As we have discussed, the traditional and still most attractive way to deal with troubled borrowers, including mortgage borrowers, is to ascertain whether it is more attractive to modify the terms of the loan or foreclose. Quite often if the borrower has reasonably steady income, a workout is a better solution.
However, in our Brave New World of securitized finance, mortgage servicers act as agents for investors, and very few of them are making “mods,” which has led to tooth gnashing of some regulators and some rather extreme proposals, such as Shiela Bair’s suggestion that loans with resets be frozen at their teaser rates (see here for why that isn’t such a hot idea).
As guest blogger John Rao at Credit Slips tells us, Bair’s quixotic salvo did produce an explanation from the industry as to why their hands are tied. In essence, there are no supervising adults:
Obviously frustrated by the slow pace of loan mods as shown by the Moody’s report (survey of 16 subprime loan servicers found that only 1 percent of loans subject to rate reset in first six months of 2007 had been modified), Chairwoman Bair stepped up her call for action in a speech earlier this month on October 4. For homeowners current with payments who have adjustable rate mortgages that have not yet reset, she called on servicers to convert the loans to a fixed rate. She said: “Keep it at the starter rate. Convert it into a fixed rate. Make it permanent. And get on with it.” Chairwoman Bair expressed concern that the process should not get bogged down by the need for individualized decision-making: “We can’t just sit here doing this kind of case-by-case, laborious restructuring process with all these millions of subprime hybrid” adjustable-rate mortgages.
A modest proposal you might say. Certainly not one that could solve the entire mortgage problem since many homeowners are defaulting on these loans even before the first rate reset. But it forced the servicing industry to come clean with proof of what we have long suspected. In a response to Chairwoman Bair, the Consumer Mortgage Coalition described a structure devoid of any warm bodies to make decisions. For private securitizations, the CMC complained that there is simply no active manager the servicer can call to get approval on a loan mod or a waiver of restrictions on mods typically found in the pooling and servicing agreements. “While this passive structure may appear to give the servicer more discretion, in fact, because of the lack of an active decision-maker from which the servicer could obtain waivers of the usual requirements, no entity exists with the authority to grant waivers,” the CMC said in its letter. “As a result, a servicer that violates the terms of the PSA faces potential legal action from the securitization trustee and even from the securities holders themselves.”
Curiously, despite this incredible admission that “no entity exists” to make a decision, the CMC nevertheless urged the FDIC to back off from its call for system-wide mods, stating that the loan-by-loan approach is preferable. That of course would seem to guarantee that loans mods will never be made.
Perhaps there is a way to reconcile the servicers’ desire for loan-by-loan mods with their problem of not having anyone to turn to for a decision. One solution is to give bankruptcy judges the authority to make decisions on individual loan modifications by eliminating the special protection for home mortgage creditors in the Bankruptcy Code.