I’d like to take a moment to direct your attention to a couple of comments from an earlier thread, that spell out in a very clear way the reason why the federal mortgage modification program has been such a screaming failure. The program is premised on a banking model that is out of date, no longer exists.
This isn’t your mom and dad’s banking system any more. That system made money by lending it out at interest. Interest income, minus costs, was a bank’s profit. Banks meticulously documented those loans and kept most of them, booking them as assets. That sort of lending required rules, oversight and judgment, because it depended on lending to a finite number of creditworthy borrowers amounts that they could repay on time.
Banks’creditworthiness – and their executives’ compensation – depended on those loans being paid off over time in the manner and amounts agreed, with as few defaults and refinancings as possible. Fees were secondary. High fees were a measure of too many bad loans, which meant loan officers or their bosses weren’t doing their jobs. Bank boards took notice and imposed consequences.
Today, that’s old hat. Banks make more money with a different business model, one built on fees instead of good loans. Fees are immediate and, until now, consequence free, no matter how rapacious they are. Bank managers make giddy amounts of money from it. Their subordinates need less experience and judgment, and thus can be hired more cheaply or their work can be outsourced to often unregulated mortgage sellers.
That model allowed – it required – banks to lend to those with no or poor credit and to lend too much money to good credit customers. Bank profits and management careers no longer relied on good loans being repaid, so managers didn’t care who the borrowers were or how much they borrowed. Raw loans alone, the more and bigger the better, were what generated fees and apparent profits.
I spent a lot of years in the banking arena, and I remember watching the shift in the 1990’s as the principal source of American banking income went from the loan business, making loans and collecting principle and interest in return, to fee generation.
Quite an amazing shift. But, if you recall, it was back in the early ’90’s that your personal checking account terms started getting smothered in $30 overdraft fees, etc. Since the mid-90’s, American banks’ profitability has been upwards of 75% fee-based, not based on interest income.
Unless Congress gets banks to return to their traditional way of making money, actually investing in real tangible things that produce real tangible value for society, they will have no free market inventive to make sound judgments about a borrower’s ability to repay a loan or credit card and they will continue to gamble with depositor’s money. As long as they are not made to honor their fiduciary duties to the investors in RMBS—who are suppose to make a return on their investment based on the repayment of the mortgage loans—the banks acting as trustees and servicers have zero free market incentive to negotiate mortgage modifications in good faith. In fact, it would appear they have a dis-incentive to do valid mortgage modifications.
The investors in RMBS would be far better off receiving a reduced profit than no profit at all, but the trustees and servicers are better off generating additional fees from foreclosure services. The entire system is rigged to screw both the borrowers and the investors who would have made money off the mortgage payments.
Unless we get back to a system where the entity making the decisions about whether to lend and how to service the loans are compensated by the successful repayment of those loans, all the bailout money in the world isn’t going to solve this problem. It just kicks the can down the road.
[Earlier posts in this series and related links at FDL’s Foreclosure Fraud Resources]