Banking Law

Sheila Bair announced late last week that she doesn't think previous efforts by buyers of mortgage loans of failed banks from the FDIC are cutting the muster and she is considering having the FDIC require that they take loan modifications to the next level: substantial principal reductions.

?We?re looking now at whether we should provide some further loss sharing for principal write downs,? Bair said. ?Now you?re in a situation where even the good mortgages are going bad because people are losing their jobs. So you have other factors now driving mortgage distress.?

She's right on the money when she asserts that we're well into the time where job losses are causing people to default. That's precisely the reason that Dallas Morning News real estate columnist Steve Brown stated last Friday that all these mortgage modification efforts that people like Sheila have been pushing are a waste of time. Why? Because: "Its the economy, stupid."

The somber truth is that most people who can no longer afford to make their mortgage payments will lose their homes. And no amount of programs out of Washington will change that.

Indeed, so-called loan modifications or workouts are much less likely to succeed today than when we first heard about them a couple of years ago.

[...]

No amount of loan modification will keep someone in a house after he loses a job and burns through his savings. He needs a job, not a new mortgage plan.

Short of giving people their houses outright, there's nothing the mortgage company can do. Almost a quarter of Americans with loans now owe more than their houses are worth.

[...]

What happens ? as soon as early next year ? when the mortgage companies decide to bite the bullet and take back all of these houses?

What will happen to local residential values when a new wave of distressed houses hits the market?

Guess.

My feeling about Ms. Bair's proposal is that if Congress wants to require purchasers of failed bank home mortgages to write off mortgage principal and have the US government cover the acquirers? write-offs with appropriated tax dollars, then let Congress debate such a law and enact it if a majority of both houses agree. What Sheila Bair is doing is making insured banks foot these costs through their assessments, since it?s the banks who fund the FDIC and it?s the FDIC that will lose money by requiring and ?covering? those principal write-offs.

Ms. Bair does pay lip service to the notion that the FDIC must engage in such social justice engineering only if it stands to recover more (or pay out less) than it would by not engaging in such unprecedented practices.

The agency now is considering whether lenders that acquire banks should share a larger portion of the losses on loans whose principal is cut and whether the FDIC will recover the additional subsidy through reduced foreclosure rates.

?I think we?re going to gain by reducing re-default rates or delinquencies with people walking away,? Bair said. ?We?ll obviously lose by providing loss-share for principal writedowns.?

I doubt we'll ever have accurate analyses that show whether or not the FDIC recovers more from such practices that it would without them. It's all a matter of populist posturing to curry favor with powers in Congress and the Executive Branch who are setting the political agenda in D.C. these days. Therefore, don't bet against this proposal becoming a reality.

As someone who represents folks who buy failed bank assets from the FDIC, I can't say that those clients won't benefit.

?For the acquiring banks, it?s great because now they get more protection for the assets that they?re picking up and they have more flexibility in dealing with the problems,? John Douglas, who leads the bank regulatory practice at Davis Polk & Wardwell LLP in New York and is a former FDIC attorney, said in a telephone interview.

Unfortunately, if the FDIC doesn't end up ultimately recovering more than it would have without this increase in loss coverage, then the rest of the FDIC-inured commercial banking sector will take it on the chin.