Day: November 17, 2008

Mortgage Restructuring Is Not Enough

Let’s be honest with ourselves.  Even if the outgoing Bush team or the incoming Obama administration can work out a scalable nationwide mortgage restructuring scheme, we will still have a housing problem in the U.S..  Specifically, we should expect a high proportion of restructured mortgages to default again within a year.  In a piece that appeared on Bloomberg this morning, Alex Stricker and I suggest that a more centralized process is needed to manage the flow of foreclosed properties onto the market, and we discuss some alternative ways to implement this idea.

There may be better ways to do this and we are completely open to suggestions – please post as comments here.  We only insist that this is one dimension of U.S housing that needs further careful consideration.

Proposed Solutions to the Securitization Problem

We’ve gotten a number of questions about mortgage restructuring proposals, both in email and in comments. One reader asks: “How does one get around the securitization problem?  The Treasury seems to be able to change rules with the sweep of a wand lately, why not the REMIC [Real Estate Mortgage Investment Conduit] rules too?” Tom K also raises this issue in a comment.

I doubt that Treasury could unilaterally modify the rules governing the securitization trusts (in which a loan servicer manages a pool of loans on behalf of the many investors who own a share of that pool). Despite the ease with which Treasury seems to be flinging money around and the, um, liberties they seem to be taking with the terms of the TARP legislation, Treasury can’t really force anyone to do anything, legally. For example, Treasury has no authority to force a bank to accept a recapitalization, which (in my opinion) is why the recapitalization terms are relatively generous: they did not want to take the risk of the core banks turning them down.

The securitization issue raises similar legal barriers. A bit of background: To generalize, the loan servicer has a legal obligation to act in the interests of the investors in the loan pool; if it doesn’t, it opens itself up to lawsuits. Now, if all of the investors have the same interests, and the service restructures a delinquent mortgage in a way that provides more value than a foreclosure, then everyone is happy. There are (at least) three problems, however. The first is a coordination problem: getting all of the investors to agree that they are happy. The second is a problem of conflicting interests: because a typical CDO is structured so that some investors get the first payments and some get the last, a mortgage modification could help the interests of some investors and hurt the interests of others. The third is a tax problem: for technical reasons, a mortgage restructuring could be treated as a new loan, which creates a tax liability (this is a REMIC rule).

This is why I think this will require legislation, and even that could be challenged as an expropriation of property.

  • The Center for American Progress has a proposal to modify the REMIC rules and an explanation of why they think it would work.
  • John Geanakoplos and Susan Koniak have another proposal to use government-appointed blind trustees to make restructuring decisions and thereby protect servicers from liability to their investors (this would also require legislation).
  • Thomas Patrick and Mac Taylor have yet another proposal (thanks, Tom K) to use Fannie Mae and Freddie Mac debt to pay off all performing securitized mortgages at face value and refinance them with 30-year, fixed-rate mortgages. (I don’t fully understand this plan: it seems to involve paying face value for $1.1 trillion in mortgages, many of which are certain to default in the future, and forcing banks to pay face value for $400 billion in mortgages that are already delinquent, and also forcing banks to accept some of the losses on the government’s $1.1 trillion. But I don’t want to draw conclusions based on a newspaper description.) This one shouldn’t involve legal issues, but it will require legislation, because of the amount of money involved.
  • Then there’s the idea of allowing bankruptcy judges to modify mortgages on owner-occupied houses, which would also protect the servicer from liability. But this would be a slow, inefficient way of solving the problem.

If there are other ideas out there, please suggest them.