Monday, August 31, 2009

Ex-Countrywide Execs’ Firm Modifies Bad Loans for Taxpayer Cash

Posted on ProPublica by Alexandra Andrews:

Among the servicers participating in the government’s mortgage modification program [1] is a new recruit that’s not like the others. PennyMac, a firm founded by the former president and chief operating officer of Countrywide, buys distressed home loans on the cheap with the goal of modifying them and later selling them for a profit. The company, whose top management consists mostly of former Countrywide executives [2], now stands to receive up to $6.2 million in taxpayer money to modify those loans, through the Making Home Affordable program. The government’s incentive payments go primarily to the participating servicer, but some of the money could also go to borrowers and investors.

A March New York Times article [3] profiled PennyMac, focusing on the fact that former top managers at Countrywide were looking to profit from rehabbing high-risk loans that had failed. Countrywide, which made high-risk loans that the company’s CEO himself called “toxic” and “poison” in internal e-mails [4], has been widely blamed for helping trigger the financial crisis.

But PennyMac may be better suited to helping struggling homeowners than other lenders taking government subsidies are.

Housing counselors have accused many of the participants in the program of being reluctant to modify loans. As a whole, participating servicers have helped far fewer borrowers than anticipated, according to the Treasury Department’s latest data release. Overall, less than [5] 9 percent of eligible loans had entered the trial modification period by the end of July — roughly four months since some servicers first began implementing the program – and the rate was even lower for some individual servicers. Bank of America, for instance, the nation’s largest servicer, checked in at just 4 percent [6] of its eligible loans. Bank of America now includes Countrywide, which, with $5.2 billion earmarked for it, is the biggest participant in the program.

According to Guy Cecala, publisher of Inside Mortgage Finance Publications, servicers and investors are loath to modify loans because most aren’t convinced that it will reduce their losses.

But PennyMac’s business strategy revolves around modification, turning “sub-performing and non-performing loans” into “restructured and re-performing loans,” according to a recent company prospectus [7].

PennyMac buys distressed loans at fire-sale prices. In January, it purchased nearly 3,000 mortgages from the Federal Deposit Insurance Corp., which sells loans taken over from failed banks. The book value for those loans was $560 million, but PennyMac paid just $43 million [8]. As a result, it has much more leeway to drastically reduce loan payments than banks holding mortgages at inflated values. “It can afford to lose more,” Cecala says.

“If they’re in fact doing that, I think it’s a wonderful thing,” says Margot Saunders, a lawyer with the National Consumer Law Center, who had initially been critical of the company’s provenance. PennyMac did not return calls requesting comment.

But PennyMac may have a hard time leaving behind its ties to the scandal-ridden Countrywide. PennyMac’s founder and CEO, Stanford Kurland, is facing a civil suit [9] (PDF) brought by the New York state comptroller and New York City pension funds, blaming him for helping push Countrywide into risky lending practices and lax underwriting standards as president. Kurland admitted to the Times that he had advocated a foray into higher-risk lending but said that the riskiest practices occurred after he left the company, in September 2006. Kurland’s lawyer told the Times that the allegations were without merit.

The suit against Kurland says he was one of three executives who “became enormously—almost indescribably—rich from insider sales of Countrywide stock at artificially inflated prices.” Kurland sold nearly $200 million worth of Countrywide stock before leaving the company, and PennyMac was funded in part by his personal treasure chest, according to the Times.

But if you ask Cecala, “basically anyone who’s been successful in the mortgage business has been tainted” by their involvement with risky subprime loans. “At the end of the day, nothing really distinguishes PennyMac from anyone else.”

As for whether PennyMac will outdo the other participants in the government’s loan modification program, “the proof will be in the pudding,” he says.

Saturday, August 29, 2009

The HAMP Mirage

Posted on Calculated Risk:

Andy Kroll at Mother Jones discusses problems with the Home Affordable Modification Program (HAMP): The Foreclosure Rescue Mirage

Industry experts are now questioning how many of the program’s estimated 235,000 modifications will actually benefit homeowners in the long term, and say that homeowners clamoring to participate in HAMP have created an industrywide logjam for mortgage servicers, resulting in substantial delays and backed-up customer service support. The Treasury’s first servicer performance report (PDF), covering March to July 2009, found that servicers had offered modifications to just 15 percent of eligible delinquent homeowners, and initiated them for just 9 percent of that group.
I've heard from servicers who've said they are just overwhelmed and are staffing up to meet the demand. And it appears the administration is trying to make improvements:
Despite its flaws, HAMP is a good-faith effort by the government to address the foreclosure crisis, and there are signs of improvement. In June, HAMP officials began conducting much more rigorous reviews of servicers, and have started a "second look" program, in which servicers’ decisions to approve or deny HAMP modifications are scrutinized. Compliance officials are also analyzing samples of HAMP-modified loans to track error rates with servicers. And government officials have on several occasions tried to light a fire under HAMP servicers to speed up the modification process.
Some believe HAMP will fall far short of the goals:
The Treasury has set a target of modifying 4 million mortgages by 2012, but Moody's estimates HAMP will in fact modify only 1.5 to 2 million.
The Treasury disagrees:
More than 400,000 modification offers have been extended and more than 230,000 trial modifications have begun. This pace of modifications puts the program on track to offer assistance to up to 3 to 4 million homeowners over the next three years, our target on February 18.
Actually the original press release stated the program "will help up to 3 to 4 million at-risk homeowners avoid foreclosure" and the new press release says "offer assistance to up to 3 to 4 million homeowners". A few word changes makes a significant difference.

The Treasury's current target is 500,000 cumulative trial modifications started by November 1st, up from the 235,000 cumulative at the end of July. At that pace (about 90 thousand trials started per month), the cumulative trial modifications started will be close to 3.0 million by early 2012 - however many of those borrowers will probably redefault. Anyone who redefaults will have been "offered assistance", but probably will not "avoid foreclosure".

The article has a few interesting anecdotes of the struggles of borrowers in dealing with their servicers.

Friday, August 28, 2009

Software Lets Consumers Create Modification Plan

Posted on the Housing Wire by Austin Kilgore:

Minneapolis, Minn.-based launched a software product for consumers to create their own mortgage modification proposals that conform to the Making Home Affordable Modification Program (HAMP).

The Web-based application has a series of online forms the borrower completes to create a modification proposal, and has functions to create hardship letters and written pre- and post- modification proposal.

The ease of the modification proposal comes at a price. The software costs $595 on its Web site. is also selling rights (at $200) to third-party individuals to resell the software.

The software developers tout the offering as a “simple, affordable and effective solution” to the growing disconnect between government programs, streamlined modification initiatives at large servicers and the growing number of financially constricted borrowers.

Tuesday, August 25, 2009

State of the Private Mortgage Insurance Industry

Capital constraints on mortgage insurance companies could impede the ability of Fannie Mae and Freddie Mac to keep up with the demand for mortgage financing during the housing recovery, according to a report by the FHFA the government-sponsored enterprises' regulator.

How to Jump-Start Mortgage Loan Modifications

Posted on Yahoo Finance by Jack Guttentag:

With no end to the housing crisis in sight, the need to modify loan contracts to make payments more affordable is greater than ever.

While the number of modifications is rising steadily, it is running far behind the need. In the first quarter of 2009, the loan servicers reporting to the government reduced the interest rate or loan balance on only 120,465 loans. This is an annual rate of about half a million, which is no more than one-fifth of what is needed.

The widespread adoption of a Web portal that would directly connect servicers with borrowers and counselors could help change this, because the current situation in the industry is in need of repair. The portal would allow users to access a servicer's specific requirements and submit modification applications just by clicking a button.

This would automatically forward the application to the servicer, who would also be alerted by email that a new borrower file has been created. All subsequent messages by the servicer and the user, and all new documents submitted by either, would be recorded and dated in the user's file.

Also, the portal would replace communication by phone and fax with documents and messages left in the portal. The correct forms would be filled out because the user would receive them directly from the servicer. Long telephone waits, the inability to find the same person and conflicting information from different people would be eliminated. The portal would allow both parties to view all messages by sender and date, so there could be no misunderstanding of what was said, when it was said and by whom. All documents would remain in the portal and be accessed by either party.

The good news is the portal that does all these things exists. It was developed by Default Mitigation Management LLC, a firm headed by Joseph Smith. (I have no financial interest in this firm.)

Improving the Process

Right now the portal is being used by attorneys with a number of enlightened servicers who account for about three-quarters of all loans. The servicer pays a small processing fee for each file, while the attorney pays nothing.

The portal needs to be opened to counselors and borrowers, hopefully in that order. Getting counselors on the portal depends mainly on the major counseling organizations (Hope Now and Neighborworks), who have not as yet committed to it. The Treasury Department, while expressing displeasure at the slow pace of modifications, appears to be keeping its hands off.

