FDIC Negotiating with Treasury for Broad Loan Modification Plan

FDIC Chair Sheila Bair has been advocating a broad program of loan modifications since the beginning of the mortgage meltdown. A program that would allow troubled homeowners to renegotiate their mortgages to into something they could pay and avoided certain foreclosure. The process has received much skepticism from Treasury and banks who would potentially absorb hair-cuts in principle or interest rates on the current loan.

FDIC was able to test their plan on IndyMac Bank, following their seizure. To date, they have successfully performed modified refinances on nearly 40,000 mortgage loans. These modifications, although a short-term lose seem to stabilize the portfolio and are done at far less expense than a foreclosure, keeping the borrower in the home.

Loan modifications work as re-negotiations of the current terms of a borrowers mortgage. The objective is generally to reduce the monthly payment to some target percentage of current income. In the case ofIndyMac Federal Bank this number is 38 percent. These negotiations often work around three levers in a mortgage loan: reducing principle to the current devaluation of the home, extending the loan terms, or reducing the mortgage interest rate.

Although available to any borrower or lender, loan modifications have been slow to reach significance outside of FDIC controlled banks. There are two main challenges. First, most loan modification are now initiated by the borrower and become alaborious process laden with lawyers and big mortgage servicer bureaucracy. Second, mortgage servicers currently have little incentive to build a program to write down these mortgages.

The FDIC plan would attempt to solve both barriers. FDIC is currently negotiating with the Treasury to construct a mortgage guaranteeprogram that would give mortgage lenders and servicers the incentive. These guarantees would insure loan modifications against eventual default after a modified refinance. The program would also establish a broad standard formodifying these loans on a grand scale.

Current proposals seem to be less rigid than current FHA programs that attempt to do similar things with a traditional mortgage refinancing, but require the mortgage lender to write the loan for less than the current market value of the home. This new FDIC plan would be structured as a cash flow refinance, targeting affordability and current income, not necessarily hair cutting home values to reduce the monthly payment.