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New Model Is Forged In Bank's Wreckage
U.S. Reworking IndyMac Mortgages By the Thousands

By Renae Merle
Washington Post Staff Writer
Saturday, November 1, 2008

PASADENA, Calif. -- Inside the stone-and-glass headquarters of IndyMac Federal Bank, regulators are carrying out an experiment that could change the course of the financial crisis by tackling the home foreclosures that are at its root.

With the Federal Deposit Insurance Corp. at the helm of IndyMac, which was seized in July after it became one of the country's largest bank failures, regulators are attempting to create a model for reworking mortgages and rescuing homeowners.

A few major banks are also trying to tackle the home foreclosure problem, a major impediment to the nation's economic recovery. J.P. Morgan Chase yesterday said it will begin modifying mortgages under a program that could keep 400,000 families in their homes. Bank of America plans to soon start modifying an estimated 400,000 loans held by its newly acquired Countrywide Financial.

But so far, private efforts have moved slowly. So attention is focused on the work of the FDIC. Its chairman, Sheila C. Bair, has been a fierce advocate of directing more assistance to homeowners instead of just to financial firms. Members of Congress have also pushed the Bush administration to help homeowners. The FDIC and Treasury Department are negotiating a plan to have the government guarantee mortgages of millions of distressed homeowners if lenders agree to significant loan modifications.

The IndyMac initiative is seen as a way to test some aggressive methods for breaking through traditional barriers to loan modification. For instance, regulators are using a formula -- rather than individually scrutinizing each borrower -- to try to decide who should and should not be saved from foreclosure. In addition, regulators have won the cooperation of a major Wall Street firm in their mortgage modification effort, something critical to their success.

But the initiative is also uncovering unexpectedly tough challenges, among them the frustration of having a complicated mix of loans in the bank's portfolio, borrowers who are difficult to reach and a number of homeowners whom regulators cannot legally help.

Jeff Lehman is one of the FDIC's success stories. Lehman, a fur retailer, fell behind in his payments earlier this year after 20 years in his West Hollywood condominium. His initial attempts to modify his loan through IndyMac were rebuffed.

But after the FDIC took over the bank, Lehman said, he received a letter proposing a more-than-$300 drop in his monthly payments. "This was definitely better than losing the place," he said.

About a dozen FDIC employees and a group of contractors have set up operations on four floors of IndyMac's headquarters, working next to the remaining IndyMac employees. With more than 7,000 employees laid off in the past year, many offices and desks are empty.

IndyMac's massive portfolio contains more than 700,000 loans, most of which are for homes in the hardest-hit parts of the country, including Southern California and Florida. More than 50 percent are adjustable-rate mortgages, with many homeowners facing an increase in monthly payments that could push them into delinquency.

The FDIC is skipping the traditional but time-consuming approach of making customized modifications to individual mortgages. Instead, regulators are plugging homeowners' incomes into a formula to determine how much they can afford to pay -- usually 38 percent of their gross monthly income. Regulators first try to reach that payment level by lowering the interest rate. If that is insufficient, they then extend the term of the loan to 40 years. If that also is insufficient, homeowners might pay interest on only a portion of the principal.

"Is it perfect? No. Is it effective? Yes," said Mike Krimminger, special policy adviser to the FDIC, who was dispatched to California to head the program he helped design. "Streamlining makes a big difference in being able to apply this to a lot of mortgages."

IndyMac has three main types of loans in its portfolio. Some are mortgages it owns. Others are loans it has managed for other lenders, such as Lehman Brothers. Still others are loans that had been bundled into pools, known as mortgage-backed securities, governed by agreements or rules that dictate what if any changes can be made to their terms.

The FDIC can easily rework the loans IndyMac owns.

Regulators achieved a breakthrough with the second type after persuading Lehman Brothers, the investment bank under bankruptcy proceedings, earlier this month to allow its 38,000 loans in IndyMac's portfolio to be included in the modification program. FDIC officials are now hoping to use Lehman's example to persuade others to sign on. The key, agency officials said, will be convincing lenders that a modified loan, even with a reduced interest rate, will be more profitable than a foreclosure.

