Sept. 18 (Bloomberg) -- BlackRock Inc. Chairman Laurence Fink said Obama administration programs to help homeowners stave off foreclosure may hinder the recovery of the mortgage market while benefiting banks that own second loans on the properties.

“I am just very worried,” Fink said yesterday in an interview in New York. “How do we get a vibrant securitization market back when we are doing these things in the short run that are good for the banking system and good for the homeowner but not as good as it should be?”

Fink said policies introduced this year to reduce foreclosures are flawed because they don’t require home-equity loans to be wiped out before the mortgage is modified. Instead, in a break with the intentions of contracts, the second loan’s terms may also be revised, spreading the financial loss among lenders, he said.

At stake is the recovery in the market for securities created from individual loans, including the almost $1.7 trillion in residential-mortgage bonds not backed by the U.S., according to Fink. Federal Reserve Chairman Ben S. Bernanke said in April the securitization market was “until recently” an important source of credit for the U.S. economy.

“This to me is one of the biggest issues facing American capitalism,” Fink said. “There is modification going on protecting our banks, protecting their balance sheets.” With the right types of changes, he added, “the homeowner is better off, America is better off, and you could say the first lien holder is better off.”

Prominent Voice

Fink, who as a First Boston Corp. executive in the 1980s helped create securities known as collateralized-mortgage obligations, will lead the world’s biggest money manager when BlackRock completes its acquisition of Barclays Global Investors later this year. The New York-based company, which will oversee about $3 trillion, has emerged as a top adviser on distressed securities to governments and financial institutions since the credit crisis started in 2007.

Fink, who also serves as BlackRock’s chief executive officer, is the highest-profile investor to call attention to potential conflicts when banks that service mortgages handle loan modifications. One concern is that many servicers, which handle billing and collection for mortgage owners, also hold home-equity loans that would lose all value in a foreclosure.

JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc., the four largest servicers, own almost $450 billion of home-equity loans, according to Laurie Goodman, an analyst at Amherst Securities Group in New York.

‘Profound Implications’

“I am glad that a firm such as BlackRock believes these conflicts are serious and the lack of resolution has profound implications on the financial markets and our country,” Bill Frey, head of Greenwich Financial Services LLC, a mortgage-bond broker and investor in Greenwich, Connecticut, said in an interview yesterday. “We have been working with a number of very large financial institutions and many hold the view.”

Frey is suing Bank of America over modifications the bank agreed to make to settle charges of fraudulent lending by state attorneys general against Countrywide Financial Corp., which it bought last year. He said the investors he is working with want “to devise strategies to enforce their contractual rights.” He declined to identify the firms or their potential tactics.

President Barack Obama’s $75 billion Making Home Affordable plan provides taxpayer subsidies to encourage loan servicers to rework borrowers’ first mortgages to cut their monthly payments to 31 percent of their incomes. Provisions for second mortgages weren’t immediately released.

Obama later signed a law giving servicers safe harbor from investor lawsuits when they modify debt using the program.

Treasury Department Reacts

The Treasury Department, responding to complaints from investors, said in April that when first mortgages are modified, participating banks with second liens would also have to revise terms. A department official said in July it hadn’t completed contracts with such requirements, and some banks said they might not sign them.

Meg Reilly, a Treasury spokeswoman, declined to comment. Officials at New York-based JPMorgan, Wells Fargo in San Francisco, and Citigroup in New York either didn’t immediately comment or return messages.

“Bank of America is committed to helping homeowners who need a modification, whether it is a first mortgage or home- equity loan,” Terry H. Francisco, a spokesman for the Charlotte, North Carolina-based company, said in an e-mail. “We believe the soon-to-be-unveiled second lien MHA program will help provide the structure necessary to accomplish more second lien modifications on a uniform basis.”

Bond Investors’ View

Bond investors would prefer that more homeowners had loan balances reduced rather than payment terms eased, Curtis Glovier, a managing director at New York-based Fortress Investment Group LLC, told Congress in July. Such aid for consumers whose debt is greater than the value of their homes is being blocked because other loan changes allow second mortgages to be kept “on the books of the financial institution as a performing asset,” he said.

Fink co-founded BlackRock as a bond manager in a one-room Manhattan office in 1988. He supported Obama’s presidential election.

Role of Securitization

Bernanke has been working to revive securitization. The Fed’s Term Asset-Backed Securities Loan Facility, a program under which the central bank lends to buyers of asset-backed debt, “has shown early success in reducing risk spreads and stimulating securitization activity,” he said on Aug. 21.

The program has helped create demand this year for $124 billion of new securities backed by debt such as automobile leases, credit cards and small-equipment loans. No private securities have been created out of new commercial or residential mortgages since early 2008.

A record $1.2 trillion of home-loan bonds not guaranteed by government-supported Fannie Mae and Freddie Mac, or U.S. agency Ginnie Mae, was issued in 2005 and 2006. Sales of commercial mortgage-backed securities peaked in 2007 at $237 billion.

The dispute over loan modifications echoes complaints by institutional investors that Obama’s handling of Chrysler LLC’s bankruptcy benefited unsecured creditors including unionized workers at the expense of secured lenders.

“If you really want to protect the homeowner, wipe out the second lien, modify the first lien,” Fink said.

To contact the reporter on this story: Sree Vidya Bhaktavatsalam in Boston at sbhaktavatsa@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: September 18, 2009 08:24 EDT