Consumer Law

It?s all about the Mortgages

By Alan White

By Alan White

Secretary Paulson is trying to solve the freeze-up of the credit markets by buying up the mortgage-backed securities (MBS) that banks are holding and cannot value. Because nobody seems to know whether MBS are worth 10 cents or 90 cents on the dollar, and because every bank, insurance company and brokerage firm owns MBS, nobody is willing to lend to anyone else, lest they turn out to be another Lehman Brothers, leaving their lenders, even overnight money market lenders, with nothing.

Mr. Paulson, in his Sunday morning talk show appearances, brushed aside questions about dealing with foreclosures. Clearly, he feels that the value of MBS is somehow predetermined, although for some reason we cannot ascertain what it is. The point being missed is that the value of MBS has not been established by the Fates. It all depends on the mortgage servicers. The underlying mortgages will take ten years or more to be resolved. They will resolve either into repayment by homeowners or foreclosures and sales of homes. The foreclosure sale route, right now, is producing about 60 cents on the dollar. The percentage recovery from homeowners given a second chance to repay is varying hugely, depending on which mortgage servicer they happen to be working with.

In the monthly subprime mortgage remittance reports I am looking at, actual realized losses to date are not high, usually around 3% to 5%. These are pools in which rating agencies are projecting losses of 25%. The future losses to MBS investors are represented by mortgages that are behind in payments, anywhere from 30 days to a year or more, mortgages that are in foreclosure, and homes already foreclosed, but not resold yet (REO). This pipeline of past and future foreclosures is what Secretary Paulson wants to buy. The losses that come out of this pipeline are entirely contingent on the servicers? success in getting delinquent homeowners to ?reperform.? Even REO can be made to reperform, if the former owner can restructure the loan balance in such a way that she can repay it.

In the gap between the 3% realized losses and the 25% expected losses in subprime mortgages lies the servicers? power of loss mitigation. A few servicers (and now the FDIC, conservator for IndyMac) are aggressively modifying mortgages and working out delinquent loans, and bringing down delinquencies in the process. Others are opting for foreclosure in almost every case. There is no standard procedure, and there are no standard or predetermined results. If we the taxpayers buy MBS, whether we make or lose money in the end will depend on how well the servicers succeed in getting mortgages to reperform.

Right now, servicers have little incentive to restructure mortgages, and every incentive to foreclose, even at 40% losses. They are clearly not behaving in a way that would maximize MBS returns. No investors are paying servicers to modify mortgages or rewarding them for reperformance success. Indeed, investors see writedowns from mortgage modifications in this month?s report, but won?t see this month?s foreclosure losses in monthly reports until many more months go by, while the houses sit in REO.

As the new mega-investors, we the taxpayers can change this dynamic. Treasury, the Fannie/Freddie conservator and the Fed can offer mortgage servicers incentive payments, based on new metrics that look at success in getting mortgages to reperform. Servicers must include in their monthly reports the on-time and delinquency status of modified mortgages, and should be rewarded if they achieve above-par results. Foreclosure sales and losses will continue, for abandoned and investor-owned homes and homes that families cannot afford under any restructuring plan. The realized losses on those sales will provide a benchmark against which to measure recoveries on restructured loans to families who can pay something, even if it is only 80% or 90% of the original loan.

Linking the taxpayer purchase of MBS with getting mortgage servicers to do a better job offering foreclosure alternatives is not just soft-hearted liberal fluff, it is hard-headed business savvy. Treasury?s number one job, one it may not yet understand, is to change mortgage servicer behavior.

Full post as published by CL&P Blog on September 21, 2008 (boomark / email).