The third category, securitized pools, can be even more complicated because, often, dozens of investors own portions of the pool. Revisions to the contracts that establish what kinds of changes can be made to mortgages must be approved by all the investors. Sometimes those contracts can forbid modification of more than a small portion of the loans in the pool.

Lenders that want to modify loans in mortgage pools have said they have been hamstrung because they fear that investors would sue them for damaging their investment.

The FDIC said IndyMac's portfolio allows modifications. So regulators have bypassed the time-consuming process of asking each investor for permission or changing the contracts.

But the contracts did have one restriction that challenged the FDIC and that it could not get around legally. They required that a homeowner be seriously delinquent before a loan could be modified. When the FDIC's Krimminger saw that, he said, he was "disturbed and bothered."

The agreements meant that hundreds of thousands of homeowners in IndyMac's portfolio facing interest rate increases on risky loans could not be covered by the program. "I wish I could say that we could do something to help people who are current but have a problem coming up, but it's difficult to do under our agreements," Krimminger said. "There is nothing worse than having somebody call and say, 'I'm current, but I think I'm going to have a problem here soon,' but unfortunately we can't do anything."

In addition, about 25 percent of the delinquent homeowners vetted by the FDIC's formula did not qualify. In many of those cases, even after the FDIC's adjustments to interest rate and principal, the homeowners could not afford the monthly payments.

Another problem is getting homeowners to respond to offers of help. The FDIC mailed 35,000 unsolicited modification invitations. About half of those included a detailed estimate of how much the program could save the homeowner. These offers, which are based on financial information about the borrowers, had a response rate above 70 percent.

But the FDIC is struggling to reach about 18,000 other homeowners for whom the agency does not have salary information. The FDIC sent those homeowners a letter asking that they call a customer-service line to discuss a modification. But only about 15 percent of those homeowners have responded.

Last week, the FDIC began hiring nonprofit groups to help it reach this population. The agency will pay the housing counseling agencies $150 if the homeowner gets in contact with IndyMac and $350 more if the modification is successful. And the FDIC is preparing another outreach program, including new solicitations that note that the average modification includes a savings of about $380 a month.

Even after homeowners receive loan modifications, there is still a considerable risk they will default. In the past, about 40 percent of homeowners were delinquent again within a year of receiving a traditional loan modification, according to a recent Credit Suisse report. And some industry officials warn that the proportion could jump if the economic downturn deepens, throwing more people out of work.

Lenders say that the FDIC effort has pointed out some possible solutions but also has highlighted problems. "The FDIC has good intentions, and they are probably demonstrating things that can be done better," said Bob Davis, an executive vice president with the American Bankers Association. "But they are also demonstrating there is no silver bullet."

The industry has pointed to its Hope Now effort, an alliance of lenders established by the Treasury Department last year. The group says it has helped about 2.5 million homeowners, but nonprofit advocacy groups say the assistance won't necessarily keep participants out of foreclosure over the long term.

Indeed, the FDIC effort also does not go as far as some housing advocacy groups would like. The program defers but does not forgive principal for homeowners who owe more than their house is worth. Regulators have in many cases made the modifications temporary rather than permanent. For instance, a loan reduced to a 3 percent interest rate will begin to creep back up after five years to the survey rate set by Freddie Mac -- currently about 6 percent.

In some cases, the FDIC effort is less aggressive than Bair advocated earlier. For example, a year ago, she said lenders should freeze the interest rate for certain subprime loans with adjustable rates. But faced with such a wide variety of loans at IndyMac, regulators determined that doing so would be impractical.

The American Securitization Forum, which represents many lenders and investors, is studying the IndyMac experiment. "As the housing market continues to experience severe stress, we are discussing with our members the approach taken by the FDIC and others as we consider additional industry initiatives to enhance the loss-mitigation process," Tom Deutsch, the group's deputy executive director, said in a statement.

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