(I have wondered whether Treasury is aware that the portal provides the means for assessing servicer performance, something it does not now have.) If the counselors don't come aboard shortly, I look for Default Mitigation Management and the servicers to open the portal to borrowers.

Generally speaking, modifying a mortgage is not that big of a deal.

"After you get the borrower's complete package, it only takes about 45 minutes from beginning to end to modify a loan," according to Smith, who has been modifying loans on a small scale for several years. "This includes reviewing a budget with the borrower (20 minutes), determining surplus income (2 minutes), completing the loan modification analysis worksheet (10 minutes), generating a special forbearance and mailing it out (10 minutes), and calling the borrower to report the result (3 minutes). A few minutes more may be needed for additional calls, generating final modification documents and follow-ups, so let's call it an hour, which is conservative."

Let's be even more conservative, assume two hours and consider an example. JPMorgan Chase has announced that it now has 3,500 loan modification counselors. Using the two-hour assumption, these workers on their own, ignoring the counselors employed by all other servicing firms, could modify 70,000 cases a week if each of them worked an eight-hour day.

More Problem Cases

Throughout the industry, there is an enormous gap between the productivity of servicers today and what is possible. The reasons for the gap are well understood. Servicers over the years focused their system development on reducing the costs of dealing with borrowers who paid. Those with payment problems were few in number and could be handled by a relatively small staff.

But as the number of problem cases has exploded, the servicers have been overwhelmed. Most have responded by substantially expanding their counseling staffs, but the systems needed for the staffs to work effectively have been lacking.

"While most loan servicers are trying to remedy the situation, progress has been slow," Smith says. "Most servicers have inadequate call routing for in-bound calls, have inadequate mail rooms, fax and image facilities, lack systems for tracking files, require excessive numbers of hand-offs in the decision process and manage largely in a fire-fighting crisis mode."

The results are well known to the borrowers and their advisers who have tried to get their loans modified. It takes forever, and sometimes it is impossible to reach the counselor with whom they had their initial contact. They may have to begin again with someone else who may not be able to find their file, and who may tell them a different story than the previous counselor.

If the borrower has not submitted all the proper forms, each one filled out correctly, the file is likely to be put aside, which the borrower may not know about unless they inquire and are lucky enough to speak to someone who knows. Files put aside often get lost, which means that the borrower has to submit the entire file again, without necessarily knowing what was wrong with the previous submission.

In some cases, a document submission gets lost in a chaotic fax room and is never logged in. When the borrower calls, no one they speak to knows anything about their submission.

Delays are compounded by needless divisions of responsibilities, including analysts who check the math and negotiators who deal with the borrower. Smith says that "if the analyst has a week of cases in his pipeline and the negotiator has the same, the borrower's total wait is two weeks, even if everything else goes smoothly."

The bottom line is that a process that could be done within the day takes weeks or months or doesn't get done at all. It doesn't have to continue to be this way.

Monday, August 24, 2009

Cure Rates Plunge Among Prime RMBS, Fitch Says

Posted on the Housing Wire by Diana Golobay:

A slower cure rate among delinquent loans erased improvements in the number of loans rolling into delinquency status among US residential mortgage-backed securities (RMBS), according to Fitch Ratings.

Cure rates decrease as fewer delinquent loans return to current payment status each months. The prime cure rate slipped from an average 45% during ‘00-’06 to 6.6% today. Alt-A cure rates dropped to 4.3% from an average 30.2% and subprime cure rates fell to 5.% from an average 19.4%.

“Recent stability of loans becoming delinquent do not take into account the drastic decrease in delinquency cure rates experienced in the prime sector since the peak of the housing market,” said managing director Roelof Slump in a corporate statement.

“Whereas prime had previously been distinct for its relatively high level of delinquency recoveries,” Slump added, “by this measure prime is no longer significantly outperforming other sectors.”

More borrowers sink underwater on their homes as prices deteriorate, largely driving the declines in cure rates. Areas like California and Florida that have seen a steeper decline in prices as a result have a higher presence in the delinquency categories. California and Florida represent 49% of the remaining outstanding balance of currently performing prime loans, according to Fitch, although the states also make up 62% of the non-current category and are “under-represented” in the cured loan category.

Fitch sees credit scores as playing a significant role in the cure rate behavior. On average, current prime loans bore credit scores at origination up to 25 points higher than those on delinquent prime loans.

“As income and employment stress has spread, weaker prime borrowers become more likely to become delinquent in their loan payments and are less likely to become current again,” Slump said.

RMBS Servicer Advance Update from DBRS

In most U.S. Residential Mortgage-Backed Securities (RMBS), the servicer is required to advance delinquent principal and interest (P&I) to the trustee to the extent it is deemed recoverable. The servicer is also expected to make escrow advances for delinquent taxes and insurance (T&I) in addition to corporate advances for reasonable "out-of-pocket" expenses incurred by the servicer in the performance of its servicing obligations in connection with a default, delinquency, or other unanticipated event, including but not limited to, foreclosure proceedings and fees associated with the management and liquidation of any REO property (including legal fees).

Methods of reimbursement are specified in RMBS legal documents. Typically, servicers are reimbursed for advances in one of two ways: (1) monthly from general collections on the pool of mortgages (pool-level recovery) or (2) from subsequent collections on the related delinquent mortgage loan after it has been liquidated or when it reinstates (loan-level recovery). Though variations exist, P&I recoveries commonly are pool-level, while T&I and corporate are loan-level. Additionally, RMBS servicing agreements frequently specify that the servicer recovers any previously unreimbursed advances when a mortgage loan is modified, regardless of the specified reimbursement type.

Most RMBS transactions permit the servicer to be reimbursed for advances at the top of the trust payment waterfall. The speed at which servicer advances are reimbursed depends upon the type of advance and the foreclosure timeline in the jurisdiction where the related mortgaged property is located. For example, judicial advances are slower to collect through foreclosure than non-judicial advances; pool-level P&I advances are typically reimbursed much sooner than corporate and T&I advances which are reimbursed primarily through liquidation proceeds.

Presently, high delinquency rates and increased foreclosure and real estate owned (REO) timelines are causing liquidity challenges for many servicers that are advancing into RMBS. Loan-level recoveries on servicing advances can take several years. Additionally, the interest cost to carry relative to the servicer’s credit facility can become a serious financial burden. Consequently, many issuers are weighing the benefit of advancing versus not advancing (P&I) in new RMBS transactions. While servicer advances are intended to provide timely cash flows and liquidity to a transaction, they do not serve as credit support. Furthermore, deals where advancing occurs typically have higher loss severities than those that do not because the advanced interest will have to be reimbursed from the trust upon the liquidation of the mortgage. As a result, DBRS has seen a growing number of inquiries with respect to transactions where servicers are not required to advance any P&I payments.

DBRS will continue to monitor the industry for its acceptance of deals without P&I servicer advances and the related impact on loss severities and timing of cash flows to the capital structure.

Thursday, August 20, 2009

Complaining to HUD about Servicing: Thunder on Deaf Ears?

Posted on Credit Slips by Katie Porter:

In my own research, and frequently on Credit Slips, I've noted problems that homeowners face in dealing with their mortgage servicers. As a recent post from guest blogger Max Gardner explained, many of these problems are structural to the servicing industry. I think the people on the phone are good folks, trying to be helpful, but without the tools, training, and resources that they need to do so. One marker of the increasing pressure that servicers are under is the HUD complaint statistics. According to this Pro Public report, mortgage servicing issues were 31% of complaints to HUD in 2006. Just two years later in 2008, that fraction has jumped to 78%. No surprise here. More families are in default or foreclosure and that means more friction between homeowners and servicers. And as many of us have pointed out, consumers aren't the mortgage servicers' customers--the mortgage note holders are. So it makes sense that consumer satisfaction ("non-customer satisfaction", so to speak) is low in the industry.

The interesting part to me is that HUDs own complaint website doesn't even list mortgage servicing as an area of concern. Four out of five consumers who contact HUD are frustrated with their mortgage servicer, but HUD doesn't even acknowledge--at least in the obvious location--that it is in charge of complaints about mortgage servicing? I think this reflects a real problem in consumer protection regulation. Perhaps HUD sees mortgage servicing as just pretty far afield from its core concerns about housing discrimination and federal housing programs. HUD, more than any other agency anyway, has authority to implement the Real Estate Settlement Procedures Act (RESPA), which provides a process (a QWR) for consumers to motivate servicers to respond to problem. But historically, and still today, HUD's oversight of mortgage servicing could generously be characterized as "thin." Is mortgage servicing an example of the need for a Financial Product Safety Commission or will the mortgage market (when, and if, it revives itself) offer new and improved servicing models that reduce consumer frustration and improve transparency?

