Bloomberg View: Vulture Funds for the Mortgage Market; a Soft-Touch SEC

Vultures for the Mortgage Market ● Repeat Offenders at the SEC

How to Fix the Mortgage Crisis? Let Markets Run Free

Nearly 11 million households owe more on their mortgages than their houses are worth. Foreclosures continue to pile up as banks take years to repossess and sell homes. Those who don’t want to walk away find themselves in a sort of debtor’s jail. They can’t sell, they can’t move for a new job, and they can’t borrow money to start a business.

If the market were working properly, millions of homeowners would have received debt relief a long time ago. That’s because it’s in the interest of creditors, who can gain by averting foreclosure. Consider a delinquent $100,000 loan on a house that is now worth $60,000. After taking possession of the house and selling it, a lender typically might recover less than $35,000, according to Amherst Securities Group, an investment firm based in Austin, Tex. By contrast, a 50 percent writedown of the principal balance could make the loan affordable and give the borrower some equity. In that case, the lender has a performing asset worth $50,000—a $15,000 difference.

So why isn’t this happening? The main reason is structural. Most loans are packaged into securities and sold to a diffuse group of investors who entrust the job of handling modifications to specialized companies called servicers. But the servicers lack the staff and expertise to do writedowns, and don’t want to risk getting sued by investors who might feel shortchanged. They also happen to make their money by charging fees, which would shrink if they reduced the value of the debts they handled.

Thankfully, the market has a solution. So-called distressed-asset investors, otherwise known as vulture funds, are ready to swoop in and buy delinquent loans for, say, 40¢ on the dollar. They would then put in the effort needed to boost the value by either negotiating principal reductions with the borrowers or fixing up and selling empty homes. Major investment companies, such as Invesco and its subsidiary WL Ross, are committing their own and their clients’ money to the business.

The challenge is getting the servicers—as well as mortgage finance companies Fannie Mae and Freddie Mac, which hold roughly $180 billion in seriously delinquent loans—to sell their inventory to the vultures. There are some things the Obama Administration could do to clear a path for these sales. First, encourage Fannie Mae and Freddie Mac, operating under a federal conservatorship, to build on a pilot program under which the Federal Housing Administration has auctioned nearly $500 million in delinquent mortgages. Remind their overseer, the Federal Housing Finance Agency, that more money now is a better deal for taxpayers than less money later.

The Administration can also give legal cover to servicers who sell loans. Minor changes in existing rules for servicers under the government’s Home Affordable Modification Program could do the trick, according to a paper co-authored by James B. Lockhart, former head of the FHFA and currently vice-chairman at WL Ross (which, of course, could stand to benefit from the changes).

Another important step is allowing servicers to sell loans that have been packaged into securities. Many trusts that hold the loans prohibit this. The government can offer to pay the legal costs of trustees and servicers who agree to change the rules. Lockhart and his co-authors estimate the cost of such a program to be in the tens of millions of dollars—a negligible amount given the potential benefit.

Finally, the Administration should encourage the mortgage trusts to let servicers charge a small sales commission. This incentive could help offset whatever conflicts the servicers might face, such as loss of fees.

Vultures play a vital role in the natural world. They make the best possible use of what others won’t touch. With some small changes, the government and the private sector could allow them to do the same for the housing market and the economy.

The SEC Gets Suckered Again

The proper legal response to the $285 million fraud settlement Citigroup reached on Oct. 19 with the Securities and Exchange Commission is: You’ve got to be kidding.

The case involves the creation and sale of one of the more toxic versions of an investment whose structure almost defies explanation—a $1 billion synthetic collateralized debt obligation that was based on other collateralized securities that were in turn tied to subprime residential mortgages. The CDO was put together by Citigroup’s broker-dealer unit in early 2007, just as the housing market started to slump. It wasn’t meant to make money for the buyers; it was designed to blow up, the SEC says. Before the year was out, the CDO was in default. Investors eventually lost almost everything.

For Citigroup, the CDO worked out well. The SEC lawsuit says the bank bet against the CDO and made a $160 million profit. The nonprofit organization Better Markets, which has asked Federal Judge Jed S. Rakoff to oppose the settlement, estimates Citigroup’s profit at $600 million to $700 million. As in most SEC deals with companies in securities fraud litigation, Citigroup will be allowed to say it neither admits nor denies wrongdoing.

The settlement wouldn’t be so troubling if this were Citi’s first offense. But since 2003 the SEC has accused Citi’s broker-dealer arm of securities fraud five times. Each time, Citigroup settled the SEC’s accusation without admitting or denying wrongdoing, paid fines, and promised not to break the law again.

The SEC is a long way from reclaiming its role as a sensible industry watchdog. Renegotiating the Citigroup settlement would set it on course to redeem its enforcement bona fides.


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