Bankruptcy

Don?t Let Servicers Be Mortgage Relief Gatekeepers (Again)

By Jean Braucher

It is not the case that a new program, or the existing HAMP, has to be put in place by servicers.  In the context of HAMP, it has been suggested that the government should approve modifications directly.  See  Wall St. J. here (discussing the idea that HAMP would have worked better if the government had dealt directly with applicants and decided which ones qualified).  Servicers could be left to distribute payments on modified (or refinanced) loans, but they should not be the gatekeepers.   We don?t want them deciding whether to approve new loans under which they would lose existing favorable contract rights.  We?ve been there.  It doesn?t work.

Second, Mayer?s comment clarifies that the program he and Hubbard have in mind would only be for government-guaranteed mortgages, those generated by the government sponsored entities (GSEs), such as Fannie and Freddie.  These mortgages are already guaranteed by taxpayers as a result of government action at the height of the mortgage crisis.  The Hubbard-Mayer idea is to convert existing government-backed mortgages at higher interest rates into government-backed mortgages at lower interest rates, using refinancings and mortgage-backed securities as the means.  Since defaults presumably would be reduced on lower-interest loans with lower monthly payments, there might even be some reduction in defaults that the government would have to cover.

It should be noted that HAMP has some degree of functional equivalence with this proposal, albeit with some important differences.  HAMP involves modifications by investors; the Hubbard-Mayer proposal involves third parties buying out the current investors.  HAMP writes interest rates down to as low as 2%, with rates going up to prevailing rates starting in year five; Hubbard and Mayer envision prevailing  interest rates from the outset, so the interest rate breaks are not as good (so perhaps with this, we could kiss HAMP goodbye, not working anyway).   HAMP requires financial hardship; Hubbard and Mayer would give mortgage relief even to those with ability to pay under their current loans, with a stimulus purpose in mind.

The Hubbard-Mayer plan would leave out those not part of the GSE share of the mortgage market.  As far as new mortgages being generated now, most are in the GSE share, but going back a few years (and these are the mortgages now most likely to be underwater and at risk of default), many were not part of the GSE share (the GSE share was 46 percent in the second quarter of 2007, for example?see here).  Still, some mortgage relief is better than none.   But note that borrowers who are under water and who would get refinancing under this plan would still be under water aftewards, so that they could not sell their homes and pay off their loans without a short sale or other workout, which at a minimum is time-consuming.  This plan works best for people rooted in one place and not so well for those who might need to move.  And of course there are labor market consequences to locking people into their homes.

How would the government subsidize these refinancings?  One way is in foregone interest on US Treasury holdings of GSE mortgaged backed securities (MBSs), over $185 billion as of May of this year.  The Federal Reserve also holds a lot of MBSs in its System Open Market Account (SOMA)?over $1 trillion as of Sept. 15, 2010.  See here.   (SOMA, of course, is a term Aldous Huxley coined.)

To the extent loans in MBSs are refinanced at lower rates, the government's holdings in these securities would no longer get the higher rates.  But maybe that?s a subsidy worth making for stimulus purposes.   Lower interest rates on refinanced mortgages would have positive tax consequences for the government, as mortgage interest deductions declined.  Whether there are any other elements of government subsidy or returns deeply embedded in the proposal is not entirely clear (at least to me).  It may be that investors in underwater mortgages (from the outset) would want quicker access to payoffs on government guarantees as part of the terms, increasing government costs on default.

But if the economic gurus think this could work, my one clear plea is based on legal and empirical knowledge:  Keep servicers out of a gatekeeping role!  They will bury alive the best of plans.

Full post as published by Credit Slips on September 21, 2010 (boomark / email).