Saturday, August 15, 2009

Lease-Backs Turn Owners Into Tenants

Posted in the Washington Post by Kenneth R. Harney:

Here are two real estate questions getting a lot of attention on Capitol Hill and from the Obama administration: When homeowners lose their houses to foreclosure, should they be able to stay in the property, leasing it back at fair market rent from the lender?

Should they also get an option to purchase the house from the bank at the end of the lease term, assuming they have the income to afford it?

Before leaving for their August break, Democrats and Republicans in the House took a rare, unanimous stand on both questions by passing the Neighborhood Preservation Act by voice vote. The bill was co-sponsored by Reps. Gary G. Miller (R-Calif.) and Joe Donnelly (D-Ind.).

The bill would remove legal impediments blocking federally regulated banks from entering into long-term leases -- up to five years -- with the former owners of foreclosed houses. It would also allow banks to negotiate option-to-purchase agreements permitting former owners to buy back their houses.

The idea, Miller said, is to "reduce the number of houses coming into the housing inventory and preserve the physical condition of foreclosed properties," which ultimately should help stabilize values in neighborhoods with large numbers of distressed sales and underwater real estate -- all at "no cost to the taxpayer."

If the bill is approved by the Senate, participation by banks would be voluntary. But the legislation might encourage banks to calculate if they would do better financially by taking an immediate loss at foreclosure or by collecting rents and then selling the property at a higher price in four or five years.

Though the bill was not opposed by banking industry, it quickly attracted critics. The Center for Economic and Policy Research said a key flaw is that it leaves decisions about lease-backs solely to banks themselves.

"If Congress does want to give homeowners the option to stay in their homes as renters," the think tank said, "it will be necessary to pass legislation that explicitly gives them this right."

Al Hackman, a San Diego realty broker with extensive experience in commercial transactions, argues that lease-backs with options to buy are a better way to go.

Hackman and a partner, Troy Huerta, have recently begun putting together what they call "seamless short sales" as alternatives for banks and property owners. In a short sale, the bank negotiates a selling price that's typically less than the owners owe on their note, eating the loss. Hackman and Huerta call their short sales seamless because the financially distressed homeowners remain in their properties, before and after the settlement.

Here's how the process works: First, the bank agrees to sell the property short to a private investor, just as it often does now. In the seamless version, however, the investor is contractually bound to lease back the house on a "triple net" basis -- the tenants pay taxes, insurance and utilities -- for two to three years.

The former owners only qualify if they have sufficient income to afford a fair market rent and can handle the other expenses, including maintaining the property. The deal comes with a preset buyout price after the lease-back period. That price is higher than the short-sale price paid by the investor, but lower than the original price of the house paid by the foreclosed owners.

Hackman and Huerta already are doing seamless short-sale transactions. Here is one moving toward escrow: A family purchased a house for $725,000 with 20 percent down in 2005, then made substantial improvements with the help of an equity line of $72,500. The house now is valued around $500,000, but is saddled with $625,000 in mortgage debts.

Enter the seamless short sale: Hackman has brought in a private investor who is willing to buy the house at current value, all cash. As part of the deal, the investor has agreed to lease back the house at $25,000 a year, triple net. In three years, assuming they've been good tenants, the original owners have the option to buy back the property for $550,000.

Hackman says the internal rate of return to investors can be raised or lowered based on rents and the buyback price, but typically are in the 8 percent to 10 percent range.

"It's a win-win," he says. "The owners stay in their houses. Private investors get a moderate return on what should be a safe investment." Plus the banks are out of the equation.

Friday, August 14, 2009

The Alphabet Problem and the Pooling and Servicing Agreements

Posted on Credit Slips by Max Gardner III:

The securitization of residential mortgage notes has created a maze of complex issues and problems for the bankruptcy and foreclosure courts. One fundamental issue is who is the actual holder and owner of the mortgage note. In order to answer this question, it is necessary to dig deep into the contracts, warranties and representations that were executed in the formation of the securitized trust.

The Pooling and Servicing Agreement (PSA) is the document that actually creates a residential mortgage backed securitized trust and establishes the obligations and authority of the Master Servicer and the Primary Servicer. The PSA also establishes some mandatory rules and procedures for the sales and transfers of the mortgages and mortgage notes from the originators to the trust. It is this unbroken chain of assignments and negotiations that creates what I have called “The Alphabet Problem.”

In order to understand the “Alphabet Problem,” you must keep in mind that the primary purpose of securitization is to make sure the assets (e.g., mortgage notes) are both FDIC and Bankruptcy “remote” from the originator. As a result, the common structures seek to create at least two “true sales” between the originator and the Trust.

You therefore have in the most basic securitized structure the originator, the sponsor, the depositor and the Trust. I refer to these parties as the A (originator), B (sponsor), C (depositor) and D (Trust) alphabet players. The other primary but non-designated player in my alphabet game is the Master Document Custodian (MDC) for the Trust. The MDC is entrusted with the physical custody of all of the “original” notes and mortgages and the assignment, sales and purchase agreements. The MDC must also execute representations and attestations that all of the transfers really and truly occurred “on time” and in the required “order” and that “true sales” occurred at each link in the chain.

Section 2.01 of most PSAs includes the mandatory conveyancing rules for the Trust and the representations and warranties. The basic terms of this Section of the standard PSA are set-forth below:

2.01 Conveyance of Mortgage Loans. (a) The Depositor, concurrently with the execution and delivery hereof, hereby sells, transfers, assigns, sets over and otherwise conveys to the Trustee for the benefit of the Certificateholders, without recourse, all the right, title and interest of the Depositor in and to the Trust Fund, and the Trustee, on behalf of the Trust, hereby accepts the Trust Fund.

(b) In connection with the transfer and assignment of each Mortgage Loan, the Depositor has delivered or caused to be delivered to the Trustee for the benefit of the Certificateholders the following documents or instruments with respect to each Mortgage Loan so assigned:

(i) the original Mortgage Note (except for no more than up to 0.02% of the mortgage Notes for which there is a lost note affidavit and the copy of the Mortgage Note) bearing all intervening endorsements showing a complete chain of endorsement from the originator to the last endorsee, endorsed "Pay to the order of _____________, without recourse" and signed in the name of the last endorsee. To the extent that there is no room on the face of any Mortgage Note for an endorsement, the endorsement may be contained on an allonge, unless state law does not so allow and the Trustee is advised by the Responsible Party that state law does not so allow. If the Mortgage Loan was acquired by the Responsible Party in a merger, the endorsement must be by "[last endorsee], successor by merger to [name of predecessor]". If the Mortgage Loan was acquired or originated by the last endorsee while doing business under another name, the endorsement must be by "[last endorsee], formerly known as [previous name]";

A review of all of the recent “standing” and “real party in interest” cases decided by the bankruptcy courts and the state courts in judicial foreclosure states all arise out of the inability of the mortgage servicer or the Trust to “prove up” an unbroken chain of “assignments and transfers” of the mortgage notes and the mortgages from the originators to the sponsors to the depositors to the trust and to the master document custodian for the trust. As stated in the referenced PSA, the parties have represented and warranted that there is “a complete chain of endorsements from the originator to the last endorser” for the note. And, the Master Document Custodian must file verified reports that it in fact holds such documents with all “intervening” documents that confirm true sales at each link in the chain.

The complete inability of the mortgage servicers and the Trusts to produce such unbroken chains of proof along with the original documents is the genesis for all of the recent court rulings. One would think that a simple request to the Master Document Custodian would solve these problems. However, a review of the cases reveals a massive volume of transfers and assignments executed long after the “closing date” for the Trust from the “originator” directly to the “trust.” I refer to these documents as “A to D” transfers and assignments.

There are some serious problems with the A to D documents. First, at the time these documents are executed the A party has nothing to sell or transfer since the PSA provides such a sale and transfer occurred years ago. Second, the documents completely circumvent the primary objective of securitization by ignoring the “true sales” to the Sponsor (the B party) and the Depositor (the C party). In a true securitization, you would never have any direct transfers (A to D) from the originator to the trust. Third, these A to D transfers are totally inconsistent with the representations and warranties made in the PSA to the Securities and Exchange Commission and to the holders of the bonds (the “Certificateholders”) issued by the Trust. Fourth, in many cases the A to D documents are executed by parties who are not employed by the originator but who claim to have “signing authority” or some type of “agency authority” from the originator. Finally, in many of these A to D document cases the originator is legally defunct at the time the document is in fact signed or the document is signed with a current date but then states that it has an “effective date” that was one or two years earlier.

Hence, we have what I call the Alphabet Problem. Now, I want to admit that I have never been strong in math or in spelling. But, the way I see all of this spells out the word FRAUD.

ACORN Targets HAMP Noncompliance

Posted on the Housing Wire by Austin Kilgore:

The Association of Community Organizations for Reform Now (ACORN) announced it’s targeting servicers it says aren’t complying with the guidelines of the Making Home Affordable Modification Program (HAMP) in its latest protest campaign.

