by Tanta on 8/03/2008 09:38:00 AM

I had intended to write a follow-up to CR's post the other day on Freddie Mac's changes to its foreclosure timelines, but . . . I had to extend my timeline. So sue me instead of Freddie Mac.

I was going to suggest that my friend P.J.'s (of Housing Wire fame) use of the term "whopping" to describe those timeline changes is a little hyperbolic. But it takes some major UberNerdity to show why that is. As I was winding up to a major Nerdfest on the subject, I see that Mish and Aaron at Implode-O-Meter have seen P.J.'s "whopping" and raised it to "doubling" in the great game of GSE Scold 'Em. I have no idea where "doubling" came from, although it appears that Mish just misread the original sentence from the Housing Wire report:

The mortgage finance giant also said that it was increasing its allowable foreclosure timeline in 21 states to a whopping 300 days from last of date payment, and 150 days from initiation of foreclosure, effective on Friday.

This is not saying that the total FC timeline used to be 150 days in these states and is now 300, and you cannot make the English language make it say that. It says that the total allowable (which word does not rhyme with "required") timeline is 300 days in total from last payment made to FC sale. Within that total 300 days, the allowable time from actual referral to an FC attorney to the FC sale is 150 days. Which means that the allowable time from date of last payment to referral to an FC attorney is 150 days. 150 plus 150 equalling 300 in base ten.

But what does all this really mean? Is it significant? Why? Are these measures expressed in terms you are used to seeing, or in rather specialist terms that may mislead the unwary? And why would only 21 states be affected? Can we have some context, Tanta?

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The first thing we need to clear up is the question of what a "foreclosure timeline" is and why Freddie Mac (and Fannie Mae) have them.

Foreclosure law is made by the states, and there are 50 different sets of state FC law out there, plus one for DC and three for the territories Freddie Mac buys loans in, giving them a total of 54 sets of laws. It is very hard to generalize about FC law, given that many different approaches, but you can basically say that all jurisdictions set a minimum timeline for completing a foreclosure (meaning, from the original filing to the FC sale) by virtue of the requirements that the law makes for various steps in the process and when they must be initiated and what has to happen before they are completed. For example, most states have some requirement that notice of the FC sale be published for three consecutive weeks prior to the actual sale date. Obviously this cannot happen until the FC sale is scheduled, which may take a long time (in a judicial FC state) or a fairly short time (in a non-judicial or "deed of trust" or "statutory FC" state). Therefore, the "timeline" always has a matter of 21 days or so added after one thing happens (sale is scheduled) and before another thing can happen (sale is held). If a given state lacked this requirement, or had a much longer or much shorter publication requirement, that state's minimum legally allowable timeframe would be longer or shorter.

I know of no state or jurisdiction that legislates "maximum" timeframes. By this, I mean that the law might say you cannot hold an FC sale less than 21 days after the sale date is determined (to allow for publication), but that doesn't mean you cannot hold the sale more than 21 days afterwards. The law might say you cannot initiate FC filings until a borrower is at least 30 days past due, but that doesn't mean you have to do that, and in reality few servicers initiate FC until a borrower is at least 90 days past due.

It helps, then, to think of FC laws as a matter of setting the shortest possible timeline for foreclosures. This will never be equal to the actual average timeline in a given state, nor will it be equal to the "optimal" or "best practices" timeline for a given state. What Freddie Mac and other investors care about is an "optimal" FC timeline.

Before we talk about this issue of what is "optimal," we also need to clear up the issue of when FC is initiated. Most states do not legislate a minimum number of days of delinquency before an FC action can be filed; there must simply be a legal default under the note and security instrument. Theoretically, in most states you can start FC when a borrower is only one month down, but it is very rare to see servicers do that, and in fact most of us would probably call such a practice "predatory servicing." FC is your last resort for resolving a delinquency, not your first resort.

