The Obama Administration is floating a proposal that would allow the government to directly buy more loans from servicers of mortgage-backed securities
With the financial crisis quickly becoming President Obama's primary burden, his Administration has intensified its efforts to stem the rising tide of foreclosures in order to solve the root cause of the difficulties. On Feb. 11, Treasury Secretary Timothy Geithner and Shaun Donovan, Secretary of the Housing & Urban Development Dept., met with community groups and key stakeholders in the banking industry to gauge support for a potential program that would allow the government to directly buy whole loans from servicers of mortgage-backed securities (MBS) in order to modify them—and keep more borrowers in their homes.
This is just one of several proposals the Obama Administration is considering as it comes to terms with the dire need to prevent further waves of foreclosures amid a deepening recession. There were foreclosure filings on 274,399 U.S. properties in January, down 10% from December but 18% higher than a year ago, according to RealtyTrac, a foreclosure research firm. In December, the Mortgage Bankers Assn. said that a record 1 in 10 U.S. families with a mortgage are either in arrears or having their house repossessed.
Banks and other mortgage servicers have being doing loan modifications under an Federal Deposit Insurance Corp. program since the first quarter of 2008, but many have failed to benefit from a cookie-cutter approach that's paid insufficient attention to the financial condition of individual homeowners. And these "mods" haven't addressed the need for a wholesale cleaning out of some of the most toxic loans, those collected in securitized pools and sold piecemeal to vast numbers of investors. The problem is that there is no flexibility to modify the terms of individual mortgages in most of the Pooling and Servicing Agreements, or PSAs, that govern these mortgage pools.
Employment is Key
At the Feb. 11 meeting with Geithner and Donovan, John Taylor, president and chief executive of National Community Reinvestment Coalition (NCRC), made the case for loan modifications on a large scale through the Homeowners Emergency Loan Program. This would allow the Treasury to buy distressed loans at big discounts, essentially equivalent to current market value, from the securitized pools. The government would only buy loans of borrowers who still have jobs, but the loans wouldn't necessarily have to be delinquent. For example, they could be loans whose monthly payments are eating up more that 50% of a homeowner's monthly income and therefore are at risk of future default.
"That creates the leeway for the government to buy these without any subsidies," says Taylor. That wouldn't even require much taxpayer money from the Troubled Assets Relief Program (TARP) if the government could turn around and sell the loans to banks that have received TARP funds, such as Wells Fargo (WFC) and Citigroup (C).
Citigroup declined to comment on whether it would be willing to buy loans from the government and modify and service them. The bank, along with JPMorgan Chase, did formally announce on Feb. 13 a moratorium on foreclosures through Mar. 12 in order to allow time for the Obama Administration to develop a plan to provide relief to struggling homeowners. Those plans are expected to be released by the end of February. Wells Fargo and Bank of America (BAC), didn't respond in time for this story to be filed.
Looking to Fannie and Freddie
Banks which end up buying the loans from the government would refinance them and either keep them in their own portfolios, or sell them to Fannie Mae and Freddie Mac to be re-securitized, Taylor adds. "Fannie and Freddie could show the investment community the way back home to trust mortgage-backed securities again," says Taylor. "When we can show that the American system of finance has returned to some responsible, ethical practices, I think the market will follow."
Mortgage loan servicers such as Selene Finance and Ocwen Financial (OCN) agree that the only real solution to the mortgage mess—and, by extension, the entire financial crisis—is to remove toxic loans from the pools and allow banks and other servicers to do modifications in line with what the homeowners can afford.
Not so fast, say MBS investors such as William Frey, chief executive of Greenwich Financial. Greenwich filed a lawsuit in December against Bank of America in New York State Supreme Court, charging that the proposed modification of roughly 400,000 loans originated by Countrywide Financial, which BofA acquired in July 2008, was illegal. Frey says he can afford to pursue the lawsuit only if the court approves all 374 trust contracts —the instruments through which investors hold MBS—as a class action. He has said that any loans the government wants to modify that are trapped in securitizations will have to be bought at par, even though that's not equitable given the much lower fair market values of many loans. Otherwise, it will take a long time for investors to trust mortgage contracts again.
Hard to Track Down MBS Investors
Taylor at NCRC and others argue that even at 70¢ on the dollar, the investors in securitized mortgage trusts would be getting more for these loans than the 50¢ and less on the dollar at which some recent sales have been done. But Frey counters that because losses are allocated to the bottom classes of investors when the loss is finalized after the sale of the loans, the sooner losses are determined, the sooner the lower rungs of investors stop getting paid. "This whole morass is actually working to the benefit of some classes. If [servicers] were to expedite the losses, they'd expedite crystallization of losses," he says. Then servicers would run a greater risk of being sued by those investors, he adds.
Safe harbor legislation that would protect servicers from lawsuits came up in hearings on the Hope for Homeowners bill that was being marked up in the House Financial Services Committee in early February, says Allan Krinsman, a partner at law firm Stroock & Stroock. "[Committee chairman Representative] Barney Frank (D-Mass.) understands this issue and has indicated he's willing to give servicers relief. Now it's about convincing the rest of the committee to put it into the legislation," he says.
It's not that easy to track down individual MBS investors, many of whom hold shares in these securities through their brokerage accounts, in a timely manner, according to Gary Silverstein, a partner in the tax department at Cadwalader Wickersham & Taft LLP. And while some investors may be willing to approve the sales, "there could be some investors who will withhold their consent to renegotiate a better deal or just out of spite perhaps," he says.
Financial Accounting Modifications Necessary
Karen Bellezza, who heads Selene Finance, which has been modifying non-securitized home loans since 2007, says the talk in the industry is that trustees aren't reaching out to investors to get their consent for loan mods, partly because they don't even know who to contact. She says she's convinced that removing these loans from the securitized pools is the only way to get control over them.
Paul Koches, general counsel at Ocwen Financial, believes the key to allowing the government to buy whole loans from the trusts that hold them before they default lies in amending Financial Accounting Standard 140 (FAS 140), which doesn't permit the outright sale of loans pre-foreclosure out of those trusts. "If that could be re-characterized as a loan servicer activity, it would arguably pass muster under FAS 140 and satisfy the purchase of whole loans" before they default, he says. He thinks that clear guidance on that point "would be a silver bullet" to start the cleanup of the financial crisis.
Making that all the more important is data from the Federal Housing Finance Administration (FHFA) showing that although just 16% of the 55 million outstanding mortgages in this country are in private label securitized trusts, those mortgages account for about 62% of the delinquencies, adds Koches.
Motivated to Get the Market Running
Not every single securitization will demand investor consent, but even the ones that don't may require a nod from ratings agencies, which might not be able to act fast enough to approve any amendments to documentation governing the securitized pools of mortgages, says Silverstein at Cadwalader.
The American Securitization Forum, a unit of the Securities Industry & Financial Management Assn. that represents MBS servicers and investors, has publicly supported the idea of government purchases of loans from private-label securities since November 2008.
Given that most people in the securitization industry are suffering, they're as motivated as anyone else to get the market running again, says Silverstein at Cadwalader. But they're resistant to aggressive proposals, such as one that didn't make it into the stimulus bill, that threaten to rescind tax-free status from any trusts that fail to agree to any changes the government may ultimately require, he adds.
Other Avenues of Relief
There are other proposed plans by the Treasury and the Federal Reserve in the offing that are intended to provide relief to struggling homeowners, including subsidies for mortgage payments. "We need a concrete program with some real rules and structure around it so the industry can move on," says Bellezza at Selene.