In the first phase of ACORN’s “Home Wrecker” campaign, it used demonstrations in cities nationwide to protest servicers who hadn’t signed on to HAMP, targeting what it called the “Home Wrecker Four” — OneWest, Litton Loan Services, American Home Mortgage and HomEq — which all eventually signed onto the program.

In phase two, ACORN said it will use the same protesting techniques to target servicers who it claims are continuing foreclosure proceedings on HAMP-eligible borrowers.

ACORN will organize protests in Los Angeles, Dallas, Wilmington and New York City, and the campaign may be expanded it include protests in Lansing, Houston, Hartford, Seattle and Little Rock.

While it conducts its protests, ACORN said it will also work with servicers to develop strategies to improve the program’s effectiveness.

American CoreLogic: More than 15.2 Million Mortgage Holders Underwater

Posted on Calculated Risk:

The First American CoreLogic Negative Equity Report for June 2009 is available on line. You have to sign up to read the report.

  • More than 15.2 million U.S. mortgages or 32.2 percent of all mortgaged properties were in negative equity position as of June 30, 2009 according to newly released data from First American CoreLogic. June’s negative equity share was slightly lower than the 32.5 percent as of the end of March 2009 and it reflects the recent flattening of monthly home price changes. As of June 2009, there were an additional 2.5 million mortgaged properties that were approaching negative equity and negative equity and near negative equity mortgages combined account for nearly 38 percent of all residential properties with a mortgage nationwide.

  • The aggregate property value for loans in a negative equity position was $3.4 trillion, which represents the total property value at risk of default. In California, the aggregate value of homes that are in negative equity was $969 billion, followed by Florida ($432 billion), New Jersey ($146 billion), Illinois ($146 billion) and Arizona ($140 billion). Los Angeles had over $310 billion in aggregate property value in a negative equity position, followed by New York ($183 billion), Miami ($152 billion), Washington DC ($149 billion) and Chicago ($134 billion).

  • ... Nevada (66 percent) had the highest percentage with nearly two‐thirds of mortgage borrowers in a negative equity position. In Arizona (51 percent) and Florida (49 percent), half of all mortgage borrowers were in a negative equity position. Michigan (48 percent) and California (42 percent) round out the top five states.
  • Percent Negative Equity by State Click on graph for larger image in new window.

    This graph shows the percent of households with mortgages underwater by state (and near negative equity defined as with less than 5% equity).

    UPDATE: States with no data from CoreLogic: Louisiana, Maine, Mississippi, South Dakota, Vermont, West Virginia, Wyoming.

    The high population states of California and Florida account for almost 35% of all borrowers underwater, but this graph shows the problem is widespread.

    Wednesday, August 12, 2009

    HAMP--Is It Really All About the Money?

    Posted on Credit Slips by O. Max Gardner III:

    Are mortgage servicers really refusing to modify mortgage loans solely because of all of the "ancillary fees" they can generate from a completed foreclosure? Is the problem really all about the money or is there something more to it?

    The New York Times reported about ten days ago that the HAMP mortgage servicers were reluctant to engage consumers in modifications because the companies collect such lucrative fees on delinquent mortgage loans. There is certainly a substantial body of evidence to support the "lucrative fees" disincentive theories. For example, the Federal Reserve Bank of Boston recently shed some light on this problem with a new study that concluded that only 3% of the seriously delinquent mortgages had been modified due to the "the simple fact that the lenders expect to recover more from a foreclosure that from a modified loan." And, the number of reported bankruptcy cases where mortgage servicers have been sanctioned for imposing unlawful, illegal and unreasonable "collateral and ancillary fees" is substantial and perhaps monumental in their numbers.

    As a consumer's bankruptcy lawyer, I have made a very good living filing adversary proceedings against mortgage servicers for the misapplication of mortgage payments and for the unlawful imposition of fraudulent legal fees and other charges. These fees include forced placed insurance, rolling or legacy late fees, property inspection and preservation fees, broker price opinion fees, statutory expense fees and just about every other type of fee or charge they can think of or you could ever possibly think of. And, since many of the servicers often own their own inspection, appraisal and insurance companies, the servicers can "double dip" and "double charge" for these "captive company fees while the foreclosure process drags on and on."

    Consequently, why would I, of all people, write anything that could be to any extent considered inconsistent with the "greed theory" for deplorable lack of realistic mortgage modifications? Well, let me be clear, I do not intend to imply in any way that servicers are not motivated by the desire to create and capture as many of these so-called "ancillary fees" as they can possibly get away with in any case, foreclosure or bankruptcy. And, I agree with those who contend that in many cases the financial incentives for the servicers are totally inconsistent with the financial rights of the bond holders in a securitized trust.

    The real problem for servicers is not just a desire to make more money but their almost total inability to comply with HAMP. The problem with the HAMP plan is that it fails to take into account the normal obligations of servicers under their respective Pooling and Servicing Agreements. In most cases, a servicer is obligated to advance to the Trustee for the securitized mortgage trust the monthly principal and interest payments for every loan that has defaulted. This can be a massive monthly financial obligation. Most servicers are not allowed to recover these "P & I Advances" until the property is foreclosed and then sold as Real Estate Owned (REO). More importantly, HAMP forces mortgage servicers to act as "full-document" mortgage loan originators. Most mortgage servicers have no experience, training or knowledge about how to originate a mortgage loan. Yet, this is exactly what HAMP is asking them to do. The $1,000 HAMP modification fee and the annual $1,000 success for performance HAMP fees do not even begin to cover the expenses the servicers must incur in order to fully comply with the HAMP "origination" rules. As a result, the so-called "financial incentives" for servicers to modify loans are totally unrealistic and fail to take into account how this system really functions.

    Accordingly, in the final analysis it really is about the money but just a lot more and for different reasons than has been reported by the media. There was "no hope" for the "Hope Now" program and there is no chance to ramp up the HAMP.

    Monday, August 10, 2009

    Truth in Lending or Truth in Ownership of Residential Mortgage Notes

    Posted on Credit Slips by O. Max Gardner III:

    During my last two Bankruptcy Boot Camps, one of the topics we have discussed has been the recent amendments to the Truth in Lending Act, brought about by Section 404 of Public Law 111-22. Specifically, our interest has been focused on the new statutory requirement that a consumer-borrower must be sent a written notice within 30 days of any sale or assignment of a mortgage loan secured by his or her principal residence. Violations of this Section provide for statutory damages of up to $4,000 and reasonable legal fees. The amendments also clearly provide that the new notice rules are enforceable by a private right of action. 15 USC 1641.

    This amendment raises several issues. In a securitization context, it is challenging to figure out what the statute might require. First, if the note is sold from the originator to the sponsor for a securitized trust and then from the sponsor to the depositor and then from the depositor to the Trustee for the Trust how many notices must be given to the consumer? Since each transaction is alleged to be a "true sale," it would appear that 3 notices would have to be given. Second, what if the mortgage or deed of trust is also "assigned" from the originator to the sponsor and then to the depositor and finally to the Trustee for the Trust? How many notices are required in this situation? Again, 3 would appear to be the correct number. Third, can the notices be combined into a single document? Fourth, can a notice of the assignment of the mortgage or deed of trust be combined with a notice of the negotiation and transfer of the mortgage note? Fifth, what notice, if any, must be given to the consumer if the Trustee simply "transfers the note" to the mortgage servicer in an effort to create "standing" to enforce the note? Is this transfer one covered by the statute? It could certainly be characterized as a "temporary" assignment of possession of the note. Sixth, what is the real difference between a "sale or assignment." We know that mortgage notes are sold by negotiation under Article 3 of the UCC and the mortgages or deeds of trust are assigned. Was the statute drafted to deal with both instruments?

    The amendments also for the very first time create a private right of action for violations of Section 131(f) of TILA (15 USC 1641(f)), which provides as follows: "Upon written request by the obligor, the servicer shall provide the obligor, to the best knowledge of the servicer, with the name, address and telephone number of the owner of the obligation or the master servicer of the obligation." The statute does not provide a time period for compliance. And, it is not clear to me if the consumer has the power under the statute to require the response to list the Owner instead of the Master Servicer.

    What is clear is that these amendments give consumers and their attorneys two new powerful tools to use in connection with the issue of "who owns and holds" my mortgage. Truth in lending may indeed now include Truth in Ownership with some serious financial penalties for non-compliance.

    Friday, August 7, 2009

    Why Should Servicers Get A Safe Harbor?

