Bloomberg News

Raskin Says Mortgage Terms Work Against Borrowers, Banks

October 04, 2011

(Updates with comment on principal forgiveness in fifth and sixth paragraphs.)

Oct. 4 (Bloomberg) -- Federal Reserve Governor Sarah Bloom Raskin said the “shocking and enormous decline” in U.S. home prices has revealed weaknesses in mortgage pooling and servicing contracts that work against the interests of borrowers and lenders.

“Servicers may not be properly motivated to perform loan modifications even when such modifications are in the best interests of borrowers and investors,” Raskin said in the text of her remarks to Maryland State Bar Association in Columbia, Maryland. “Can this contract be saved? I think the answer is no -- at least not in its current form.”

A U.S. unemployment rate stuck at 9 percent or higher for the past five months and falling house prices have tested the solvency of mortgage holders. About 8.4 percent of all mortgages were delinquent at the end of the second quarter, and 4.4 percent were in foreclosure, according to data from the Mortgage Bankers Association.

“An estimated 3 million families are not able to refinance their mortgages at today’s historically low interest rates because they are underwater on their mortgages,” Raskin said. That calculation is based on a Fed Board staff estimate of the number of borrowers with fixed-rate mortgages of 4.75 percent or higher and a loan-to-value ratio of greater than 100 percent.

Loan Principal Reduction

Raskin said in the question-and-answer session that she is starting to hear more discussion about the possibility of loan principal reduction as a solution to foreclosures. The problem of rewarding borrowers who can’t pay versus those who are current on their mortgage balances, is still “hanging over” the concept, she said.

“I see people beginning to talk about principal reduction again whereas it had waned in influence,” she said.

Raskin said loan pooling and servicing agreements, or PSAs, in their current form have a number of misaligned incentives.

Servicer compensation is not tied to the performance of the loan, and in most cases, she said, servicers receive no extra payment for preventing default. Servicers are not reimbursed for the labor-intensive costs of loan modification. The service agreements do provide reimbursement for some foreclosure expenses.

‘Loss Mitigation’

“It is imperative to reconsider the compensation structure so that servicers have adequate incentives to perform payment processing efficiently on performing mortgages, and to perform effective loss mitigation on delinquent loans,” Raskin said. “After the compensation structure is reconsidered, the PSAs need to be amended or renegotiated in order to facilitate more workouts.”

Pooling and servicing agreements should also clarify “the situations in which loan modifications and other mitigation strategies should be pursued,” she said.

Residential investment contributed 0.09 percentage point to the economy’s 1.3 percent annual rate of growth in the second quarter, and subtracted 0.06 percentage point from growth of 0.4 percent in the first three months, according to the U.S. Commerce Department. Home prices in the U.S. fell 4.1 percent for the year ended July, according to the S&P/Case-Shiller index of property values in 20 cities.

Fuel Growth

Fed officials continue to look for ways to fuel economic growth and boost employment. They have held the benchmark federal funds rate in a range of zero to 0.25 percent since December 2008.

U.S. central bankers decided last month to extend the maturity of the Fed’s bond portfolio by selling short-term securities and purchasing Treasury securities with maturities of six to 30 years. The Fed also plans to reinvest principal payments from maturing mortgage-backed securities and agency debt back into mortgage-backed securities. Fed officials are next scheduled to meet Nov. 1-2.

Raskin completes her first year at the Board of Governors today. Prior to her appointment to the Fed by President Barack Obama, Raskin was Maryland’s Commissioner of Financial Regulation.

--Editors: Gail DeGeorge, Vince Golle

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Tim Homan in Columbia, Maryland at thoman@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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