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Do Delinquent Mortgages Heal Themselves?

Barbara Kiviat points to some testimony from Alan White of Valparaiso University which takes issue with that paper by economists at the Fed and MIT I wrote about a couple of weeks back. In that study, reseachers argued that a big reason we're seeing so few loan modifications -- despite government incentives -- is that delinquent home owners might self-cure, i.e. catch up on their payments. (Another big reason is the risk of redefault.) If a sizable portion of delinquent borrowers do self-cure, then loan issuers might be economically justified in not rushing to rework mortgages in large volumes.

Here is what White had to say:

The difficulty with this paper -- and I make some reference to it in my written testimony -- is that it makes a bunch of assumptions which I think are just not based on what's happening out there in the real world market today. They assume, for example, that large numbers of homeowners who are behind on their mortgages can get caught up and pay their loans in full, so of course the investors will lose money if we allow bankruptcy courts or voluntarily reduce their debt by 10 or 20 percent because if we just left everything alone they would have paid 100 percent.

I looked at the data that I'm getting from the investor reports. The cure rates for defaulted mortgages are less than 10 percent. The chances that somebody who's behind now is going to be able to refinance or catch up are slim to none.

The problem I have with White is that the Fed/MIT paper didn't assume a rate of self-curing; it found that 30 percent of people who were are least 60 days delinquent on their mortgages subsequently either got current, paid off their mortgages entirely (meaning they basically sold their homes or refinanced), or at least dropped down to only a 30-day delinquency. What's more, this came at a time (from the beginning of the downturn through the end of 2008) when home prices fell 27 percent, according to Case-Shiller, meaning prepayment (i.e., paying off the mortgage) should have been pretty difficult.

So, at the very least, characterizing the chances that someone can catch on payments up as "slim to none" seems like an exaggeration. Moreover, even if fewer people are able to catch up now because home prices have continued to fall (now down about 32 percent from the peak), it's not at all clear that the drop in self-curing would be big enough to change lenders' incentives to modify.

But both White and Paul Willen, one of the Fed/MIT paper's authors who testified last week on loan mods, agree that government needs to do more to reduce foreclosures. Fortunately, there are a number of options to choose from 

--Zubin Jelveh