    Posted on FinReg21 by Isaac Gradman:

    On May 21, 2009, President Barack Obama signed into law the Helping Families Save Their Homes Act (Public Law 111-22), a bill with ostensibly noble goals of helping to ease the fallout from the greatest financial calamity since the Great Depression. But behind the grandiose title and the provisions aimed at keeping troubled borrowers in their homes, the bill carried with it powerful protections for influential mortgage lenders—companies whose irresponsible lending had helped fuel the subprime mortgage meltdown and the broader credit crisis that followed. These protections, known as the “Servicer Safe Harbor,” revealed that families were not the only group that Washington was trying to “save.” This article traces how the Servicer Safe Harbor came to be included in P.L. 111-22 based on the actions of a single investor advocate and explores why this legislative parachute for servicers may not be constitutional, let alone just.

    In Part I of this article, I explain the role that servicers played in the housing bubble that preceded the meltdown, and how their continued involvement impacts the mortgage market. In Part II, I discuss the massive litigation brought against Countrywide Financial by the Attorneys General of dozens of states, and how this litigation led to one of the largest, and potentially most ill-conceived, legal settlements in history. In Part III, I introduce the pending litigation initiated by William Frey and his firm, Greenwich Financial Services, which seeks to prevent Countrywide from ignoring its contractual obligations in carrying out this settlement. In Part IV, I recount the introduction and passage of the Helping Families Save Their Homes Act. In Part V, I explore the constitutional ramifications of the Servicer Safe Harbor and what it means, not only for Frey’s suit, but also for investors and taxpayers. And, finally, in Part VI, I discuss how an alternative solution could remedy this misguided and potentially unconstitutional reallocation of losses from mortgage modification.

    PART I – The Securitization Spire

    To understand the importance of the Servicer Safe Harbor, it is useful to know something about securitization, the process at the heart of the explosive growth in mortgage lending over the last decade. Securitization was intended to help normalize the risk of mortgage lending and create safer investments out of residential mortgage loans, which were historically volatile and risky to own. The reason for this was that a bank or other owner of a mortgage loan faced two risks: on the one hand, the borrower could default, forcing the holder of the loan to conduct a costly foreclosure to recoup a portion of the investment, and on the other, the borrower could pay back the loan all at once (known as a “prepayment”), putting the holder of the loan in the undesirable position of having to find someplace else to invest its excess capital.

    Securitization, as recounted memorably in Michael Lewis’ Liar’s Poker, was Wall Street’s solution to this problem. The idea was to buy-up large numbers of mortgage loans and sell securities backed by the cash flows from these loans. These so-called mortgage-backed securities made it possible for investors to hold a piece of a diversified pool of several thousand mortgages that would theoretically have a predictable rate of return, and investors loved them.

    The process of a securitization went as follows: a large lender or bank (known as the “Originator”) would make loans based on a published set of underwriting guidelines, either directly or through its correspondent lenders and brokers. The Originator would then immediately sell most of these loans to a Wall Street investment bank (known as the “Seller and Sponsor”), while sometimes remaining involved as the “Master Servicer” and earning a healthy yearly fee for servicing the loans. We will come back to the importance of servicers shortly. The Seller and Sponsor that now held the loans (or one of its related entities) would deposit the loans into a securitization trust and market securities based on the income stream from those loans to investors. These securities were divided into tiers or “tranches” and given ratings by the ratings agencies based on their seniority in the cash payment waterfall. Often, mortgage insurance would be placed on the individual loans or loan pool, guaranteeing repayment of a percentage of the loan principal in the event of default, and thereby boosting to investment grade the ratings given to the securities. And large institutional investors, hungry for investment-grade securities providing a significant rate of return, would buy up these bonds as fast as Wall Street could create them.

    If structured properly, securitizations can be an efficient and valuable tool to spread risk and increase investment in residential mortgage loans. However, starting in 1995, and continuing for the next decade, the United States experienced the greatest period of home price appreciation in its history, and the proper safeguards that should have been placed on mortgage-backed securitizations were thrown out the window. Demand from investors for mortgage-backed securities outstripped the number of available loans, inducing lenders to loosen their guidelines to create more lending opportunities. “Subprime lending” was seized-upon as a way to generate greater loan volume, broadening a class of low- or no-documentation loans that formerly was reserved for wealthy individuals who did not wish to disclose all of their income sources.

    “Subprime” borrowers are defined by the United States Department of the Treasury as those with “weakened credit histories [and]...reduced repayment capacity.” Under ordinary circumstances, banks would have shied away from lending money to such borrowers. But housing prices increased so steadily from 1995 to 2005, fueled in large part by historically-low interest rates, that the short-term risk of borrower default was dampened significantly. Borrowers struggling to make payments could often refinance their loans at more favorable rates, or if they defaulted, their homes could be sold at a price that recouped most of, or even more than, the original principal of the loan.

    Under these conditions, all of the players in the securitization cycle stopped caring as much about whether these loans were being made wisely, i.e., to borrowers who actually had the ability to pay them back. Instead, lenders began originating greater and greater volumes of loans regardless of the credit risk: loans which they could immediately turn around and sell off their books to Wall Street, which could likewise turn around and sell slices of that risk to investors. And as long as home price appreciation continued, this game of hot potato proved very profitable. But so dependent was this game on the idea that housing prices would continue to rise, that when home prices simply leveled-off at the end of 2005 and the beginning of 2006, the music stopped, and the market for mortgage-backed securities disappeared with it.

    Part II – The Greatest Trick Bank of America Ever Pulled

    When the dust from the greatest financial meltdown since the Great Depression had cleared, what was left at the center was a giant pool of so-called “toxic” assets—mortgage-backed securities and derivatives that could not be properly valued because the underlying mortgages were defaulting at rates previously unknown and difficult to project. In its early attempts to curtail the fallout from this crisis, Washington passed legislation designed to reduce foreclosures by encouraging loan modifications to allow borrowers to continue to meet their payment obligations. Loan modifications are also known as “workouts,” because they are new payment plans servicers “work out” with distressed borrowers to allow them to stay in their homes, usually by lowering interest rates, reducing principal amounts, or extending loan terms (i.e., the borrower would have more years to pay off the loan, thus lowering monthly payments). Federal bills such as the HOPE for Homeowners Act and programs such as Making Homes Affordable took stabs at encouraging workouts, but these attempts were largely unsuccessful. When Washington probed into the reason for this failure, legislators discovered that the servicer, the only party with the legal right to authorize a workout, was often not cooperating.

    As described above, the servicer was often the lender that had originated the loan but then sold it off, and now held the rights to service the loan. Servicers were paid a fee by the securitization trust in return for interfacing with the borrower, collecting payments, and forwarding these payments to the trust. The securitization trust agreements, commonly known as pooling and servicing agreements, obligated servicers to act on behalf of the ultimate bondholders, and thus to maximize the money coming into the securitization structure. The pooling and servicing agreements would also authorize servicers to negotiate a loan modification if the borrower were in danger of default, but generally only when investors agreed or when the net present value to investors was maximized by a workout rather than a foreclosure sale. Fearful of offering loan modifications without investor approval or without substantial proof that the workouts would bring more money to investors in the long run, servicers were reluctant to offer the large-scale, and extremely costly, loan modifications that Washington was encouraging.

    At the same time, horrific tales of irresponsible lending practices were coming to light, putting large lenders/servicers like Countrywide squarely in regulators’ sights. On June 26, 2008, California Attorney General Edmund “Jerry” Brown sued Countrywide, its CEO Angelo Mozilo, and its president David Sambol for allegedly pushing California borrowers into mass-produced, risky loans for the sole purpose of earning enormous profits by reselling these loans on the open market. The suit sought restitution, injunctions, and civil penalties for Countrywide’s allegedly “predatory” lending practices. That same day, Illinois’ Attorney General Lisa Madigan filed a similar suit on behalf of the residents of her state. By the end of September 2008, 11 states had filed related suits against the country’s former number one home mortgage lender.

    These suits were eventually consolidated, and on October 6, 2008, Jerry Brown announced, with great fanfare, that Countrywide had agreed to settle all actions to the tune of over $8.4 billion. The Attorneys General involved hailed the deal as a model for the rest of the country in solving the housing crisis, and Brown called it “the biggest mandatory loan modification in American history.” The settlement included provisions halting foreclosures while modifications were worked out, cash payments to borrowers who were victimized by predatory lending practices, and loan modification assistance for an estimated 400,000 borrowers in danger of losing their homes. Bank of America, which had acquired Countrywide in July 2008, described the settlement as a win for investors, borrowers, and the mortgage market as a whole.

    But with regulators, industry executives, and commentators tripping over themselves to praise the accord, few seemed to realize (or at least acknowledge) what a huge win the settlement was for Bank of America itself. This was because, as was typical in the securitization cycle discussed above, though Countrywide had originated the loans at the center of these lawsuits and the settlement agreement, it no longer owned those mortgages. Instead, it retained only servicing rights to these loans, and thus would not bear the costs of loan modifications arising from lowered monthly payments, principal amounts, or interest rates. It was the ultimate bondholders, who had invested in the securities backed by these loans, and who had carefully negotiated protections against unfettered loan modifications in the pooling and servicing agreements, who instead would be on the hook for the overwhelming majority of the $8.4 billion Countrywide promised to aid distressed borrowers.

