Wednesday, April 29, 2009

Yet Another Program to Enrich Banks at Taxpayer and Borrower Expense

Posted on Naked Capitalism:

The latest bit of looting fobbed off as a win for homeowners is a program to shovel money to second mortgage lenders:
The Obama administration unveiled a new program to help borrowers with second mortgages stay out of foreclosure, offering cash to servicers, investors and borrowers who modify loan terms.

Guess what? Plenty of seconds are under water and have NO economic value. But they play like pigs in foreclosure and renegotiations. So this program will validate values above market value for these homes and unnecessarily enrich second mortgage holders, who otherwise would have to eat their losses.

Elizabeth Warren wrote about it last November:
"Hostage value" in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to reposses the collateral. The classic example was the old practice of taking a security interest in all of a family's household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released. This version of the practice involving household goods is now banned by the FTC. In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions.

Rescue programs limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender. But the mortgage lenders want more. If they don't get it, they won't release the mortgage--even though the lenders won't get anything close to 100% of the value of the home if they are forced to foreclose. They hold the home hostage: Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home.

The mortgage lenders are counting on the leverage of their hostage taking to do better than 100% payment. So long as they hang on. rescue efforts are irrelevant and renegotiation won't work.

The bankruptcy amendments that passed the House this week would break the hostage value of the home. The amendment would give families a chance to negotiate deals that would take them out of ruinous mortgages and let them get into something that is affordable--with or without a rescue plan. The mortgage industry oppses the bill, saying it will decide "voluntarily" when they will or will not turn a homeowner loose--which is another way of saying they want to hang on to the hostage value.

The new Treasury program is being spun as a benefit to first mortgage holders, but I am skeptical. As Warren made clear, the remedy is cramdowns, writing the value of the property down to current market value and treating any surplus mortgage amount as unsecured debt. This is standard process in corporate bankruptcies, and no one has a problem with it there, but it is treated as a heinous idea for residential property. More from Bloomberg:
The program is primarily aimed at borrowers who are “underwater,” owing more on their mortgages than their homes are worth.

No other legislative changes are required for the administration’s revised housing plans to take effect, the officials said.

The new measures may ease mortgage investors’ concerns that the biggest banks and servicers would be tempted to rework too many loans under the program in order to bolster their home- equity portfolios, Laurie Goodman, an analyst at Amherst Securities Group LP in New York, said in a telephone interview.

“Certainly, it appears that the Treasury has listened to first-lien investors,” Goodman said. Today’s announcement “goes a very long way toward addressing their objections,” she said.

The second-lien program should be up and running in about a month, the officials said. They estimated that about 75 percent of all U.S. mortgages are managed by servicers that already have agreed to participate in the government’s modification programs. Servicers are administrators in the relationship between lenders and borrowers.

The mortgage initiative offers subsidies to servicers and lenders, including bond investors, to help lower borrowers’ housing payments to 31 percent of their income. Because modifications are voluntary, the Treasury is offering incentive fees to encourage participation in the program.

The $12,000 in possible incentive fees has several components. Many of the fees are paid over time, as an incentive for borrowers and servicers to strike deals that will last.

When modifying first mortgages, servicers can receive $1,000 up front, and $1,000 per year for three years. If the mortgage being modified is eligible and not yet delinquent, they can also receive $500, for a maximum possible total of $4,500.

This is just more bells and whistles and expense pursuing the wrong course of action. Mortgage cramdown would take care of much of this, and the threat of this as an option would cut down investor and servicer unresponsiveness (although I have been told that in BK, the lowest tranches take the hit first, while in a mod, the writeoff is distributed across the tranches, so this bit of tranche warfare has been ignored. And since the servicers often have parents that hold top tranche paper, this all appears unlikely to work, or more accurately, to guarantee activity designed to establish that it won't work).

It was three plus years into the Depression until Gordian knots like this got cut. However, with Obama having put his name on programs to help the banksters, I wouldn't hold my breath that we will see course changes even when Plan A is revealed to be failing.

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