Amidst the gallons of ink spilt, here and elsewhere, over the nationalization debate, the AIG collateral payments, and the AIG bonuses, I neglected to comment on the details of the new housing plan, which were released on March 4. When the initial plan was announced in February, I was concerned about the seeming lack of any provision that would enable servicers of securitized mortgages to modify those mortgages without being sued by the investors who bought the securities. (In brief, the problem is that the pooling and servicing agreements (PSAs) that govern those securitizations may not allow loan modifications, or may require the servicer to gain the consent of all of the investors, which is practically impossible.) People who know housing better than I said there was something in there.
If it is, I still can’t find it in the March 4 documents (fact sheet, guidelines, modification guidelines). In any case, an important question is whether the plan will do enough to encourage servicers to modify securitized mortgages, as opposed to mortgages they own. “A New Proposal for Loan Modifications,” a short (13-page) paper by Christopher Mayer, Edward Morrison, and Tomasz Piskorski that will appear in the next issue of the Yale Journal on Regulation, describes the problem clearly and makes three proposals to solve it. (A longer version with appendices is available here.)
The problem, as described in Part 1, is that servicers for securitized mortgages do not have the incentive to maximize the economic value of the mortgages, but rather to maximize their servicing fees and avoid lawsuits from investors, which leads them to foreclose in situations where a servicer that owned the whole mortgage would make a modification. To get around this, they propose three things:
- Incentive fees to servicers of 10% of all payments made on securitized mortgages, in order to provide them with the incentive to maximize the stream of mortgage payments.
- Compensation to lenders of second liens, in effect paying them not to hold up a loan modification.
- New legislation protecting servicers from lawsuits by their investors.
The last proposal raises the issue of the Takings Clause of the Fifth Amendment, “nor shall private property be taken for public use, without just compensation,” which could be interpreted to mean that legislation affecting the rights of investors in mortgage securities is unconstitutional. The authors make an argument, complete with multiple Supreme Court citations, that that interpretation would not be correct in this case. (The Takings Clause is implicated by other policy issues raised by the crisis, such as the recent legislation to impose punitive taxes on bonuses.)
The administration’s housing plan, as far as I can tell, provides a different form of #1 (flat cash incentives for modifications, rather than incentives based on the stream of payments), and some form of #2, but doesn’t directly address #3. (By the way, if you’re interested in the mechanics of how loan payments will be reduced, it’s on pp. 3-8 of these guidelines.)
By James Kwak
15 thoughts on “Modifying Securitized Mortgages”
The House passed H.R. 1106, which contains a safe harbor provision for servicers.
Mortgages should not be securitisable.
This is relatively modern financial “invention” that did not work. There are no long-term systematic reasons for doing this if we wish to have a stable economy mush less a housing market.
If a bank thinks it is a good loan to make, then let them keep it on their books. This is the only thing that ensures good lending practices. Transfers of mortgages should be only to other banks when they need to balance their portfolios, and should be strictly limited.
Anything else is just transfer of risk and an attempt to leverage when neither of these is in our overall societal interest.
Has anyone heard how the court ruled in the Florida case where the mortgage-ee told the forclosue company to prove that they actually has her signature on a contract? The paperwork couldn’t be located because her loan had been sold off so often nobody had the physical paperwork.
An odd precedent indeed.
Check out this video— Bird and Fortune did this routine in Feb. 2008, and absolutely nailed it….
While I fully agree with your sentiment, it seems as though ANY contract is a “commodity” that can be legally sold over and over. All manner of financial contracts, not just mortgages, are endlessly traded, as are bargeloads of grain and other physical commodities etc (not to mention their “futures contracts”), businesses themselves, etc, etc, etc. I’m not sure that legislating “originate-to-hold” for certain types of financial contracts would be found constitutional. But, yeah, “book-to-flip” has obviously proven disasterous.
Thanks. Do you know if this has a good chance of passing the Senate, or is it one of those things the House does sometimes just to make a statement?
Hear-hear method man! Additionally, we need to “unrepealing” the repealed Glass=Stegall Act.
I’m not sure I agree. I tend to think that stopping a firm from selling something increases inefficiency.
If a purchasing firm is diligent in evaluating a purchase of a set of securitized mortgages, they should be able to drive a hard bargain if they are being sold a bunch of toxic waste.
It seems to me that what needs to be treated more carefully is the creation of tranches out of these mortgages. Clearly, the mortgages in any given pool are much more correlated than anyone had thought. I think it was the idea that someone could create low risk investment by prioritizing payments on a set of fungible high-risk investments that was the central problem.
