Monday, July 13, 2009

Dodd and Frank on Over-Valued Second Liens

One of our highest priorities as Chairmen, respectively, of the Senate Committee on Banking, Housing, and Urban Affairs and the House of Representatives Financial Services Committee has been to help people save their homes from foreclosure. To do so, we have sought to create adequate tools to address the foreclosure crisis created by the bubble in housing prices, aggressive marketing of risky mortgages, weak underwriting standards, and inadequate regulation.

A key part of this effort was the creation of the HOPE for Homeowners (H4H) program, enacted as part of the Housing and Economic Recovery Act of 2008 (HERA), and the improvements made to the program in the Helping Families Save Their Homes Act of 2009. The program is premised on the view, expressed by Federal Reserve Board Chairman Bernanke and others, that the creation of equity for troubled homeowners is likely to be an effective tool for helping families keep their homes and avoid foreclosure.

In recent discussions with servicers, investors in mortgage backed securities, and Administration officials, it has become clear that one of the most significant impediments to the success of H4H is the unwillingness of subordinate lien holders to extinguish their liens as required for participation in this program, even in return for offers of reasonable compensation. This is true despite the fact that these subordinate liens may have minimal economic value.

We understand that the nation’s largest mortgage servicers carry on their balance sheets significant volumes of these subordinate liens in the form of closed-end second mortgages

or home equity lines of credit. We are concerned that the loss allowances associated with these subordinated liens may be insufficient to realistically and accurately reflect their value, especially in light of the historically poor performance of first lien mortgages and seriously diminished values of the underlying collateral. As you know, the nation has experienced sharp declines in home prices, with further declines expected in many markets. This has resulted in as many as 20 percent of all homeowners having mortgages that exceed the value of the home. These numbers are likely to be much higher in the case of option ARMs and subprime loans.

Many subordinate liens stand behind these mortgages. Carrying these loans at potentially inflated values may contribute to resistance on the part of servicers to negotiate the disposition of these liens, and thus may stand in the way of increasing participation in the H4H program. Inadequate reserving would also overstate the capital position of these institutions at a time when an accurate picture of the capital adequacy of the banking system is crucial.

We urge you and your staff to look into this issue as expeditiously as possible to ensure that we can achieve the vital goal of the H4H to help American families build equity and keep their homes. Please be in contact with us or our staff to review your findings in this area as soon as possible.

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