The biggest money managers are asking Congress to fix a largely frozen part of the U.S. mortgage-bond market with a step that would echo moves taken during the Great Depression.
The Association of Institutional Investors, whose members include Pacific Investment Management Co., Fidelity Investments and Schroders Plc, asked lawmakers in a letter today to create an “unambiguous fiduciary standard” for trustees of mortgage bonds without government backing as a Senate committee considers a bill that would overhaul the $9.4 trillion home-loan market by replacing U.S.-controlled Fannie Mae and Freddie Mac.
The money managers are pushing for Congress to step in as they did with the corporate-bond market in 1939, when the Trust Indenture Act created new duties and responsibilities for debt administrators in order to protect investors and give them the confidence to extend credit following evidence of misdeeds after the stock market crash of 1929. Pimco, Schroders and BlackRock Inc. are among asset managers that want something similar for mortgage securities that suffered about $450 billion of losses through 2012.
“You have representatives of trillions of dollars of capital refusing to buy new private-label residential mortgage-backed securities because this problem of no one looking out for investors’ interest isn’t solved,” Chris Ames, a senior portfolio manager at Schroder Investment Management North America Inc., part of a global asset manager that oversees about $435 billion, said in a telephone interview. “The time to fix this is now.”
Mortgage-bond investors are seeking the shift after finding they needed to band together to push trustees such as Bank of New York Mellon Corp. into action to receive compensation from banks for loans that were riskier than promised and to create changes to allegedly poor management of the debt by servicers.
“Promises are made to investors when these securitizations are created, and nobody” party to the transactions “has been acting to identify if those promises were kept, and if they weren’t kept, to enforce the contractual remedies,” Kent Smith, an executive vice president of portfolio management at Pimco, which oversees the world’s largest bond fund, said in a telephone interview.
The trustees’ roles include collecting cash and data from mortgage servicers and passing them to investors. They’re also the only parties tasked with taking action for the deals, such as filing lawsuits. They generally perform “only ministerial duties” that are “commensurate with the minimal fees paid,” according to a letter to lawmakers this month from the American Bankers Association.
While the ABA opposes a fiduciary role, Schroders has supported lobbying for it by the Association of Institutional Investors, whose members oversee more than $10 trillion in mutual funds, pensions and other accounts, Ames said. Two amendments to the Fannie Mae-Freddie Mac bill set to be considered by Senate’s banking panel as soon as tomorrow creating the adjustment were prepared by Senator Sherrod Brown.
“This is a win-win proposal,” the Ohio Democrat said in an e-mail. “If mortgage servicers and trustees have a stake in preventing defaults, more Americans will stay in their homes rather than face abuses while trying to modify their mortgages or avoid foreclosure. Meanwhile, investors like pension funds will be protected and we can attract more private capital back.”
Events during the Great Depression also pushed lawmakers to look for ways to restore confidence, according to Charles Geisst’s “Wall Street: A History.”
One spark: After the corporate empire of Ivan Kreuger collapsed, U.S. investors were rocked by the debt of one of his firms turning out to be backed by virtually worthless Yugolsav government bonds, not the French notes that were its initial collateral. That the debt’s trustee quietly allowed the substitution by the Swedish financier, engineer and industrialist known as the Match King was among the failures by such bond administrators that convinced Congress to pass the 1939 law, according to Geisst’s book.
Mortgage-bond transactions have been typically perceived to be exempted from the Trust Indenture Act, though plaintiffs including the Policemen’s Annuity and Benefit Fund of the City of Chicago have challenged that view in court, according to a report by law firm Arnold & Porter LLP.
Michael Stegman, the Treasury Department’s senior housing specialist, has been asking investors, issuers and others to come together to address “the lack of trust” that’s brought sales of mortgage securities that aren’t U.S.-backed to a “virtual standstill,” he said at an event in New York in March. The push by bond buyers signals they see a need for action in Washington.
“We encourage policy makers to reinforce trustee obligations by explicitly defining their role as fiduciaries,” Tara McDonnell, a spokeswoman for BlackRock, the world’s largest money manager, said in an e-mail.
Brown’s amendments, which would apply to privately issued securities, would help taxpayers shrink their role in the market and restrain borrowing costs amid the retreat, the Association of Institutional Investors said in the letter to the Senate banking committee’s members and signed by Loomis Sayles & Co. executive John R. Gidman, the group’s president. BlackRock isn’t a member.
Without reforms, the bonds “would have to be incredibly cheap, which means that the rates to borrowers would have to be incredibly high, to generate the yield required for us to participate in the market,” Pimco’s Smith said.
The American Bankers Association “strongly opposes” the effort, James Ballentine, an executive vice president at the group, wrote in an April 17 letter to the Senate Banking Committee members. The issues vexing investors were created by the “woefully inadequate” legal language in mortgage-bond contracts, which will be improved by new rules that the Securities and Exchange Commission has proposed, he said.
“If corporate trustees were subject to a fiduciary duty and the attendant level of liability, they would have to demand a significant increase in their fees, which would ultimately be borne by investors and homeowners,” he said.
The market would be healthier if mortgage-bond buyers had an advocate that could ensure servicers aren’t doing things like hiring affiliated companies to mow the lawns of foreclosed homes at inflated prices, Ames said.
A fiduciary duty for trustees is also needed to protect investors from government accords with banks and loan servicers that allow the firms to meet their legal obligations by writing down mortgages owned by investors, rather than their own loans, he said.
“The trusts are getting raided, and there’s nobody guarding the hen house,” Pimco’s Smith said. “There hasn’t been a meaningful year of issuance since 2007, and without this, I don’t see a year of meaningful issuance in our future.”
Sales of non-agency securities tied to new home loans totaled $13.4 billion last year and just $1.3 billion so far this year, after peaking at $1.2 trillion in both 2005 and 2006, according to data compiled by Bloomberg. That’s also partly because bond investors are being crowded out by government-backed programs and banks seeking to hold loans as investments.