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Who Speaks for Mortgage "Lenders"?

posted by Adam Levitin

Katie Porter makes an incredibly important point in her recent post about how securitization structures may be impeding mortgage modifications because the ultimate holders of risk on the mortgages are not the ones involved in the modification decision.  Mortgage servicers, who typically hold a small interest (if any) in the loans are the ones making the modification decisions.  When servicers do hold positions in the mortgage-backed securities, they are first lost positions, so the servicers likely takes a loss regardless of a modification or foreclosure, meaning that their interests are not aligned with the other MBS holders.

Let me take Katie's post a step further and suggest that the relevant voices on the lending side of the mortgage market have not been heard.  The ultimate risk on mortgages is held by mortgage-backed securities holders, private mortgage insurers, and pool-level bond insurers.  These parties have been entirely absent from the conversation on modification and bankruptcy reform. 

Instead, we have been hearing servicers and originators (such as the Mortgage Bankers Association) speaking for the entire mortgage lending industry.  But there is strong evidence that servicers are themselves part of the problem and that some may be faithless agents to the MBS holders they represent. 

If Congress is concerned about the impact of foreclosure legislation on the mortgage lending industry, it should make sure that the conversation includes parties who bear the ultimate risk in mortgage loans--the private mortgage insurers and the bond insurers and the major pension plans and mutual funds that hold MBS.  For that matter, the state regulators of insurers should also be involved in this as a safety-and-soundness issue.  Limiting mortgage loan losses limits the insurers losses. 

There seems to be little disagreement that foreclosure would result in a larger loss on a mortgage than a modification.  One would think, then, that the market would respond by modifying non-performing mortgages to a level that homeowners could afford.  But this hasn't been happening on a large scale.  As we think about why this market isn't working, securitization structures should get a lot of attention. 

As Katie noted, securitization structures can create impediments to modification.  Sometimes it is contractual, such as pooling and servicing agreements (PSAs) that forbid servicers from modifying mortgages or severely constrain the modifications that are allowed.  Other times the PSAs create incentive structures that lead servicers to prefer foreclosure to modification. 

Going forward, one hopes that the securitization market will fix this--MBS purchasers will recognize the importance of good servicing in portfolio performance and will be willing to pay a premium for MBS with PSAs that give servicers the ability to make necessary modifications and the incentives to do so.  I say hopefully because I am not at all convinced that many MBS purchasers understood exactly what they were purchasing.  (Maybe signaling works, but maybe not...)

But for existing mortgages, the contractual and incentive impediments created by securitization pooling and servicing agreements remain a problem, and the only clearly Constitutional way to overcome them is via bankruptcy.  If mortgage modifications were allowed on all properties in bankruptcy, it would allow a bypass to the obstacle created by modification.  Bankruptcy modification is an involuntary workout that should be possible when there are market problems preventing voluntary workouts.  This is essentially a parallel to companies with public debt using bankruptcy to restructure the terms of their bonds.  Many bond indentures forbid the indenture trustee from modifying the terms of the debt absent unanimous consent of the bondholders, raising a huge structural obstacle to loss-minimizing modifications. 

Notably, the loss calculus for MBS holders or PMI insurers or bond insurers should not change depending on whether a workout is voluntary or not--it will still produce a smaller loss than foreclosure.  The Bankruptcy Code's best interest test guarantees that, and in the current market especially foreclosure outcomes are  brutal.   

This, of course, is just my evaluation of the market.  But the voices that should be heard from the mortgage industry about this are the MBS holders and the insurers, not the servicers and originators.

Comments

I want to point out that bankruptcy is not the only clearly Constitutional way to break the logjam created by securitization (and also second mortgages.) There is also eminent domain. After Kelo, there is no doubt that a HOLC-type organization armed with eminent domain powers can Constitutionally seize mortgages, pay the servicer the appraised value of the property, and refinance. This would leave the various investors to fight for the proceeds among themselves, insulated from the plight of the borrower.

I'm not arguing that eminent domain is better (or worse) than bankruptcy. But it is an alternative, and it is Constitutional.

Wow, that would hurt. The investors that is. It might work out better for debtors though. If mortgages were paid off at present value what happens to all of that amortized interest? Big ole bite is what would happen. You will probably knock off 1/3 to 1/2(my guess) of the potential profit on interest. The bonds I dare say might not make any money whatsoever and I don’t know if the insurance would cover that kind of stuff. Maybe it would, I don’t know. I think its great out of the box thinking. I like it, but I think the potential down side of the risk to the everyday person whose retirement fund invested in that stuff might be a little high. I may be wrong, so if I am somebody please tell me so. I would like to know.

I'm not so sure that Kelo goes that far, Joe. It's one thing for government to use eminent domain to seize both title and physical real property for redevelopment purposes. But seizing just title and leaving the property intact for forced refinancing looks quite different. To be sure, one would think a case that allows the seizure of title and physical property would allow the seizure of title alone, but the former fits in the traditional pattern of eminent domain, the later does not. Still, it's a very interesting thought..

Note, that seizure of mortgages via eminent domain or the purchase of mortgages via FHASecure puts taxpayer dollars on the line. Bankruptcy accomplishes the same result without risking taxpayer dollars.

Adam -

I'll say that my legal history is as bad as virtually everything else about my legal knowledge... but it seems that Kelo didn't fit the traditional pattern of eminent domain, Hawaiian Housing Authority didn't fit the traditional pattern... even Poletown didn't really fit the traditional pattern of eminent domain, really. If the only difference here is that we're not razing the buildings, well, I don't really see that as a particularly big hurdle, once we've crossed the line that those cases seem to cross.

