and then we sell the assets of the failed bank. And frequently, a failed bank has a lot of delinquent loans, and we have found through decades of experience on this that if you restructure the loans and get them to perform, you can get a better price for them. So it makes business sense and we are coming at it from that perspective. So we do think we have a good plan, but it is not our way or the highway. We are open to refinement or what have you. But we need to come to closure on this and get a program up and running, because we are already behind the curve. So while we are definitely trying to provide our best thinking and are open to suggestions and improvements, we also need to make a decision and move on.
Why has the Bush administration resisted implementing your plan?
There are two parts to this. One is the loan modification protocol that we have developed at IndyMac. I think everybody supports that: the White House, the Treasury Department. The [government sponsored enterprise's] own loan modification program draws heavily from what we've done at IndyMac. The same with the Hope Now Alliance with some of the individual announcements by [Bank of America], Citigroup, and JPMorgan Chase. So I think everybody agrees that using a systematic approach and using a combination of interest rate reductions and principal forbearance or writedowns is the way to go and to do it systematically.
I think, really, where there is disagreement is whether government money should be put into the mix to provide financial incentives to get this done. I think they don't feel that TARP money [should be used for our proposal]. So that's the area where there continues to be dialogue, and that's where we haven't gotten closure."
House Financial Services Committee Chairman Barney Frank has said that the TARP legislation explicitly empowers the government to use such funds for foreclosure mitigation. Do you agree with him?
Section 109 [of the TARP legislation] is very explicit about using credit enhancements and loan guarantees to facilitate loss mitigation. And we designed our proposal to fit within that language. There were discussions with the Hill on that point. It was always our understanding that that was the expectation of that language. So, I think it's just a difference in perspective and understanding. But again, we'd like to get over that hurdle and compromise on something because we do think you need a national program with financial incentives and some reporting and auditing that goes along with that to make sure it gets done.
Are you concerned about a moral hazard problem with this program?
There is no proposal that anybody can come up with that doesn't have any moral hazard or potential for gaming, but we do think that we have minimized those risks. One is, we are just providing an affordable payment. So if you already have an affordable payment, you are not going to qualify for this.
The Office of the Comptroller of the Currency recently said that more than 50 percent of all loans that were modified in the first quarter of this year went delinquent again within six months. How do you reconcile that with your belief that loan modifications can prevent unnecessary foreclosures?
"I think you need to be careful. Redefault risk is a significant concern, that's why we are proposing loss sharing because that's an area out there where you can get a lot of investor push back. But unfortunately, there are no comprehensive government data on this because the reporting on loan modifications has not been granular. The OCC report defines loan modification as anything that changes contract terms—so that could be anything: It could be a very short term interest reduction or it could be an increase in the payment—I've seen loan modifications sometimes that do that. So, you don't have any information on what kind of modification it was: whether it's a long-term sustainable modification or not. We don't know whether they verified income. That's been very important at IndyMac and it has slowed us down, but it is working. Because we think if we verify income we will lower our redefault rate. So with a low, affordable debt-to-income ratio, and income verification, we think we can get those redefault rates down.
So essentially what you are saying is i f modifications are done properl y, the redefault rate would be lower?
That is our operating assumption at this point. If you document the income and meaningfully reduce the payment, you should improve your redefault rate.
Have you had any contact with the new administration about your program?
"We've briefed them and have had very good dialogue. They've had a lot of questions, they wanted additional analysis. So we are providing our best thinking, the president elect is very interested in foreclosure mitigation, I know he has publicly spoken to that several times. So we are providing our very best thinking on this. Again, we think we have a good proposal that will work, but we just want a decision made. We are happy to be flexible and make changes, improvements, or advise on different approaches. But we do think we've reached the trigger point and a decision needs to be made. We need to get a program in place.
What about your own future? Will you serve in the new administration? Do you have other political ambitions?
"I have no other ambitions. This is an independent agency; it's a fixed term until 2011. My operating assumption is that I am staying here. And, obviously, if the new administration wanted to make changes, we would accommodate that. But we haven't gotten any indication from them so we are just doing our job. Frankly, I need to just do my job right now because we have a lot of work ahead of us. I don't know what the future brings. I just know that I'm doing my job now and everybody at the FDIC is working 24-7 to deal with these really unprecedented times."