    If the Attorneys General were truly hoping to punish Countrywide for its irresponsible lending practices, foisting the cleanup costs on innocent investors was a remarkably ill-conceived way to do it. On the other hand, if regulators had no intention of holding Countrywide financially accountable, the settlement was pure political lip service. But regardless of whether this cost-shifting was understood by regulators and simply ignored for political reasons, or whether regulators simply did not understand the ownership structure underlying securitizations, the fact that Countrywide and Bank of America had passed the financial liability for their allegedly predatory practices onto investors was not lost on the bondholders themselves. Yet, no investor had the appetite to stand up to the influential Bank of America, let alone the political momentum that had gathered behind the aggressive pursuit of loan modifications, as more than a dozen states had now signed on to the Countrywide settlement. Two months later, investors would find their voice in the form of one individual who had the stomach to battle Countrywide in court, and bear the brunt of the political backlash that followed.

    Part III – A Lone Voice for Investors

    On December 1, 2008, broker-dealer Greenwich Financial Services LLC (Greenwich Financial) filed a lawsuit in New York State Supreme Court for the County of New York, asking for a declaration that Countrywide be forced to repurchase the loans it modified pursuant to its settlement with the Attorneys General (now involving 15 states), at a price not less than the full unpaid principal balance (UPB) of the loans. The complaint in Greenwich Financial Services, et al. v. Countrywide Financial Corp., et al. (the “Complaint”) opens with the following allegation:

    "To settle allegations of widespread predatory lending made against it by the Attorneys General of at least 15 States, Countrywide Financial Corporation has agreed to reduce payments due on hundreds of thousands of mortgage loans by a total of up to $8.4 billion. Most of these loans are owned not by Countrywide, but rather by trusts to which Countrywide sold the loans in the process of securitization…Countrywide plans not to absorb the $8.4 billion reduction in mortgage payments itself (even though it was Countrywide’s own conduct of which the Attorneys General complained in the proceedings that Countrywide has now settled), but rather to pass most or all of that reduction on to the trusts that purchased mortgage loans from Countrywide. (Complaint ¶1)"

    The Complaint is styled as a class action and seeks relief on behalf of the “thousands” of persons or entities who hold certificates in one or more of the 374 affected securitizations.

    The moving force behind this class action was Greenwich Financial CEO William Frey, a self-styled advocate for investors’ contractual rights, who had up to that point used the fund only to manage his family’s holdings. Since March of 2008, Frey had been vocal in his opposition to conducting loan modifications without investor approval and had received an “outraged” letter from six members of the U.S. House of Representatives on October 24, 2008, that “strongly urge[d Frey] to reverse” his decision to oppose their legislative efforts to encourage loan modifications. Though Greenwich Financial specialized in the structuring and distribution of mortgage-backed securities, it had never been involved in subprime transactions and had not been involved in so-called Alt-A transactions (generally referring to loans with less than full documentation of the borrower’s income and/or employment) in the past five years, as Frey had deemed the underlying collateral “junk.” But that all changed when Frey was approached by a bondholder that desired to challenge Countrywide’s actions under the cloak of anonymity.

    A Wall Street Journal article published on the day the Complaint was filed stated that while Frey did not initially hold any of the Countrywide bonds that were the subject of the settlement, he subsequently set up a fund (called “Distressed Mortgage Fund 3”) to accept “substantial holdings” in Countrywide bonds from one investor who “wanted to challenge the company’s actions while staying out of the spotlight.”1 Frey refused to disclose any information about this investor, explaining that, “[t]his is a vehicle designed to put me in charge of resolving these pools.”

    Soon, it became clear why this anonymous investor had wanted to remain in the shadows. On February 8, 2009, 300-400 protestors converged on the front lawn of Frey’s home in Greenwich, Connecticut, wearing yellow shirts with “Stop Loan Sharks” emblazoned on the front and dragging furniture onto Frey’s lawn to symbolize the dislocation felt by borrowers who had been foreclosed upon and forced from their homes. The protest was part of a three-day “homeowners’ workshop” sponsored by the Neighborhood Assistance Corporation of America (NACA) and aimed at several top executives of companies who refused to allow NACA to renegotiate the terms of loans on behalf of its members.

    While these protestors were not entirely blameless themselves, as many had contributed to the mortgage crisis by borrowing beyond their means, their demonstration on Frey’s front lawn generated considerable negative publicity for Frey and his lawsuit.2 Yet, Frey believed he was the only person who was willing and able to act as an advocate for bondholders who had no say in the Countrywide settlement (which had now been joined by over 30 state Attorneys General), and he was willing to forego popularity to continue pursuing this cause. Moreover, it appeared that Frey had a strong case, as investor contract rights in the pooling and servicing agreements underlying the securitizations at issue made it clear that modified loans had to be repurchased at a price equal to the unpaid principal balance by the servicers effectuating those modifications. Analysts began to speculate that a win for Greenwich Financial in the lawsuit would spell doom for Bank of America and the other large servicers facing enormous liabilities from the mortgage loans they originated, held, or serviced. What analysts and Frey failed to anticipate, however, was that Congress would come along and pull investors’ contract rights out from under their feet.

    Part IV – Friends in High Places

    While Greenwich Financial v. Countrywide moved forward in the New York State courts and homeowner advocacy groups were organizing to protest Frey’s actions, a new front in the battle over loan modifications emerged in Washington, D.C. Since the initiation of Frey’s suit, Bank of America had been using its best efforts to lobby legislators in the nation’s capitol for legal protection. Though no single entity ever has a monopoly on political influence, it appears that Bank of America’s lobbying efforts paid tangible benefits when, on March 5, 2009, the U.S. House of Representatives passed H.R. 1106, known as the “Helping Families Save Their Homes Act of 2009.” The bill had been introduced by representatives Paul E. Kanjorski (D-PA), who was the second biggest recipient of Countrywide campaign contributions since 19893, and Michael N. Castle (R-DE), whose second largest contributor during the 2007-08 election cycle had been Countrywide/Bank of America,5 making Castle one of the top ten beneficiaries of Bank of America in the prior year (behind mainly presidential candidates). The bill could not have been better for Countrywide in its lawsuit with Greenwich Financial if the text had been written by Bank of America itself.

    Section 201 of H.R. 1106, entitled “Servicer Safe Harbor For Mortgage Loan Modifications,” contained a provision that essentially relieved Countrywide and other servicers from liability for complying with the settlement with the Attorneys General and performing large-scale loan modifications. With respect to any residential mortgage loan for which default was reasonably foreseeable, the borrower was living in the home, and the servicer reasonably believed that modification would generate a higher net present value recovery than foreclosure, Section 201(a)(2) stipulated that:

    "Notwithstanding any other provision of law, and notwithstanding any investment contract between a servicer and a securitization vehicle or investor, a servicer—

    (i) shall not be limited in the ability to modify mortgages, the number of mortgages that can be modified, the frequency of loan modifications, or the range of permissible modifications; and

    (ii) shall not be obligated to repurchase loans from or otherwise make payments to the securitization vehicle on account of a modification, workout, or other loss mitigation plan for a residential mortgage or a class of residential mortgages that constitute a part or all of the mortgages in the securitization vehicle…"

    In other words, Frey’s contracts would no longer be worth the paper on which they were printed. As if that were not enough, H.R. 1106 provided that servicers would be given cash incentives of $1,000 for each loan modified, as a further encouragement to conduct workouts. This meant that the same servicers that had often irresponsibly originated these problematic loans in the first place would be paid to correct their own mistakes.

    In response to this sudden shift in the legal landscape, Frey tried to fight back with a lobbying campaign of his own. On March 25, 2009, Frey gave a talk in Washington to more than 30 money managers with stakes in the $6.7 trillion mortgage bond market, warning them that government efforts to assuage the housing crisis would undermine debt contracts and do more harm than good. Also presenting at the bond investor conference, which was attended by, among others, representatives from Royal Bank of Canada's Voyageur Asset Management Inc. and Thrivent Financial for Lutherans, were David Grais, the lawyer representing Frey in his suit against Countrywide, and Laurie Goodman, an analyst at Amherst Securities and UBS AG’s former fixed income research chief. As a result of this meeting, a group of investors with residential mortgage-backed securities holdings totaling more than $100 billion hired Patton Boggs LLP, Washington’s biggest lobbying firm, to gear up for the fight in Washington over the pending legislation.6

    But Frey and his fellow investors had showed up too late to the lobbying party to nip the Servicer Safe Harbor in the bud. Though their lobbying efforts were able to generate some positive press in the mainstream news media7 and some softening of the bill in the Senate (while an amendment introduced by Senator Bob Corker (R-TN) to significantly limit the Servicer Safe Harbor was promptly defeated by a 2-to-1 margin), the bill simply had too much political momentum behind it. On May 6, 2009, the Senate passed a version of the Helping Families Save Their Homes Act (S. 896) containing a more moderate version of the Servicer Safe Harbor, by a vote of 91-5. On May 19, the House passed the Senate’s version of the bill by a 367-54 margin, and two days later, President Obama signed it into law (P.L. 111-22).

