Selling delinquent mortgages to investors is a tough balancing act
The housing bust has left an estimated 820,000 severely delinquent mortgages in the hands of the US Department of Housing and Urban Development (HUD), Fannie Mae, and Freddie Mac—and by extension, US taxpayers. In 2010, HUD began selling bulk nonperforming loans to investors to better assist these borrowers and reduce taxpayer risk. The government-sponsored enterprises (GSEs) followed suit with their own program in 2015.
But some argue that sales to profit-seeking investors push many borrowers into foreclosure because of inadequate protections. Urban Institute research shows that the sales benefit both borrowers and investors, and at a recent panel sponsored by CoreLogic and the Urban Institute, experts discussed ways to improve the program.
Nonperforming loan sales reduce foreclosures, helping borrowers and taxpayers
A foreclosure is the least desirable outcome for borrowers and taxpayers. Nonperforming loans auctioned to investors “are on average at least 29 months delinquent and would likely be headed to foreclosure in the absence of the sale,” according to Erik Cribbs, senior adviser at HUD. Private investors have greater flexibility to modify nonperforming loans and mitigate losses than HUD or the GSEs, so the sales are a win-win.
The program works for investors, too
Investment firms that buy nonperforming loans also support the program. “The FHA (Federal Housing Administration) and the FHFA (Federal Housing Finance Agency) have made several improvements to their programs over the years in order to create a process that is transparent and inclusive,” according to Don Mullen, founding partner at Pretium Partners, an investment firm that buys delinquent notes.
Not surprisingly, this market has grown steadily in recent years as HUD and the GSEs have accelerated sales. “HUD has sold over 105,000 delinquent notes under this program, while the GSEs have sold just under 40,000” according to Housing Finance Policy Center director Laurie Goodman. And this represents only a small fraction of the roughly 820,000 severely delinquent loans in the HUD and GSE portfolios, suggesting opportunity for further growth.
Despite this success, there is room for improvement. Four particular changes have potential benefits and costs:
Mandatory borrower outcomes: According to Julia Gordon, executive vice president at the National Community Stabilization Trust, “all buyers of delinquent notes should be required to achieve one of several mandatory borrower outcomes for a certain percentage of loans in a pool.” The current requirement to meet mandatory outcomes for 50 percent of notes in a pool is in place only for HUD’s Neighborhood Stabilization Pools, which represent only a small percentage of all sales. These outcomes are reperformance via successful modification, short sale to owner-occupants, conversion to a rental property, sale to a nonprofit entity, or donation to a land bank.
Extending mandatory outcomes to all sales would pressure servicers to meet the increased thresholds. However, Eric Stein, special adviser at FHFA, noted that the agency “doesn’t require mandatory outcomes because investors could fail to achieve those outcomes for reasons they don’t control,” such as a recession. And investors worried about such exogenous risks would price for it by lowering their bids or reducing their participation. Instead, FHFA chose to mandate overall parameters under which buyers operate.
Restrictions on abandoned and very low value homes: When buyers purchase notes backed by vacant, substantially damaged, or very low value homes, they often have to spend time and resources to complete a foreclosure. Often, the less costly alternative for investors is to walk away, to the detriment of the neighborhood.
Ultimately, investors price for this risk by lowering their bids and passing the cost on to taxpayers. Ensuring that loan pools are free from such homes or allowing investors to return such notes would better protect homeowners and neighborhoods, reduce risk for investors, and lead to higher bids. Both HUD and FHFA are exploring ways to reduce the number of notes backed by low-value or abandoned homes. FHFA recently updated its guidelines prohibiting investors from walking away from vacant properties.
- More data transparency: Housing researchers, including those at the Housing Finance Policy Center, have urged the government to release detailed performance data that would allow external researchers to study program effectiveness and provide feedback. While HUD has released limited auction-level data, FHFA hasn’t followed suit. According to Stein, the FHFA is “currently working to publicly release performance data on GSE note sales by end of June.”
- Greater partnerships between private and nonprofit sectors: Because nonprofits work at the neighborhood level and are mission oriented, they are often better equipped than investors to conduct borrower education and outreach. That said, limited nonprofit capacity to buy loans outright and manage assets on a large scale often act as barriers to such partnerships because investors with large nonperforming loan portfolios are more likely to seek partners with the capacity to handle large loan volumes.
Do these four changes risk rendering the programs too prescriptive, constraining investors enough that they would lower bids? As Mullen stated, excessive tightening of requirements could give investors a reason to divert capital to Europe’s distressed sales market, reducing opportunities for US homeowners. In contrast, selling notes with inadequate protections could unnecessarily expose borrowers to undesirable outcomes.
Policymakers should do all they can to further improve outcomes for borrowers and neighborhoods while minimizing taxpayer losses. That said, active investor participation is what makes the program successful. Making sure it works for everyone will always require a careful balance of policy considerations.
In this June 6, 2009, a bank-owned property in the North Hill neighborhood of Fairfax, Va., is shown. (AP Photo/Liz Schultz)