Homeowners and the Bailout

By Alan White

For homeowners as well as for banks, the bailout deal announced today could be a turning point, or it could be more of the same, depending on what Treasury actually does with its enormous new powers. Treasury could buy mortgage securities at deep discounts, causing banks and investors to absorb losses (much of which they have already reserved for), and then aggressively restructure the underlying mortgage debt, passing on writedowns to homeowners in distress. Or Treasury could pay high prices for the securities to bail out financial institutions and then continue the senseless foreclosure policy servicers are currently following, losing billions by foreclosing and reselling homes.

The bill (download here, but be warned there is a lot of server traffic now) requires Federal contractors (who will now be hired in droves) to develop foreclosure prevention plans, and submit monthly reports to Congress on the number of foreclosures and the number and type of modifications. This is all still precatory, in a sense, but has the potential to change the paradigm in mortgage servicing and start a process of genuine mortgage restructuring. Treasury can imitate the FDIC in its takeover of IndyMac, or it could continue accepting the bland assurances of HOPE NOW.

The foreclosure provisions are in sections 109 and 110. The Treasury Secretary is directed to implement a plan to maximize assistance for homeowners, and to consent (as owner or investor) to reasonable requests for loan restructuring, including interest and principal write-downs.

On the other hand, it is unfortunate that the bankruptcy modification tool was not incorporated in the legislation. Giving bankruptcy courts the ability to rework the subprime mortgages of 2005-2007 when servicers refuse to do so voluntarily would add real impetus to the restructuring effort, and as Adam Levitin has demonstrated, would not impair the future supply or price of mortgage credit.

It may also become quickly apparent that Congress needs to tinker with some tax law provisions that drive the limitations in pooling and servicing contracts that in turn govern securitized mortgages. Servicers are prevented from doing anything that endangers the special tax status of mortgage trusts they administer. This may mean that Treasury cannot effectively tell servicers what to do, or buy mortgages out of securitized pools, without some adjustments to the REMIC tax provisions. In my view, if there is a will to restructure mortgages, a way will be found.

On a related note, Ruth Simon reports in today's Wall Street Journal that the kind of modifications offered to homeowners in foreclosure matters a great deal in how well these homeowners do making their new payments. Not surprisingly, modifications that reduce interest, principal and monthly payments have much higher success rates than the other kind (where payments and principal are increased to recoup interest arrears.)

Comments

[Hope to Homeowners]

One good thing that has come out of all of this is the hope for homeowners program. This program can really go a long way in shoring up home values across the country. It is somewhat unfair to bailout the people that were not as careful about financing their home but the decline in home values is really effecting everyone.