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Tuesday, April 6, 2010

Bank Of America: To Forgive And Forget

Bank Of America: To Forgive And Forget 


Among the government bailouts none has fallen as flat as modifying mortgages so that borrowers don't lose their homes. Reducing monthly payments by lowering interest rates hasn't stemmed defaults because the most troubled mortgages are often those in which the house is worth far less than the loan. Wednesday, Bank of America said it would try reducing the principal on those mortgages in hopes of keeping borrowers current. If it works, the bank and 45,000 Americans will make out better than they would have otherwise, but it could also set a precedent rife with moral hazard.
Bank of America 's plan is to forgive principal on mortgages where the loan is worth at least 20% more than the property. Those include exotic and irresponsible loans like option ARMs that let homebuyers pay no interest for a time as their balance balloons, but also prime loans that have fallen delinquent. Barclays Capital analyst Jason Goldberg estimates the forgiven amount could be as much as $3 billion.
As pilot programs go, BofA's comes late in the game but could still have a meaningful effect on how the end of the financial crisis plays itself out, says Goldberg. A quarter of American mortgages are underwater, with negative equity in the home. American banks hold $1.5 trillion of those loans and have been generally reluctant to recognize the losses accumulated by the real estate bust. That has led to a situation where no one acts, though it is in everyone's best interests to do so. If BofA is willing to write off principal up front and thinks it can recoup some of those losses by keeping customers in their homes, other banks may follow suit.
There is also evidence the strategy works. Wells Fargo knew when it rescued Wachovia from failure that the latter's balance sheet was rife with liar loans. Aside from assigning itself tens of billions of dollars in losses up front, Wells coped by forgiving principal and lowering interest rates on the most egregious of Wachovia's loans. So far it's worked, with 52,000 loans modified and the overall portfolio doing better than expected.
BofA's latest effort to keep owners in their homes did not come about without a nudge. The forgiveness program is part of a settlement with Massachusetts officials over predatory lending charges related to the bank's purchase of subprime lender Countrywide Financial. Add to that the fact that Charlotte-based BofA urgently needs to repair its loan portfolio which, Goldberg estimates, has a quarter of mortgages and a third of home equity loans underwater. The bank is also under pressure from federal officials who are disappointed with current mortgage modification programs that have seen borrowers default repeatedly despite reduced monthly payments.

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