    Though the final version of the Servicer Safe Harbor is watered-down from the original version proposed in the House, the legislation still operates to undermine bondholders’ contract rights and relieve from liability the very entities which were often responsible for creating these distressed loans. The final version of the Section 201(b) Servicer Safe Harbor stipulates that, “[n]otwithstanding any other provision of law, whenever a servicer of residential mortgages agrees to enter into a qualified loss mitigation plan” and “reasonably determine[s]” that such workout will benefit investors and interested parties on the whole, that servicer “shall not be subject to any injunction, stay, or other equitable relief to such [interested] party, based solely upon the implementation by the servicer of a qualified loss mitigation plan.” The “Rule of Construction” of Section 201(b) further provides that servicers would still be liable for “actual fraud in the origination or servicing of a loan or in the implementation of a qualified loss mitigation plan, or for the violation of a State or Federal law, including laws regulating the origination of mortgage loans, commonly referred to as predatory lending laws.”

    Part V – Will Servicers Be Let Off the Hook?

    So what does this bill mean for Frey’s suit and investment in mortgage-backed securities in general? In a conversation with Frey over lunch in New York last month, Frey told me that “the lawsuit is not dead—we believe we can still pursue our contract rights.” Frey bases this belief on the fact that legislators removed the phrase “notwithstanding any investment contract between a servicer and a securitization vehicle or investor” from the preamble to the House version of Section 201, leaving only the phrase “[n]otwithstanding any other provision of law.” Frey interprets this to mean that the Servicer Safe Harbor cannot operate to abrogate contract rights. While Frey is correct that the final Servicer Safe Harbor does not provide servicers the sweeping relief from liability featured in the original version in the House, it certainly muddies the waters. The absence of a specific provision allowing servicers to disregard contract rights is not nearly as strong for Frey as a provision explicitly protecting those rights would have been, and it sounds like an uphill fight to convince any court that, based on the bill’s legislative history, this federal legislation should not be interpreted to trump private contracts.

    If the bill is indeed interpreted to bar investors from insisting upon the repurchase of loans modified by servicers, investors could still attempt to force repurchase by arguing that servicers are not acting within the terms of the Servicer Safe Harbor. One potential avenue of relief could be the provision of Section 201(b) requiring servicers to modify only when they have determined that such workout would “likely provide an anticipated recovery on the outstanding principal mortgage debt that will exceed the anticipated recovery through foreclosures.” The question is whether investors can force servicers to repurchase loans they modify without showing that the expected net present value (NPV) from modification exceeds the expected NPV from foreclosure. The bill seems to allow servicers to "reasonably determine" on their own when the anticipated recovery from modification will "likely" exceed the anticipated recovery from foreclosure, irrespective of any NPV analysis. This creates a serious conflict of interest due to servicers’ considerable holdings in second-lien mortgage loans that they would otherwise have to modify before the first liens held by investors, and courts may force servicers to take investors’ interests into account to the same degree as their own.

    However, if, as seems likely to me, investors are not able to argue around the application of the Servicer Safe Harbor, resulting in a massive transfer of wealth from investors (including pension funds, retirement funds, and other bondholders) to banks, Frey and other investors would have a cognizable challenge to the Helping Families Save Their Homes Act on constitutional grounds. Though they would like to be able to argue that the legislation abrogates contracts in contravention of the Constitution’s Contracts Clause (Article I, Section 10, clause 1), that clause only provides that “No State shall. . .pass any. . .Law impairing the Obligation of Contracts”; it does not limit the rights of the federal government. Instead, investors will have to seek shelter under the Takings Clause of the Fifth Amendment, a notoriously difficult road to hoe.

    The Takings Clause states simply: “[n]or shall private property be taken for public use, without just compensation.” In the landmark case of Pennsylvania Coal v. Mahon, 260 U.S. 393, 415 (1922), the Supreme Court articulated the traditional formulation of the Clause: “while property may be regulated to a certain extent, if regulation goes too far it will be recognized as a taking.” More recently, the Court has held that the purpose of the Clause is “to prevent the government from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.” Eastern Enterprises v. Apfel, 524 U.S. 498, 522 (1998). Yet, the question of how the dozen words of the Clause and this stated purpose apply to particular government action has engendered a mountain of impenetrable Supreme Court precedent that makes it next to impossible to predict what regulations the Court will find go “too far.”

    In Connolly v. Pension Benefit Guaranty Corp., 475 U.S. 211, 224 (1986), the Court revealed that, in the “regulatory takings” context (when a law or regulation indirectly causes an alleged taking, rather than a “classic taking” involving direct government appropriation of private property), this shifting nature of Takings Clause jurisprudence was intentional:

    "we have eschewed the development of any set formula for identifying a “taking” forbidden by the Fifth Amendment, and have relied instead on ad hoc, factual inquiries into the circumstances of each particular case."

    However, to aid in this determination, the Court has identified three factors of “particular significance”:

    "(1) the economic impact of the regulation on the claimant; (2) the extent to which the regulation has interfered with distinct investment-backed expectations; and (3) the character of the governmental action. (Connolly, 475 U.S. at 225 (internal quotation marks omitted).)"

    Eastern Enterprises provides the best recent example of how this standard has been applied to alleged regulatory takings and illustrates how the Court might evaluate a challenge to the Servicer Safe Harbor. In that case, Eastern Enterprises, a former coal operator, challenged the Coal Act’s requirement that it contribute premiums to stabilize a health care fund for retired coal workers based on its participation in the coal industry some 30 years prior. In the majority opinion, written by Justice Sandra Day O’Connor, the Court first noted that while “a strong public desire to improve the public condition is not enough to warrant achieving the desire by a shorter cut than the constitutional way of paying for the change” (id. at 523), “the fact that legislation disregards or destroys existing contractual rights does not always transform the regulation into an illegal taking.” Id. at 527.

    Analyzing the regulation under the three factors articulated above, the Court found that the first factor—economic impact—was met because the Coal Act imposed a burden on Eastern Enterprises of $50 to $100 million. Id. at 529. Under the second factor—interference with reasonable investment-backed expectations—the Court found that the Coal Act’s allocation scheme reached back 30 to 50 years to “attach[ ] new legal consequences to an employment relationship completed before its enactment,” and thus interfered with Eastern Enterprises’ expectations. Id. at 532 (internal alterations and quotation marks omitted). Finally, as to the nature of the governmental action, the Court found that, while it was understandable that Congress would seek a legislative remedy to what it perceived to be a significant problem,

    "when…that solution singles out certain employers to bear a burden that is substantial in amount, based on the employers’ conduct far in the past, and unrelated to any commitment that the employers made or to any injury they caused, the governmental action implicates fundamental principles of fairness underlying the Takings Clause. (Id. at 537.)"

    Based on these findings, the Court held that the Coal Act’s allocation of liability ran afoul of the Takings Clause, and that the Act’s operation should be enjoined as applied to Eastern.

    The makeup of the Court has changed since Eastern Enterprises was decided in 1998 and will likely experience further change before any challenge to the Servicer Safe Harbor is to be taken up by the Court. This, combined with the fact that the Court has shifted directions on similar regulatory takings challenges (see Connolly, 475 U.S. at 224 (holding that the Coal Act’s nullification of a contractual provision limiting liability was not a taking)), means the outcome of any such challenge would be a crapshoot. However, applying a similar analysis to the Servicer Safe Harbor as was applied in Eastern Enterprises, I believe that legislation would also run afoul of the Takings Clause.

    First, the economic impact of the legislation is tremendous—the large majority of $8.4 billion in losses from loan modifications would be dumped onto the laps of investors rather than born by the servicers who were contractually obligated to absorb those losses. Second, the Safe Harbor obliterates the reasonable investment-backed expectations of investors. These investors specifically sought to include provisions in the pooling and servicing agreements underlying the bonds they were investing in, which prevented servicers from modifying the terms of these mortgages without paying for them. Allowing the government to abrogate these contractual rights without just compensation would work a significant injustice against the investors who believed that their contracts protected them against this very risk (not to mention discouraging future investment in the U.S. mortgage-backed securities market). Finally, just as in Eastern Enterprises, the nature of the government action in this case singles out an isolated group of persons and entities to bear a substantial burden that is largely unrelated to any commitment they made or to any injury they caused. Indeed, it would be difficult to argue that the investors who purchased these distressed loans were somehow more responsible for their existence than the lenders who originated them. Overall, it seems that allowing the Servicer Safe Harbor to stand would contravene the Court’s statement that “justice and fairness require that economic injuries caused by public action must be compensated by the government, rather than remain disproportionately concentrated on a few persons.” Eastern Enterprises, 524 U.S. 498 at 523 (internal alterations and quotation marks omitted).8 Fairness would seem to require that the costs of a financial crisis of this magnitude, with its broad-reaching causes and effects, be borne by the society as a whole, and not by an insular minority.

