The Foreclosure Problem Is Also the Problem of Untangling the Mess of Securitization

December 19th, 2008 | Tags: Foreclosure

The various schemes undertaken by the authorities to mitigate the foreclosure crisis are not simple and straightforward as is apparently being made out. The foreclosure problem is also the problem of untangling the mess of securitization.

The mortgage process got complicated when mortgages were bundled together and sold in bits and pieces, cut up into slices to investors across the world as securities. Servicers were appointed to collect the mortgage dues and interact directly with the borrowers. The problem now arises is that most of the servicers do not have the authority to modify loans – something that the government is desperately trying to do to stem the tide of foreclosures. The servicers – a vast majority of them – have the power to make small modifications like lowering interest but they cannot write off the amounts from the principal.

The servicers inked agreements many years ago. At that time nobody thought that such wide scale modification of loans would be required. Professor Richard Marston of Wharton refers to it as the “evil part of securitization.” He said, “Once you get into trouble there should be a (modification) mechanism … It should have been written into the contracts that some neutral party had the authority to change the mortgages.” The dichotomy is that had such a clause been inserted then the investors would not have found these securities attractive because there would have been uncertainty about the flow of cash.

Experts comment that modifications are simple and easy when the loans are in the books of the lenders or in the accounts of entities like Fannie Mae and Freddie Mac. The contenders are facing each other across the table and can do whatever they want to. But the majority of the troubled loans like sub-prime and Alt-A that had been granted to borrowers with questionable credit credentials were made into packages and securities. Investors dotted across the globe bought these. Even if servicers give their nod to the modifications the question will now arise about how much legal right they have to do so.

Congressional research done on the subject noted in October 2007, “The holders of different securities from the same mortgage pool are often paid different amounts …Further clarification may be required to assure servicers and trusts that thy will not be subject to investor lawsuits if they provide workouts to troubled borrowers.”