What's Holding Back Mortgage Modification?
One supposed obstacle to sorting out the millions of mortgages that have gone bad is that the home loans have been bought by investment banks, bundled together into bonds, and sold to investors. This widespread process of "securitizing" loans makes it difficult to go back and modify the terms of individual mortgages so that strapped borrowers might be able to continue to make payments, according to mortgage industry experts. In particular, this argument goes, the middlemen known as mortgage servicers, who administer home loans, are contractually prohibited from adjusting interest rates or balances, without risking a wave of lawsuits filed by purchasers of mortgage-backed securities.
But this problem has been vastly overstated, say some industry lobbyists and government officials. "One of the biggest lies out there is that servicers can't take action. They certainly can," says Mike Krimminger, special policy adviser to FDIC Chairman Sheila M. Bair.
Foreclosure Is Cheaper
During the mortgage boom, $7 trillion worth of home loans, including hundreds of billions of dollars worth of subprime mortgages, were packaged and sold to investors in the form of bonds. According to an analysis by foreclosure research firm RealtyTrac, about half of all subprime loans that have entered foreclosure were securitized and sold to investors. In normal times, mortgage servicers, which include giant lenders such as Countrywide and specialty firms such as Litton Loan Servicing, a unit of Goldman Sachs (GS), have a simple and lucrative job: collect payment from borrowers, administer escrow accounts, and forward funds to investors.
But as mortgage defaults have surged in the past two years, these caretakers are under pressure to do more to stop the bleeding by modifying loan terms. Many have balked or dragged their feet, say industry experts, hoping the housing market will rebound. One reason is that servicers earn more, under most current contracts, when they foreclose, compared with when they modify a loan. Adding staff and technology to manage modifications is costly. That's one reason the Obama Administration says it plans to increase incentives for loan managers to modify mortgages in its new bailout programs, expected to be detailed in the next few weeks.
"The cost-benefit calculation of the servicers has been very lopsided" in favor of foreclosures, says Alan S. Blinder, a professor of economics and public policy at Princeton University.
Few Contracts Bar Modification
Contract prohibitions are another argument used by servicers to explain why more can't be done. The claim, however, may be exaggerated. Securitization experts say the vast majority of securitized mortgage contracts, known as pooling and servicing agreements, have few or no provisions preventing changes to loans' terms. In more than 85% of these agreements, "there are no meaningful restrictions on a servicers' ability to modify," says Tom Deutsch, deputy executive director of the American Securitization Forum, a New York-based unit of the Securities Industry & Financial Management Assn., which represents servicers and investors. "Most [mortgage-backed] securities contracts expressly permit or do not prohibit loan modifications."
Intransigence may be driven more by the fear of litigation than explicit contractual obligations. It's not completely unwarranted. In December, investment fund Greenwich Financial sued Countrywide over terms of an October settlement with 11 state attorneys general. The agreement requires Countrywide to modify the terms of certain subprime loans. Greenwich claims that language in 374 Countrywide mortgage trusts created between 2005 and 2007 require Countrywide either to foreclose on defaulted mortgages or to buy them back at face value before they are modified. "Those are Countrywide's only options," says William Frey, chief executive of Greenwich Financial.
Bank of America (BAC), which acquired Countrywide in July 2008, has not filed a response to the lawsuit. In a December statement, Bank of America noted that loan modifications have been "occurring for decades without objections or challenges, so we are especially troubled at the timing of this complaint. No one benefits if we allow these homeowners to advance toward ultimate foreclosure. We are confident any attempt to stop this program will be legally unsupportable." A motion to move the case from New York Supreme Court in Manhattan to federal court in New York is pending.
Rewriting Loans Stems Foreclosures
Despite the fear of lawsuits, some mortgage middlemen are now stepping up efforts to accelerate modification of securitized loans. At Litton Loan Servicing, which handles about $70 billion worth of mortgages, nearly one-third of troubled loan modifications in November involved a reduction in the principal balance, a step that many servicers—and major lenders—have been reluctant to take because it is often the most costly to investors compared to interest-rate freezes and extending a loan's term. Litton says its analysis shows principal reductions led to a 50% decrease in borrowers who redefault on their mortgages, according to recent reports. Litton has declined several requests for an interview from BusinessWeek.
Legislation pending in Congress would offer servicers protection from lawsuits, known as safe harbor. A Feb. 6 letter reviewed by BusinessWeek from the American Bankers Assn. to James B. Lockhart III, director of the Federal Housing Finance Administration, which oversees mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), says the banking trade group's members plan to redouble efforts to modify securitized loans—and help negotiate with investors on behalf of servicers worried about legal liability. "This letter is going to be held up in part as a plea to investors to recognize this industry (loan modification) practice as a benefit to the overall economy," says Robert Davis, executive vice-president of the trade group. He says the ABA wants mortgage servicers to interpret contract language "liberally."
With Jane Sasseen, BusinessWeek's Washington bureau chief, and Robert Berner, a senior writer based in Chicago