    Part VI – What’s the Answer?

    Anyone who claims to have an easy solution to the foreclosure crisis is not being honest. While it is clear that distressed mortgage-backed securities, or “toxic assets,” are causing significant destruction to our economy because they exist in a state of limbo—in which they cannot be properly valued, sold, or reengineered—cleaning up the mess is no simple matter. Due to the number of different players with varying interests that are involved in any securitization, any plan to unwind these toxic assets and allocate losses will be inherently complex and costly. Governmental efforts to date have sought to utilize broad strokes and blunt instruments to fix the problem. A more rational approach must involve a case-by-case, loan-level analysis. Thus, in the event that the Servicer Safe Harbor is ultimately amended by Congress or struck down by the Supreme Court, I offer some suggestions for dealing with this crisis in a manner that takes its causes into account.

    As an initial matter, it must be recognized that every loan is unique, with its own set of circumstances that control what solutions are feasible. Thus, there is no way to avoid the harsh reality that somebody must review every mortgage for which payments have stopped and determine how to resolve it, either by inducing the borrower to make reduced payments or by liquidating the asset. The most logical actor to oversee this process is not the servicer or the investor, both of which have inherent conflicts of interest, but, unfortunately, the federal government. Whether the government would enlist Freddie Mac or Fannie Mae to oversee this process or create a new agency, the reality is that the foreclosure crisis is a matter affecting the nation as a whole, and the reconciliation process must be carried out by an entity with the public interest in mind.

    In order to oversee the process of resolving distressed mortgage loans, the government must take control over the securities that are backed by these loans. To this end, the solution initially proposed of using Troubled Asset Relief Program (TARP) funds to purchase these toxic assets still makes sense. If dampening the effects of the foreclosure crisis is truly in the public’s interest, using taxpayer dollars to do so seems fair and logical. Furthermore, by using this significant capital outlay to buy these assets from investors and banks (at some amount that takes into account their depressed value but still constitutes “just compensation” so as not to run afoul of the Takings Clause), those entities would no longer be stuck in financial purgatory, holding onto illiquid assets that cannot be properly valued.

    Once the government takes control of these securities, it must, with the cooperation of mortgage servicers, investigate every delinquent or defaulted mortgage loan to determine which of three categories the loan falls into. Category I would consist of mortgages that appear to be the product of fraud on the part of the borrower. So, for example, if the borrower lied about his or her income, there was no arms-length sale, the borrower never existed, or the borrower never intended to occupy the premises and was merely a speculator, this loan should be foreclosed-upon immediately. Foreclosure is undoubtedly a costly process to be avoided, if possible; but besides being politically unpalatable to subsidize lying borrowers staying in their homes, there is no way to implement a workout if the borrower never intended to pay the loan back.

    Category II would be for loans that the government determines were a product of negligence, misrepresentation or improper/illegal lending practices on the part of the lender (or its correspondent lender or broker) that originated the loan, e.g., the lender falsified the borrower’s income without the borrower’s participation, induced the borrower into a riskier or more costly loan than necessary, or engaged in any number of other predatory practices. In these cases, the loan should be modified at the expense of that lender. These lenders made considerable representations and warranties when originating and selling off the loans at issue and promised that the loans would meet certain guidelines and comply with the law. They profited handsomely off of the sales of these loans, made on the premise that lenders would stand behind loans if they did not meet the concrete lending guidelines they agreed to follow. If it turns out these representations were false, it should be that lender, not the investor or the taxpayer, who should bear the cost.

    Finally, for the overwhelming majority of troubled loans that the government determines were made in good faith, but the borrower lost his or her job, took a cut in pay, or got in over his or her head for any number of legitimate reasons, the government must place them in Category III—for loans requiring a closer look. If the borrower could likely remain in his or her home with a reasonable modification to the terms of the mortgage, this workout should be effectuated; and the cost should be borne by the taxpayer, as it is in the public’s best interest that foreclosure rates decrease, and borrowers continue to make payments on their mortgages and remain in their homes. If the borrower would require a modification that would be so significant as to not be reasonable (e.g., the borrower can afford a mere fraction of the monthly payment or would have to be placed on a 60-year plan to pay it off), the reality is these loans should also be placed in foreclosure. Determining where to draw the line of “reasonableness” in the amount of a modification would be a difficult decision, but the line must be drawn. Due to the considerable loosening of lending standards over the past decade, many borrowers qualified for loans that they could not afford and never should have been able to purchase the homes they did. It cannot be good public policy for the taxpayer to continue to subsidize individuals living beyond their means.

    There is precedent for such a solution, and it may not ultimately require the enormous capital outlay that some commentators have predicted. Those familiar with the example of the Home Owners’ Loan Corporation (HOLC) will recall that the government established just this sort of vehicle in 1933 to refinance the loans of distressed borrowers to help avert foreclosures. The HOLC came to own nearly one fifth of the home loans in America but was ultimately able to sell off the loans and any underlying properties acquired via foreclosure—and even turned a small profit—when the market stabilized. In the present case, there is good reason to believe that an entity that could afford to hold these loans for long enough could recoup a significant portion of its investment (or even a profit) when the housing market recovers.

    In this manner, though the process may take several years, we ultimately may be able to unwind these toxic assets and free up our credit markets to once again make reasonable loans to borrowers who actually can pay them back. Hopefully, this time we will ensure that tighter lending guidelines are enacted and followed, that borrowers maintain sufficient equity in their homes so they are incentivized to continue making payments, and that lenders maintain enough “skin in the game” so that they are not incentivized to churn out ever-increasing numbers of loans that can be quickly sold off their books. Only in this way can we prevent the next credit crisis from emerging during the next period of growth and expansion in the housing market. In the meantime, everyone who participated in this crisis must bear a share of the cost to clean it up—even the servicers.

    Isaac Gradman is an attorney at Howard Rice Nemerovski Canady Falk & Rabkin, in the firm's Litigation Department. Gradman has been involved in the litigation arising from the subprime mortgage crisis, and is the author of a law blog called The Subprime Shakeout. The views and opinions expressed herein are solely those of the author, and do not reflect those of Howard Rice Nemerovski Canady Falk & Rabkin or any other organization.


    End notes

    1 Ruth Simon, "Mortgage-Bond Holders Get Voice: Greenwich Financial’s William Frey Challenges Loan Servicers Like Bank of America," Wall Street Journal, December 1, 2008.

    2 See, e.g., Amanda Norris, "Protest targets ‘predator.’"The Stamford Times, February 11, 2009.(available at; Paul Jackson, "NACA Targets Mortgage Investor as ‘Predator.’" (, February 12, 2009) (available at

    3 Previously available at, but Countrywide contributions are no longer segregated from those of Bank of America. Kanjorski’s fourth largest contributor for the 2007-08 election cycle was Bank of America



    6 Jody Shenn, "Mortgage Investors Form Battle Lines Over Housing Aid." Bloomberg, April 23, 2009(available at

    7 See Gretchen Morgenson, "A Reality Check on Mortgage Modification," New York Times, April 25, 2009, and Eric Brenner and Hamish Hume, "How Big Banks Want to Game the Mortgage Mess," Wall Street Journal, May 4, 2009.

    8 The strongest counterargument to this analysis, and possibly the saving grace of the Servicer Safe Harbor, is likely its language stipulating that a servicer may not be held liable “based solely upon the implementation by the servicer of a qualified loss mitigation plan.” This, combined with the provision’s “Rule of Construction” protecting investors’ rights to pursue repurchases if the servicer violated a predatory lending law or originated a loan in a fraudulent manner, indicates that servicers cannot be relieved from liability for fraud and predatory lending by modifying the loan. Supporters of the Servicer Safe Harbor may argue that this means that the law does not effect a “complete taking” and still allows servicers to be held liable if their fraudulent actions engendered the troubled loan. Still, the Act is silent as to whether servicers may continue to be held liable or forced to repurchase loans that they originated negligently, a much more common issue with a much lower threshold of proof. As described above, during the housing boom, lenders often looked the other way and ignored red flags regarding the legitimacy of borrower statements or their ability to pay back loans. If investors are no longer able to enforce their contract rights to put such loans back to the lenders, lenders would have a strong argument that the bill is not consistent with what “justice and fairness require.” See Eastern Enterprises, 524 U.S. 498 at 523.