Loan Modifications, Not Government Bailouts May Be the Answer

Bank of America is to launch an $8.6 billion loan modification program. Initiated as settlement for a mounting number of predatory lawsuits inherited in the acquisition of Countrywide. This loan modification program could trigger two historic landmarks: the largest predatory lending settlement and the largest loan modification program.

Bank of America Swallows Countrywide's Poison Pill

Bank of America, haunted by a toxic mortgage portfolio of interest-only and option ARMs originated by Countrywide, was being pursued by several State Attorneys General helping borrowers recover from potentially deceptive mortgage practices and products.

In a broad, multi-state settlement, Bank of America has agreed to work out as many as 39,000 borrowers according to statements by Bank of America--expected to reach $8.6 billion in loan work-outs and other related borrower compensation.

This predatory lending settlement is likely to eclipse that of Household Finance ($484 million) in 2002 and Ameriquest Mortgage ($325 million) in 2006.

Loan Modifications the Medicine

Taking a page from the IndyMac Federal Bank loan modification program, long advocated by FDIC Chair Sheila Bair, Bank of America will modify the mortgages of delinquent borrowers or homeowners likely to become delinquent due to adjusting interest rates or ballooning loan balances.

Like the IndyMac Federal Bank approach, Bank of America will first attempt to refinance borrowers into principle reducing Hope for Homeowners' government-backed loans.

Loan modifications are renegotiations of the original mortgage terms with the objective of avoiding foreclosure. Most loan modifications use the adjustment of one or more characteristic loan terms (i.e., interest rate, term, or principle) to create a more affordable, sustainable mortgage payment.

IndyMac Federal Bank and Bank of America loan modifications both seem to be targeting similar work-out structures: lower interest rates (as low as 2.5%) for a period of time, lengthening the term, or reducing principle in an effort to reduce monthly payments below 34% of the borrowers current (verified) monthly income.

This program will earmark $150 million for relief of borrowers in foreclosure, $70 million to provide financial assistance to borrowers who will lose their homes, and $220 million for residents of additional states expected to sign the Back of America agreement.

Currently, California, Florida, and Illinois attorneys general, the most aggressive pursuers of the agreement, are signatories. However, Arizona, Connecticut, Iowa, Michigan, North Carolina, Texas, and Washington are expected to quickly sign-on to the agreement as well.

Loan Modifications May Yield More than Expensive Bailouts

Although motivated in different ways the FDIC and Bank of America loan modification plans seem to be pointing to a more efficient, and financially sound way of stemming the housing crisis.

Keeping homeowners in their homes arguably is the quickest way to put a floor on housing prices--the core of all our recent economic and market instability.