Part Three: More Glitches in the Treasury Secretary's Mortgage Bailout Plan

Adjust text size

Article Tools

print this article

add bookmark

digg this

reddit

save to del.icio.us

Part Two - Who the Treasury Secretary's Mortgage Bailout Plan Doesn't Help

Unless the pace of foreclosures can be slowed, the housing market is going to get worse before it gets better. One of the methods floated to slow the pace is modifying loans of borrowers facing foreclosure.

But borrowers, mortgage brokers, regulators, attorneys and other foreclosure experts say the process of modifying these loans is badly broken.

"You've got this massive gridlock," said Ira Rheingold, executive director of the National Association of Consumer Advocates, which represents attorneys who act on behalf of homeowners facing foreclosure. "People sort of think they need to do something, but no one knows what to do. You've got all these different parties involved. How do you bring them all together?"

One problem is getting all the parties involved in the process on the same page.

The disconnect starts with borrowers who have fallen behind, or are about to, once their monthly payments jump.

Most of the mortgages written at the height of the lending boom were resold to other lenders or bundled in portfolios with hundreds of other loans, chopped up into securities and sold to investors. Now some borrowers don’t even know who owns their contract.

Once the mortgage holder is identified, borrowers face the task of getting through to the right person.

Some homeowners say they get conflicting information from different departments at the same lender. For example, the department devoted to modifying loans may not have received notice that the foreclosure process has begun.

Part of the problem stems from the sheer volume of loans going bad, an outcome that few lenders were prepared for. The fact that so many mortgages were pooled and sold to investors adds another level of complexity.

Modifying a mortgage loan is a complex task under the best of circumstances.

In many cases, the information in the original loan may be incomplete, especially in the case of "no documentation" loans that were popular with both lenders and borrowers at the height of the boom. Today, underwriting standards are much tighter, making many loans difficult to modify.

"If you switch from a non-verification of employment status, and income and asset status, where you're going to fully verify everything during this transition, you're going to see in excess of 50 to 60 percent of the notes in California go into the can, because they're not going be able to qualify under those new guidelines," said Michael Zoretich, a mortgage broker in Brookings, Ore.

Many state and federal officials have called on the lending industry to streamline the refinancing process.

One proposal that’s been floated would allow borrowers with adjustable loans who are current and able to pay the starter rate to convert to a fixed-rate loan at the initial rate. California recently won agreements from some lenders to adopt similar guidelines, but the agreements are voluntary.

Fixing those starter rates for the life of the loan would vastly simplify the process of modifying loans and, in many cases, would amount to refinancing homeowners into mortgages at current market rates. Estimates show about half of subprime loans written in 2006 have starter rates above 8 percent.

But it remains to be seen whether the investors who bought the bonds backed by these high-rate loans will agree to give up the return they expected. Though the loan servicers managing these portfolios have some discretion to make changes in individual loans, they have to show that any changes improve the overall performance of the portfolio. By cutting rates, and return, on too many mortgages, the loan servicer who agrees to new terms with borrowers risks the wrath of investors.

Last month, Federal Reserve Board Chairman Ben Bernanke told Congress' Joint Economic Committee that pushback from investors is another reason why lenders need to set up standard guidelines to modify mortgages in greater volume.

"By providing a systematic approach to addressing these mortgages, lenders actually protect themselves against claims by investors or others who feel that they are arbitrarily changing or modifying the loans," Bernanke said.

So far, those guidelines have been difficult to establish, in part because there are so many different types of loans and parties involved in servicing them.

For example, after an explosion of second mortgages during the lending boom, many borrowers facing default have more than one lender to contend with, and those lenders may have conflicting interests. A lender holding a first mortgage who wants to modify terms may face opposition from a holder of a second mortgage, who may be left with little equity to cover the loan.

With the industry unable to develop strategies for heading off bad loans as fast as they wrote them, some loan servicers have apparently focused on coping with the aftermath of bad loans rather than negotiating new terms to keep the homeowner current. As a result, some borrowers facing big payment increases say they're being told that there's nothing that can be done until the loan is in default.

These borrowers are being urged to miss their payment, and then negotiate a workout with the lender, because the lender is saying they don't have the authority to do anything until people start missing heir payments.

One proposal making its way through Congress could provide some relief.

Under current bankruptcy laws, a borrower can ask the court to work out a new payment schedule for all debts except a primary mortgage. If Congress changes the law, homeowners could declare bankruptcy and ask a judge to modify their loan terms. If the judge agrees, lenders would have to agree.

Consumer advocates say the change could speed up loan modifications without even getting the bankruptcy courts involved. Lenders would be forced to negotiate new terms, or suffer having a judge do it for them.

Investors have also been critical of Sheila Bair, chairman of the Federal Deposit Insurance Corp.

She has been urging mortgage servicing companies to agree to permanent conversions of adjustable-rate loans to fixed-rate loans. The change Bair envisions would apply only for borrowers who are current on mortgage payments but unable to afford loans that reset to higher rates.

Still, some on Wall Street are skeptical.

Richard X. Bove, an analyst with Punk, Ziegel & Co., called the plan "yet another idea to drive funds away from the markets," adding that "the concept of forcing banks to keep bad loans on their books violates every precept of regulation in American banking."

Critics say companies would face lawsuits if they permit modifications that are not in the best interest of investors. Supporters argue that investors would stand to benefit because they would avoid the cost of a foreclosure, estimated to be around $50,000 per loan.

However, less than a third of $1 trillion in outstanding subprime mortgages are likely to qualify for the plan, said Guy Cecala, publisher of Inside Mortgage Finance.

The economic benefits are at best uncertain for many mortgage investors, he added, even though he expects most players in the industry to participate, if only to avoid a tarnished reputation with the public. Publicly opposing the plan is "like criticizing apple pie."

And loan servicers, which collect and distribute payments to investors, are being asked to give extensions, which could range from two to seven years, for subprime mortgages due to reset at higher rates in the coming years.