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ASU expert to testify before congress about bailout


November 13, 2008

Home loan modifications may be the best way to help homeowners stay in their houses and to get the economy back on track. That’s the word from a top expert who’s testifying in front of Congress Friday about the bailout plan now called the Troubled Assets Repurchasing Program (TARP).

“While U.S. Treasury Secretary Henry Paulson has announced that TARP will not be used to purchase troubled loans from banks, it is still of tantamount importance to stabilize the housing and mortgage markets, and loan modification is one of the best tools available to the Treasury, even if they decide in the short run not to deploy it,” says Professor Anthony Sanders of the W. P. Carey School of Business at Arizona State University.

Sanders is a former director and head of asset-backed and mortgage-backed securities research for Deutsche Bank in New York who has consulted with domestic and international banks, as well as the World Bank, European Central Bank and Bank of Japan. He has previously testified about Fannie Mae and Freddie Mac to the U.S. Senate Banking Committee. Friday’s testimony will be to the Domestic Policy Subcommittee of the Oversight and Government Reform Committee of the U.S. House of Representatives.

Sanders references a Hope Now Alliance Survey that shows 14.44 percent of subprime mortgages are 60 days or more delinquent. The same survey shows the rate of prime mortgages that are 60 days or more delinquent has almost doubled over the past year, too. He says this creates a time-sensitive situation.

“We are in the midst of the subprime meltdown, and a second wave of ALT-A (low-documentation mortgages) adjustable rate mortgages (ARMs) are beginning to reset,” says Sanders. “Therefore, it is of critical importance to find ways to slow down the delinquency and foreclosure waves if economically viable.”

Sanders explains there are two objectives for loan modifications: 1.) home preservation aimed at keeping borrowers in their houses and 2.) stemming systemic risk where loan modifications are used to minimize the severe costs of default and foreclosure. Sanders says both of these goals can be met if the borrowers to be assisted are required to be employed, have their incomes verified, and meet other criteria to ensure they can keep making payments.

“In addition to helping homeowners, the financial system will also benefit from loan modifications, such as reducing the loan rate, freezing the loan rate, lengthening the loan period or even reducing the loan principal,” says Sanders. “Since foreclosures involve many transaction costs, including legal filings and selling expenses, that can add up to almost 50 percent loss severity on subprime loans. It will actually be of greater financial benefit to the lender, in many cases, to make the modifications. Pursuing foreclosure is most beneficial only when cure is unlikely, even with loan modifications.”

Sanders says that part of the solution will involve mortgage lenders starting to consider formulas where the mortgage can be refinanced at the current mortgage value instead of the amortized book value. Another important element is identifying borrowers with a high likelihood of succeeding with the loan modifications. Sanders cites Freddie Mac’s Early Indicator tool, which helps to identify and contact borrowers likely to become seriously delinquent before it’s too late.

Sanders says, “Thus, loan modifications are not a bailout of borrowers, but rather, an attempt to reduce costs to lenders and investors, while at the same time preserving homeownership and reducing systemic risk in the economy.”

To read Sanders’ complete testimony, go to http://www.public.asu.edu/~absander/.