Toxic Mortgages

Tuesday, 03 March 2009 00:00

Financial Crisis: "Silver Bullets" for Toxic Mortgages?

The Obama Administration is floating a proposal that would allow the government to directly buy more loans from servicers of mortgage-backed securities

By David Bogoslaw

With the financial crisis quickly becoming President Obama's primary burden, his Administration has intensified its efforts to stem the rising tide of foreclosures in order to solve the root cause of the difficulties. On Feb. 11, Treasury Secretary Timothy Geithner and Shaun Donovan, Secretary of the Housing & Urban Development Dept., met with community groups and key stakeholders in the banking industry to gauge support for a potential program that would allow the government to directly buy whole loans from servicers of mortgage-backed securities (MBS) in order to modify them—and keep more borrowers in their homes.

This is just one of several proposals the Obama Administration is considering as it comes to terms with the dire need to prevent further waves of foreclosures amid a deepening recession. There were foreclosure filings on 274,399 U.S. properties in January, down 10% from December but 18% higher than a year ago, according to RealtyTrac, a foreclosure research firm. In December, the Mortgage Bankers Assn. said that a record 1 in 10 U.S. families with a mortgage are either in arrears or having their house repossessed.

Banks and other mortgage servicers have being doing loan modifications under an Federal Deposit Insurance Corp. program since the first quarter of 2008, but many have failed to benefit from a cookie-cutter approach that's paid insufficient attention to the financial condition of individual homeowners. And these "mods" haven't addressed the need for a wholesale cleaning out of some of the most toxic loans, those collected in securitized pools and sold piecemeal to vast numbers of investors. The problem is that there is no flexibility to modify the terms of individual mortgages in most of the Pooling and Servicing Agreements, or PSAs, that govern these mortgage pools.

Employment is Key

At the Feb. 11 meeting with Geithner and Donovan, John Taylor, president and chief executive of National Community Reinvestment Coalition (NCRC), made the case for loan modifications on a large scale through the Homeowners Emergency Loan Program. This would allow the Treasury to buy distressed loans at big discounts, essentially equivalent to current market value, from the securitized pools. The government would only buy loans of borrowers who still have jobs, but the loans wouldn't necessarily have to be delinquent. For example, they could be loans whose monthly payments are eating up more that 50% of a homeowner's monthly income and therefore are at risk of future default.

"That creates the leeway for the government to buy these without any subsidies," says Taylor. That wouldn't even require much taxpayer money from the Troubled Assets Relief Program (TARP) if the government could turn around and sell the loans to banks that have received TARP funds, such as Wells Fargo (WFC) and Citigroup (C).

Citigroup declined to comment on whether it would be willing to buy loans from the government and modify and service them. The bank, along with JPMorgan Chase, did formally announce on Feb. 13 a moratorium on foreclosures through Mar. 12 in order to allow time for the Obama Administration to develop a plan to provide relief to struggling homeowners. Those plans are expected to be released by the end of February. Wells Fargo and Bank of America (BAC), didn't respond in time for this story to be filed.

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