Managing the COVID created economic crisis: is it different this time? by Rajinder (Raj) Singh

managing the COVID created economic crisis: is it different this time?

by Rajinder (Raj) Singh

Ten months into the economic downturn created by the worldwide pandemic, it is natural to compare with the last global financial crisis (GFC). While both the cause and effects are quite different this time around, there are plenty of clues about how to recover. CROs across the financial services industry were well prepared with a toolkit built during the safe years to respond quickly and effectively in case of an unexpected downturn. This article focuses on the many public-private home retention strategies developed and employed in the aftermath of the GFC. Some of these will need to be recalibrated and deployed to nurse the borrowers and the housing industry back to strength.

The 2020-21 economy is indeed exhibiting a K-shaped divergence – elevated levels of unemployment rate in the non-college degree population and people on pandemic assistance programs while home prices keep appreciating throughout the nation. The generous mortgage forbearance (payment deferral) programs are masking the significant percentage of unemployed or under-employed borrowers who are actually delinquent in their mortgage payments and will face serious liquidity problems as these programs expire. The loss mitigation programs needed to deal with this scenario are where there will be similarities with the GFC, albeit the borrowers are in a much better equity position this time around.

First, a bit of a recap of U.S. mortgage history. Serious delinquency rates (three or more payments missed) for conventional mortgages peaked at around 7% in 2010. Lax underwriting standards, layered risk products, and significant equity extraction through cash-out refinancings exacerbated the impact of recession. Foreclosure rates peaked at 2.3% around the same time. This translates to approximately 1 in 10 mortgage borrowers either evicted or facing serious consequences during 2008-10. Fast forward to early 2020, this statistic had improved to under 1 in 3000 properties with a serious delinquency or foreclosure filing. It took almost a decade to return to pre-GFC levels. A variety of programs were developed and deployed to get the massive mortgage default problem under control. These programs sought solutions across myriad borrower situations -- borrowers with temporary hardship, permanent job loss, or sharp drop in home value causing negative equity and a disincentive to continue with mortgage payments.

Home Affordable Refinance Program (HARP) targeted borrowers who, despite their good payment behavior, were “trapped” in their mortgages. They could not refinance at the prevailing lower interest rates since the drop in home prices made their current loan to value ratios too high, or current credit scores had deteriorated, or current debt-to-income was too high under the new mortgage underwriting standards of the lenders. This program ran for a decade and helped three and a half million borrowers transfer their balances and existing mortgage insurance cover to a new mortgage with lower monthly payments as long as they were current on their existing mortgage for the previous six months and no more than one late payment in the previous twelve months. This program was arguably one of the best home retention initiatives that worked effectively and did not create any moral hazard, since home retention was in the best interest of all stakeholders involved and nobody could game the criteria.

Home Affordable Modification Program (HAMP) was another very successful home retention initiative where there was active government subsidy to encourage lenders and borrowers to work together. This was targeted towards borrowers who experienced reduction in household income or temporary hardship. The loan was restructured to ensure the new monthly payments were affordable. The program was divided into a trial payments period and permanent loan modification period. The lender/servicer was paid scheduled cash incentives based upon borrower repayments. One and a half million borrowers opted for this program over a decade with more than half of them remaining current on their modified mortgage or having paid off their loan, quite an impressive statistic.

Home Affordable Foreclosure Alternatives (HAFA) program was targeted at borrowers who re-defaulted on or did not qualify for HAMP and were willing to settle without the expensive and time-consuming foreclosure process through short sales (selling the house for a lower price than the loan balance) or deeds-in-lieu.

Foreclosure is the least desirable outcome for a mortgage; it is in the best interest of the lender, guarantor, and the society to find alternate solutions when borrowers get into financial trouble. It is especially imperative during a recession when you do not want the entire housing industry to endure an avalanche of foreclosures at the same time, creating a downward spiral for home prices. The programs delineated above helped soften an even deeper hit to the housing economy by spreading out the pain over many years and also provided the borrowers the wherewithal through lower monthly payments, etc. to restore their financial health. The cost was shared among the various stakeholders – the government (subsidies for HAMP), mortgage insurers (first loss claim payments), lenders (residual losses), and of course borrowers who lost their homes or significant equity in their homes.

The key learning in post-GFC housing recovery is that you need a suite of tools to deal with the various nuances; there is no one-size-fits-all solution. All these solutions require close cooperation and transparency between all the stakeholders: borrower, lender, mortgage insurer, and the regulator.

author

Rajinder (Raj) Singh

Raj Singh is Chief Risk Officer of Global Mortgage Insurance division of Genworth Financial. He serves as director on the boards of Genworth Australia, India Mortgage Guarantee Corporation (joint venture with National Housing Bank, IFC, and ADB), and Genworth Seguros de Credito a la Vivienda, Mexico. He also serves on the Board of Appalachian Trail Conservancy. Raj has held senior executive roles in the global financial services sector, including Citigroup, GMAC Financial Services, GE Capital), and U.S. Bancorp. He has served on the boards of Genworth Canada and Banco de America Central (BAC) International Bank. Raj holds an MBA in Finance from the University of Rochester’s Simon Business School, an MS in Mechanical and Aerospace Engineering from Rutgers University, and a B.Tech. in Mechanical Engineering from the Indian Institute of Technology Kanpur.