On the other hand, no investor wants a servicer who dorks around and doesn't commence FC filing until the borrower is a whole year down. Therefore, investors like Freddie Mac set maximum timelines for servicers to commence FC. That deals with the dorking around problem. They do not set minimum timelines for commencing FC other than the statutory minimum, on the whole. The way they deal with the problem of a servicer foreclosing too quickly is by compensating servicers for successful foreclosure avoidance: they pay up in bonuses to servicers who resolve modest delinquencies with collection efforts, repayment plans, or other workouts, and they penalize servicers whose FC rates are much higher than they should be (since that costs investors money).

In order to establish investor timelines, there must be some definition of the starting point. Freddie Mac's rules on this subject are and have always been based on the time elapsed from "Due Date of Last Paid Installment," or DDLPI. There are very good reasons for this; it's a more dependable number than days of delinquency, and given that mortgage interest is always paid in arrears, a number of days since DDLPI will tell you exactly how many days of past-due interest have accrued on a loan. But you do not want to confuse it with days of delinquency. If a borrower makes his May payment, skips his June payment, and today is June 30 or July 1, depending on how you calculate these things, the borrower is 30 days delinquent and 60 days from DDLPI. Thus, if Freddie Mac says that a servicer must initiate FC by 150 days from DDLPI, that means by no later than the 120th day of delinquency.

It does not mean that a servicer may not initiate FC before 150 days DDLPI/120 days DQ. "No later than" means "no later than." I remarked earlier that in general servicers initiate FC around the 90th day of delinquency on average. This is true. Freddie does not require the servicer to wait until the 120th day; it allows the servicer to wait that long and still be considered acceptable to Freddie Mac.

The fact of the matter is that Freddie's timeline for DDLPI-to-initiation has been 150 days on most first lien loans since more or less forever. This is not something new. Freddie did just "standardize" this so it is now true for all loans. It used to be that second liens and some weirder first liens (like previously modified loans) had a 120 day DDLPI rule (90th day of DQ). For that small group of loans, the timeline has extended by 30 days. For the overwhelming majority of Freddie-owned loans, the pre-filing timeline has not changed.

What has changed, for 21 states, is the maximum acceptable timeline for initiation of FC to completion of FC. In Freddie-speak, "initiation" means "referral to FC attorney" and "completion" means FC sale completed. (In some states, it isn't over on the day of sale; there may be a "validation" period afterwards before title actually transfers, or there may be a post-sale redemption period. So a foreclosure sale is "completed" on or sometimes after the "sale date," but never before.)

Again, we need to bear in mind that there are three timelines floating around here: the statutory minimum (the quickest a foreclosure can be in a given state under the law), the real-world average (which is always greater than the statutory minimum, given backlogs and bottlenecks and holidays and other real-life stuff), and the recommended maximum (which is best understood as how high your "average" can get until your investor considers you inefficient or not trying hard enough).

Freddie has always published for its servicers a table of timelines for each state. They vary by state because some states have very short statutory minimums and some have very long ones. The idea was that servicer expectations would take into account those legal limits. I assume this idea is uncontroversial.

According to a very important paper published earlier this year by Freddie Mac economists Amy Crews Cutts and William A. Merrill, Interventions in Mortgage Default: Policies and Practices to Prevent Home Loss and Lower Costs, the national average "optimal statutory timeline" from FC referral to completion as of 2007 was 120 days from FC referral to sale date; taking into account post-sale issues like redemption or confirmation periods, and adding pre-referral days since DDLPI, the national average optimal statutory total timeline was 292 days. The actual average (real world) number of days was 355. ("Optimum statutory" here is a kind of hybrid of statutory minimums and practical additions; the authors calculate a plausible number of days for certain steps in the process to take that aren't controlled by law. For instance, in calculating these timelines they provide for five days for title work to be completed. The law simply requires that title work be completed; it doesn't say how long that will take.)

But nobody works to national averages; everybody works to a timeline for a given state. Per Cutts and Merrill, the longest timeline belongs to Maine, with "optimal statutory" days from FC referral to completed sale of 209 days, "optimal" total number of days from DDLPI to completion of 359 days, and "actual average" of 598 days DDLPI to completion. (Freddie Mac's current allowable maximum for Maine is 505 days, which means that on average servicers are not doing that well in Maine.)

