Doesn’t Sheila Bair Have Anything Else To Do?

As some of you may know, I am no fan of Sheila Bair, the Chairwoman of the FDIC. So it was more than just  satisfying to see the Wall Street Journal take her and her crusade for mortgage modifications head on this morning.

I won’t waste your time going over past Bair proposals. If you have an interest just put her name into the search box on this page and it will pull up past posts. What I do want to touch on is her most recent proposal. Really, it isn’t new, just a tweak here and there to the program she imperiously instituted at IndyMac Bank at the expense of uninsured depositors and debt holders.

To roll out its plan nationwide, the FDIC wants to offer private loan servicers a new incentive to modify troubled loans. The private firms would do the same thing the feds have been doing at IndyMac, except they would move the monthly payment down to 31% of pretax income, instead of 38%. The FDIC would pay servicers $1,000 for every loan they modify, and taxpayers will share the losses if loans re-default.

To get to 31%, lenders could offer borrowers lower rates, longer terms or even “principal forbearance.” This means that part of the original loan would be converted to an interest rate of zero, and it would not have to be repaid until the home is sold or refinanced — or the loan matures. In other words, the borrower gets lower payments now but may have a problem again later if home values don’t rise and he needs to sell. Other modifications might create a lower interest rate now that rises over time, again squeezing borrowers at some future date. Sound anything like “subprime” loans?

Under the FDIC plan, a borrower would have to stay current for at least six months under the modified terms to make sure that lenders aren’t just dumping their losers on taxpayers. Well, not all of their losers anyway. The FDIC is still assuming a 33% re-default rate, even at the lower debt-to-income ratio. All of this is why the White House estimates Ms. Bair’s plan could cost as much as $70 billion next year — not $24 billion.

Many readers probably also tripped over the idea that moving monthly payments to 31% of pretax income is sound finance. Some may ask why anybody who borrowed or lent above that threshold should receive assistance from taxpayers, most of whom are still paying the rent or mortgage on time. Others might wonder how lenders will know what a borrowers’ income is in order to set the new ratio. False or undocumented income is the reason many of these loans failed the first time. At IndyMac, the feds are checking reported incomes against IRS data, but private lenders who participate in the new program will have more flexibility in “verifying” income. Sound familiar again?

It’s important to keep in mind that the FDIC’s success with loan modifications at IndyMac have been mediocre at best. The Journal mentions that 5400 loans have been modified over the past three months. That number seems to be pretty much accepted as does the fact that the FDIC identified and contacted some 40,000 customers of the bank that it determined would be eligible for a loan modification plan. Here’s the rub with that rather miserable track record. The FDIC won’t disclose the data behind the numbers. There’s no way to know how many loan mods are the result of the FDIC program and how many were actually underway before the agency seized the bank. Anyone want to bet that their numbers actually look awful?

There has been a lot of head scratching as to why Bair was so hell bent to get in the middle of this issue. Most analysts assumed she was angling for a bigger job in the next administration and this was her way to get her name out front. It’s pretty clear that didn’t work so it wouldn’t be a bad idea at all if she were to just focus on her job and let the chips fall where they may.  I’m pretty sure that Obama figures he has a lot bigger fish to fry than loan modifications. Look for him to let Barney Frank’s Fannie/Freddie contingent in Congress take the lead and any subsequent heat on this one.

While that is a scary crew in whose hands to leave this issue, they can’t do much more damage then Ms. Bair seems intent on causing. After all, as the Journal points out, she is proposing to create a subprime, no doc, modified option ARM as the solution to the problem.

Just an aside, here. I’ve read little other criticism of Bair before today’s WSJ broadside with one exception. John Hempton who writes Bronte Capital makes me look like a piker when it comes to criticizing the Chairwoman. He flat out wants her fired. Take a look at his blog for some good analysis.

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