Servicers’ Obstacles to Loan Modification Aren’t as Numerous as They Claim

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What’s Holding Back Mortgage Modification?

Many mortgage services say they can’t modify terms to let homeowners avoid foreclosure. But there may be fewer obstacles than they claim

This Issue

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February 23, 2009

Home Wreckers

One supposed obstacle to sorting out the millions of mortgages that have gone bad is that the home loans have been bought by investment banks, bundled together into bonds, and sold to investors. This widespread process of “securitizing” loans makes it difficult to go back and modify the terms of individual mortgages so that strapped borrowers might be able to continue to make payments, according to mortgage industry experts. In particular, this argument goes, the middlemen known as mortgage servicers, who administer home loans, are contractually prohibited from adjusting interest rates or balances, without risking a wave of lawsuits filed by purchasers of mortgage-backed securities.

But this problem has been vastly overstated, say some industry lobbyists and government officials. “One of the biggest lies out there is that servicers can’t take action. They certainly can,” says Mike Krimminger, special policy adviser to FDIC Chairman Sheila M. Bair.

Foreclosure Is Cheaper

During the mortgage boom, $7 trillion worth of home loans, including hundreds of billions of dollars worth of subprime mortgages, were packaged and sold to investors in the form of bonds. According to an analysis by foreclosure research firm RealtyTrac, about half of all subprime loans that have entered foreclosure were securitized and sold to investors. In normal times, mortgage servicers, which include giant lenders such as Countrywide and specialty firms such as Litton Loan Servicing, a unit of Goldman Sachs (GS), have a simple and lucrative job: collect payment from borrowers, administer escrow accounts, and forward funds to investors.

But as mortgage defaults have surged in the past two years, these caretakers are under pressure to do more to stop the bleeding by modifying loan terms. Many have balked or dragged their feet, say industry experts, hoping the housing market will rebound. One reason is that servicers earn more, under most current contracts, when they foreclose, compared with when they modify a loan. Adding staff and technology to manage modifications is costly. That’s one reason the Obama Administration says it plans to increase incentives for loan managers to modify mortgages in its new bailout programs, expected to be detailed in the next few weeks.

“The cost-benefit calculation of the servicers has been very lopsided” in favor of foreclosures, says Alan S. Blinder, a professor of economics and public policy at Princeton University.

Few Contracts Bar Modification

Contract prohibitions are another argument used by servicers to explain why more can’t be done. The claim, however, may be exaggerated. Securitization experts say the vast majority of securitized mortgage contracts, known as pooling and servicing agreements, have few or no provisions preventing changes to loans’ terms. In more than 85% of these agreements, “there are no meaningful restrictions on a servicers’ ability to modify,” says Tom Deutsch, deputy executive director of the American Securitization Forum, a New York-based unit of the Securities Industry & Financial Management Assn., which represents servicers and investors. “Most [mortgage-backed] securities contracts expressly permit or do not prohibit loan modifications.”

Intransigence may be driven more by the fear of litigation than explicit contractual obligations. It’s not completely unwarranted. In December, investment fund Greenwich Financial sued Countrywide over terms of an October settlement with 11 state attorneys general. The agreement requires Countrywide to modify the terms of certain subprime loans. Greenwich claims that language in 374 Countrywide mortgage trusts created between 2005 and 2007 require Countrywide either to foreclose on defaulted mortgages or to buy them back at face value before they are modified. “Those are Countrywide’s only options,” says William Frey, chief executive of Greenwich Financial.

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