That – and the huge amount of leverage. The mortgages may only be failing at a rate of 10% in a particular pool of mortgage, but because the top tranche was rated AAA, firms assumed they could use massive leverage without risk.
If the mortgages were properly tranched and rated, they would have been treated as riskier investments, less leverage would have been used, and there wouldn’t have been a fundamental problem.
There are good reasons to securitize mortgages. The primary one is the mismatch of liabilities and assets that occurs with a 30 year fixed mortgage financed with deposits and CDs. A second reason is to diversify the risks a lender is taking with respect to the geographic markets it serves. The risk with securitzed mortgages is that the originator has no exposure on imprudent mortgages he generates. The answer may be to hold the originator responsible for any defaults that occur in the first five years of a mortgage. Another possibility is some financial instrument that hedges exposure on the mismatch of maturities. This sort of instrument may already exist.
It’s up in the air because a part of the bill is the toxic cramdown provision. If the Senate can get a deal on cramdown, it’ll pass.
This blog is called “Baseline Scenario”, and of the few post I have read the concepts are far removed from what I would call “baseline”. I don’t have a background in applied economics, but as a system designer I do have a background in all things “baseline”.
Baseline for our governing wealth distribution is simple. It started out when the first settlers came over. A guy stakes out a piece of land. He can grow crops on it, raise livestock, hunt, or catch fish. He uses the local forage to build his house. He either uses cotton he grows or skins from his livestock or hunted critters to make cloths. In order to pay for means to feed, house, and train soldiers for the protection of the country, he either gives the tax collector portions of his crops, livestock, or money made off of them. A man and their family are dependant upon their own merits to make either wise or stupid decisions that will affect the likelihood of their survival.
You grow food, you eat it, you have children, and you teach them to do the same. The governments only job is to see that you can do that without interference from other nations or other citizens. That is Baseline. Nothing in there about the government helping out banks, buying up toxic assets, or making laws that protect the consumer. The only time we have trouble in this country is when the government gets away from that “baseline”.
I don’t show a button on the main article, so I am posting here, as it seems the most pertinent to my point:
I know this is way too simplistic, but:
The simple recourse would seem to be to buy out the securitized mortgage by way of a re-finance, thus wiping out the previous one and replacing it with an altogether new one.
This originates with the mortgagee, and can be structured in any way acceptable to both sides of the agreement. If the government needs to step in and help on these (subsidize), it is a hell of a lot simpler than all the other options out there.
This clears the books of the toxic debt, replacing it with a clean one.
If the government has to subsidize this, I can’t see how it would be any more costly than all the plans out there. And the sooner they did this, the better it would have been.
All the complicated crap being talked about – finding who owns what, securitizers, modifying loans and risking lawsuits, blah, blah, blah, fades immediately away if a re-fi happens.
Isn’t all this turning it all into a Rube Goldberg thing, when a simple re-fi would solve everything? Get the damned bad debt off the books.
In this entire mess – and it is a stinking, foul smelling mess – everyone’s attention is on the banks, and it seems the simple solution is on the mortgagee end.
If James Kenneth Galbraith is right, that in the Great Depression the banks never did get really going again, but the economy was working halfway decent anyway. Why are we focusing all our efforts on the banks?
Let’s get to work solving Joe Main Street’s problem first. Let the gamblers lose their money. They knew what they were risking. Supposedly it was money they COULD risk. Why does Joe Main Street have to wait for all this stuff – which may take 5-20-20 years to work itself through – to get worked out? He is going to be on the street any moment now. If the gamblers lose everything, that is the risk they took. Joe Main Street wasn’t even aware that working a 7-to-3:30 job was a risk. It sure wasn’t supposed to be.
Yes, those complicated securitized mortgages are going to hurt someone. WHY NOT THE PEOPLE WHO TOOK THE RISK? Right now it is all going to come down on innocent bystanders – people who bought mortgages based on the recommendations by the sellers, and by the taxpayers. WHY IS THAT? That is not right, folks.
I did not MEAN to post that whole quote, dammit! I only highlighted three sentences… SORRY!
“Dilligence” is increasingly vaporous and rare. In the early days, I came across a memorandum and prospectus for a Home Mortgage CDOs. In the tables of best-worse cast performance, the returns used a 5 year Present Value at the average interest payments for the many underlying, individual loan payments. However unsophisticated, the adoption of mark to market accounting makes this entire asset class really blow. A good argument can be made for Mark To Market, but is can certainly sober up the market for CDOs.
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