In the first half of this year, borrowers defaulted on modified mortgages at rates higher than almost every estimate. According to the Office of Comptroller of the Currency statistics released today, 36% of borrowers who had their loans modified in the first two quarters of 2008 re-defaulted after just 3 months. After six months, the redefault rate was roughly 56%. After eight months, 58% of borrowers re-defaulted.
“The results were surprising, and not in a good way,” OCC director Dugan said.
This poses a serious challenge to government plans to stem foreclosures by modifying mortgages. The idea behind loan modification is to lower mortgage payments and overall debt in order to make the mortgage more affordable for a borrower. But borrowers are defaulting at high rates anyway, showing that modifications won’t be the panacea that advocates like FDIC head Sheila Bair have claimed. And, of course, that all the bailout programs will likely be far costlier than projected.
What’s worse, these results are for the first half of 2008. Since then, real estate values are plummeting and unemployment skyrocketing. The redefault rate is likely significantly higher for the third and fourth quarters. It’s more evidence that regulators and politicians should probably get out of the business of preventing our real estate from reaching prices where the market clears.
Dugan admirably admits that he doesn’t know why the redefault rate is so much higher than expected. This is an important start. Too often when regulators and politicians claim pricing is irrational or that mortgage products bought by the government will yield positive returns, it seems they are operating according to old models about mortgages defaults and home affordability. Those models are broken. It’s time to start admitting our own ignorance.