With pressure mounting for Congress to enact a 90-day moratorium on home foreclosures, mortgage servicers are warning that the move could have the perverse effect of prolonging the housing downturn.
"A foreclosure moratorium would make a correction take much longer and have unintended consequences on servicers who already have liquidity constraints," said Dennis Stowe, the president of Residential Credit Solutions, a buyer and servicer of distressed mortgages.
Pooling and servicing agreements typically require that servicers advance all the principal and interest payments, as well as tax, insurance, maintenance, and foreclosure costs, to investors regardless of whether the borrower is paying.
Servicers get reimbursed for expenses incurred while a loan is delinquent but only after the property goes into foreclosure, so getting repaid can take nine months to a year. A foreclosure moratorium would indefinitely extend the advances that servicers pay to investors and come as borrowing facilities that servicers rely on to make advance payments are strained by the liquidity crunch.
Large banks with servicing operations may be able to handle the financial strain of paying advances to investors, but independent servicers and special servicers that deal with defaulted borrowers are already cash-strapped, said Matt Stadler, a principal and the chief financial officer at National Asset Direct Inc., a New York buyer and servicer of distressed loans.
"Advance lines are ballooning, and servicers are paying interest on those advances," he said.
Mr. Stadler likened the state of the servicing industry to the "I Love Lucy" episode in which Lucy is furiously grabbing chocolates off a fast-moving conveyor belt.
"The borrowers are just piling up, and servicers are inundated and overwhelmed with calls they can't answer, short sales they can't complete, and not enough staff," he said. "They need more manpower."
House Financial Services Committee Chairman Barney Frank, D-Mass., has argued for months that a blanket moratorium on foreclosures is needed because servicers are not moving fast enough to modify loans.
"We're likely to see some kind of legislation that halts foreclosures even if it doesn't go into effect until Jan. 21st," said Robert Gnaizda, the general counsel of the nonprofit Greenlining Institute.
Some lenders are voluntarily halting foreclosures, including JPMorgan Chase & Co., which imposed its ban Oct. 31 on owner-occupied properties financed by Chase Home Finance LLC, Bear Stearns' EMC Mortgage Corp. unit, and Washington Mutual Inc. The company also said it will do independent loan reviews and offer new financing to help borrowers avoid foreclosure.
Mr. Stowe, the former president and chief executive of Saxon Capital Inc., which Morgan Stanley bought in December 2006, said servicers are already being pinched by laws passed in California, Florida, and New York that require borrowers be contacted before default or foreclosure notices are filed.
"The longer you stretch out foreclosures, the more advances build up," he said. "There's limited liquidity for servicer advances because everybody that provided liquidity is also having credit issues."
Foreclosure filings rose 71% in the third quarter, to 765,000, compared with the same period a year earlier, according to RealtyTrac Inc., which tracks defaults.
Analysts have been paying particular attention to housing prices because the influx of real estate-owned properties from foreclosures has put downward pressure on prices overall. Radar Logic Inc., a New York data and analytics company, released a report Friday that found home sales were up in 19 of 25 cities in August.
Fred Cannon, an associate director of research and the chief equity strategist at KBW Inc.'s Keefe, Bruyette & Woods Inc., said that as banks move REO off their books the housing market could find a bottom in the second or third quarter of 2009. A foreclosure moratorium could prolong the housing downturn by keeping those REO properties off the market, he said.
Clay Cornett, the president of Fidelity National Default Solutions, agreed. "It will prolong the agony and keep us from finding a bottom in housing prices, which is what is required to stabilize the market," he said.
For more than a year now, lenders, investors, and servicers have all claimed that they were doing everything they could to avoid foreclosures largely because of the costs. A foreclosure can cost up to $50,000 per property.
Yet servicers are first in line to be repaid for advances they have made when a home goes into foreclosure, which may be a disincentive to help troubled borrowers.
"The only way servicers get their money back is when a property gets sold or goes into foreclosure," Mr. Stadler said. "A moratorium doesn't fundamentally change anything since many of these borrowers in the late stages of default have already abandoned the property."
The business model that servicers used during the heyday of the housing market also constrains the industry.
When delinquency rates were below 2%, servicers mainly acted as collection agents, making automated phone calls to defaulted borrowers. As delinquencies rise, many loss-mitigation specialists lack the skills to handle the complexities of offering options to borrowers, Mr. Stadler said.
More often, servicers put borrowers on repayment plans, which let borrowers catch up on arrears over six to 18 months. Unlike modifications, these plans are not restricted by investor requirements.
A crucial problem is that manyloan modification agreements ultimately fail. "It's well known within the industry that modified loans have a recidivism rate of 50%," said KBW's Mr. Cannon. "What the borrowers really want is principal reductions, and the banks don't want to forgive debt because, if you start forgiving principal, what's fair? And where does it stop?"