I'm not disagreeing that this might be a bad idea; I'm not disagreeing that it LOOKS different. But I'm not so sure I see where you're coming from when you suggest that departure from the "traditional pattern" is so clear, in an age where the traditional pattern seems to be getting pretty nontraditional.

What makes you think that not knocking down the buildings makes such a big difference?

Fair point. Why should we distinguish between tangible and intangible property rights? Perhaps because once it is only intangible rights like title that are being seized we've moved really far away from the origins of eminent domain. We might be on a slippery slope, but that doesn't mean we'll necessarily go all the way to the bottom. Still, I'll back away from my original suggestion that bankruptcy is the only constitutional option. It is the only clearly constitutional option. We really don't know how far eminent domain extends after Kelo.

Let me also suggest that there is a practicality problem--how does the government know which mortgages to seize? Assuming that the government could get the information, it would still take a while to obtain and sort, and by then it might be too late.
But seizing title to properties located all

It's late... I need sleep...I know better but I'm going to take a quick swing at it anyway...

How does the government know? My guess would be the same predictive analytics that all of the servicers are using...

Interestingly enough, the Commonwealth of PA recently passed legislation allowing foreclosure with either possession of the note OR possession of the mortgage. Apparently, it is no longer necessary for an entity to own both in order to bring foreclosure on PA homeowners....

This is a serious question: at what date will you fix the value of the property for purposes of the "workout?"

Since prices are falling and liable to fall further, if you settle the "workout" too early, the homedebtor will be underwater again in short order. Another default is then likely-- either because the homedebtor refuses to make payments on a property worth less than he owes on it, or because the homedebtor expects another concessionary "workout."

If you wait for prices to bottom out then you will let plenty of foreclosures happen before you step in (assuming you can time the market at all).

These problems will crop up whether the lender (servicer?) offers workouts or the bankruptcy court is empowered to impose them (that is, adjust the loan to the apparent value of the security, even for home loans).

Though bankruptcy courts know very well how to adjust loans, the markets for the (property) securities in question are rarely as uncertain as the residential- real- estate market today.

There seem to be two threads going here. One concerned with protecting home owners equity. The other concerned with upside down homeowners.

By far the biggest problem is upside down situation. Millions of houses are already empty. Market signals were not working - way too many houses were built. The ones that were built were too big. Millions more homeowners are upside down and the payments are or have reset.

So what do you do if you are upside down???? And your payments are double what you can afford or what you rent the same thing for down the street???

If you are smart you have waited till about now. The systems in place just can not deal with millions of families tossing the keys. You quit paying the mortgage. Stay in the house until they physically throw you out. Which at some point will not happen any more. The worst thing for everyone is an empty house. If / when they throw you out, you move in with family or friend until you can find a place of your own. You have saved the mortgage payments and you can afford to do that.

Over the next 5 or maybe 10 years the price of housing is forced back to 2 1/2 x yearly wages and no one ever again expects to retire by "investing" in real estate. The prices are forced down by families willing to continuously move in order to lower their monthly costs. Families moving in together and jumping around can out wait the investors.

Eventually there may be some sort of organized response to the crisis but I doubt it.

Cities, towns, and neighborhoods will get tired of empty houses and force the houses to be sold somehow. Maybe eminent domain against empty property as a public nuisance and danger. Towns have the incentive to keep house occupied or they get no taxes. Neighbors can get together and put pressure on local government.

What is the end result?

There are $10 Trillion in home mortgages in US now. I can see $5 Trillion or more written off over next 5 years. Congress, Fed, etc are now thinking $Billions - wrong sorry.

Who takes the hit? Who are the investors? I think it will turn out to be various retirement funds - Pension Funds IRAs 401K.

Which means the retirement plans of boomers will not happen.

The principal in retirement funds are locked up and will never be repaid. Pension funds and their managers are not dealing with reality. Funny - the boomers are still pouring money into those funds as the responsible people they are. So where is this new retirement fund cash flow pointed now? Commodities....... Which will also crash very soon. Same pattern as houses.

Will that destroy the economy? No - it will improve it......... How?????

In many ways

The debt is circular. The same people / families who owe mortgages also own retirement investments.

Imagine how many fees are paid in the process of investing, lending, borrowing, processing all that money. All the record keeping and paper work goes away.

People will stop the process of trying to save for retirement - because the theory is not correct. They will just pay off their house and work as long as they can.

The Hedge Funds and Mutual funds will go away - no source of funds.

The economy will stop blowing and popping bubbles. Stop or reduce business cycles which I think have been driven by the retirement fund hot money.

The economy will be simpler easier to manage and easier to understand.

Look at Warren Buffet - still lives in the house he bought when he got out of school. Less moving around driven by people "living off house appreciation"

Houses only built that people actually want to live in.

More resources for real problems like energy / environment. Or even grand human adventures like space travel etc.

This concept will ripple across the world and increase resources to help 3rd world join mainstream world economy.

A mortgage modification is available to most people for a fraction of the cost of a refinance.

Banks are required to speak with
an attorney who requests a loan workout.

We at Lender Modification dot com have a team of lawyers and paralegals who can get people out of foreclosure or into a fixed rate if they have an adjustable one.

Contact us today for a fee consultation.

Gavin@LenderModification.com
www.LenderModification.com

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