Negative Equity Not A Factor In Re-Defaults
Recent approaches by the Obama administration for mortgage mods in Prime and Alt-A have sought to appease negative equity perceptions (and reality) of borrowers, with the end result being a substantial push for loan mods, as HOPE targets a 3-4 million loan mod total over the duration of the program (which is substantially behind schedule as only 230,000 mods so far have been enacted). Yet empirical data indicate that negative equity is an irrelevant issue in examining the behavior of re-defaulters.
Some findings by Credit Sights (presented via Research Recap) indicate that negative equity, whether tangible or not, has moderate if any impact on redefault rates, with subprime re-delinquency hitting 40% while prime and Alt-A at approximately 30%.
Thus it is only a matter of time before a new mortgage mod program appears, one which instead focuses on interest and principal payment forbearance. Of course, the benefit of this would be to postpone eventual re-re-redefaults far into the future, presenting a case for the green shooters to claim that things have again stabilized as delinquency numbers "improve" sharply, while negative would be a delay in the disclosure of how bad any given underlying mortgage security portfolio is.
In terms of security impact, Credit Sights has this to say:
Such a delayed repayment schedule will likely see junior RMBS benefit at the expense of senior notes. Subordinated bonds may continue to receive coupon payments thanks to more mortgage borrowers being able to make their payments. At the same time, senior noteholders will need to wait longer to receive their principal back and are still at risk of losses if the borrowers default.
However, the perverse incentive on defaults to increase if repayment terms are adjusted also becomes a concern.
…while negative equity may not be sufficient to encourage large numbers of comfortably-off borrowers to default, the prospect of being able to negotiate much better terms might.
As always, the administration is aggressively juggling with critical variables and is only focused on extracting as much NPV as possible out of any situation, with little to no regard for what happens to the economy several years down the line as the cost side of the equation become the dominant one. Then again, Bernanke will by then have inflated debt to manageable terms, unfortunately side by side with the dollar having reached hyperinflationary status. That, or the deflationists are right, and the tens of trillions of consumer net worth will never be replaced to stimulate an inflationary environment, no matter how many Fiatscos, in the parlance of our times, are printed each and every day.