The shortest timeline belongs to Tennessee, with "optimal statutory" days from FC referral to completed sale of 33 days, "optimal" total number of days from DDLPI to completion of 183 days, and "actual average" of 248 days DDLPI to completion. I do not know what Freddie's old timeline used to be for TN, because the current online Servicing Guide has now been updated and I don't have access to the old version. But TN is one of the 21 states that just got changed to 300 days total (150 days from referral to completion), which means the old timeline for TN was less than 300 days.

Since TN had the shortest timeline, I think we can conclude that of the 21 states that got an increase to 300 days, TN got the biggest increase. California, for instance, per Crews and Cutts had a "statutory" total timeline of 266 days and an average total, again as of last year, of 268 days. Freddie's new timeline for CA is 300 days. Given that it is possible that the average has increased markedly since 2007 with record numbers of foreclosures, it seems possible to me that CA's actual average as of mid-2008 is now pretty darned close to 300 days, or even more than that. This provides some context for how "whopping" the increase in the allowable timeframe for CA is.

So now we can think about why it might be that Freddie decided to increase the timelines in the fast-foreclosure states. Obviously, the main rationale is to allow servicers to continue to make workout efforts during the FC process, which will in the nature of things increase the time a loan spends in the FC process, without penalizing them for failing to meet Freddie's standards.

Perhaps, though, the better question is why Freddie upped the limit on these 21 states to only 300 days. Why not give everyone 400 days? Or 505 days, like Maine gets? What's so special about 300 days?

I suspect the answer to that is found in the research that Cutts and Merrill did on foreclosure timing:

[T]he costs associated with foreclosure rise significantly with the length of the foreclosure timeline, by as much as 12 percent for every 50 days added to the timeline. Perhaps more importantly, we find that the likelihood a borrower will reinstate her loan out of foreclosure falls as the length of time in the legal foreclosure process increases – by our estimates, states with excessively long legislated foreclosure timelines could increase the probability of successful reinstatement of delinquent borrowers by 3 to 9 percentage points by shortening their statutory timelines to match the national median timeline. Timelines that give the borrowers too much time in the legal foreclosure process tip the balance from the threat of imminent home loss from perfected foreclosure towards the benefit of “free” rent for the duration of the process, providing an incentive for borrowers to forego reinstatement of the loan even if they have the means to do so. By the same reasoning, some very short timeline states may find that lengthening their legal foreclosure timelines may improve cure rates out of foreclosure by giving delinquent borrowers enough time to cure the delinquency once the formal legal foreclosure process has been initiated.

The authors posit that the "sweet spot" for foreclosure timelines--long enough to allow borrowers to cure, short enough to correct incentives and control costs to investors--is "roughly 270 days" from DDLPI to completion.

It looks to me like Freddie just rounded up "roughly 270" to 300. In other words, for the states with a too-short statutory timeline, Freddie set its timeline into the "sweet spot." Because it is not really possible for Freddie to set the too-long states into the "sweet spot," they are unchanged. Only state legislatures can shorten the statutory process; Freddie Mac can't.

But why have this distinction between pre-filing (150 days from DDLPI in the "short states") and post-filing (another 150 days)? Well, any investor wants servicers to focus their loss mitigation efforts early in the delinquency process. In Freddie Mac's view, if you make the FC referral too early in the process, you are incurring unnecessary legal expenses for a lot of loans that will "cure" short of foreclosure. You may also be putting too much pressure on borrowers. That's a fine line to hold: if you don't threaten some borrowers with FC, they'll never do anything about the problem they have. On the other hand, if you start the judicial machinery too soon, some borrowers who could cure will give up because they think it's hopeless. Economically and psychologically, it's a delicate balance.

I realize that for a lot of people (like Mish), nothing any of the GSEs do will ever be anything except wrong. But still. It would be helpful to try to understand what they are actually doing before going off on doomsday scenarios. I am not claiming that the Freddie Mac changes were just a "nothingburger," but they are hardly anything to freak out over in my view. If you want to freak out, you need to at least read the reporting correctly.

Yes, children, you can have some context.