The nation’s mortgage investors have just won a court victory in New York, a decision likely to change the way we modify loans and foreclose on houses. In effect, you can pretty much throw out a lot of the policies, practices and thinking seen to date. A new reality is here.
Like a good mystery novel the battle between mortgage investors and loan servicers has a bunch of twists and turns. To unravel our little tale — and to explain what just happened in New York — let’s go back to the beginning: You want a loan to buy or refinance a home. You go to a lender and get your mortgage. In the majority of cases your loan will be quickly sold, packaged with other loans on Wall Street and then used to create a mortgage-backed security.
Mortgage-backed securities — MBS — are then bought by investors worldwide, typically pension funds and insurance companies. The money they spend is used to pay the folks on Wall Street who assembled and packaged the loans. The banks and brokers on Wall Street pay the lenders who created your loan. Since they once again have cash, the lenders can make new loans, collect new fees and then the process will repeat itself. As to the investors, they’re entitled to the interest and principal repayments from the mortgages they own.
So how does any of this impact you, the borrower?
First, the money for your mortgage likely came from an investor. No investor, no loan. Fewer investors, higher rates and maybe no loans for a lot of borrowers.
Second, the odds are overwhelming that you will never hear from an investor. Instead you will make your payments to a “servicer” who collects money for the investor and — if necessary — starts a foreclosure proceeding if you don’t make your payments.
The servicer is pretty much like a real estate broker hired to sell your home. The broker is not empowered to sell your home for any price or with any terms, instead he must sell within the standards set out with a listing agreement. In a similar sense a servicer is an agent of the investors who own your mortgage and must act within certain boundaries, standards which are generally created in what’s called a pooling and servicing agreement or PSA.
The PSA is a complex document, but it does have a few particulars of interest to us. For instance, it might say that a servicer cannot modify any loans or maybe just a small percentage of loans. It might also say that if a servicer wants to modify a loan without permission of the mortgage owner that’s fine — as long as the servicer buys back the mortgage.
In January 2008 Bank of America announced that it would purchase Countrywide Financial for roughly $4 billion. Countrywide had been a major purveyor of option ARMs, and by October Bank of America announced “the creation of a proactive home retention program that will systematically modify troubled mortgages with up to $8.4 billion in interest rate and principal reductions for nearly 400,000 Countrywide Financial Corporation customers nationwide.”
This wasn’t exactly a voluntary effort. Eleven states had sued over Countrywide’s practices. As California’s attorney general put it, the settlement agreement was likely to “become the largest predatory lending settlement in history.”
It would seem that the deal between Countrywide and various state AGs solved a lot of problems, but did anyone notice something strange? Countrywide and Bank of America were agreeing to modify loans they were servicing but which in many cases they did not actually own.
Some investors were upset by the Countrywide deal for several reasons.
First, their contract with Countrywide — that PSA — did not allow wholesale loan modifications.
Second, they argued that Countrywide had an inherent conflict of interest. If delinquent loans were foreclosed then Countrywide would lose the stream of income it was getting from loan servicing — income that would continue if loans were modified.
Third, some investors thought it was possible that their loans might be modified more than loans which were actually held in portfolio by Countrywide, that Countrywide could play favorites to its advantage.
The situation would seem fairly ripe for a big court battle and then the government intervened. In March of this year a new law was passed which created a “safe harbor” for loan servicers which effectively said they could not be sued for modifying mortgages.
Or did it?
None of this sat right with the Greenwich Financial Services Distressed Mortgage Fund or QED L.L.C., mortgage investors which sued Countrywide claiming their rights under the PSAs had been violated. Now, according to a decision just released by U.S. District Judge Richard J. Holwell, investors have a right to sue because the “safe harbor” language is not absolute — servicers must show they have sought to maximize the “net present value” of the investor’s loans.
The Changed World
Until the Countrywide case is settled servicers may well have spectacular levels of liability for any mortgage they modify — remember the deal set out by many PSAs is that servicers who modify loans without investor permission are required to buy back those mortgages, potentially at a cost of hundreds of billions of dollars, money which servicers simply don’t have. The result is that a modification slowdown is now likely without new laws from the federal government.
This means a lot of people are about to get hurt. The question is: Which people?
- Banks have yet to fully define their losses and efforts by the federal government to create public-private partnerships to buy toxic loans have generally gone nowhere.
- Private mortgage insurance companies have lost billions and are likely to see additional losses.
- For all the talk about loan modifications the terrible reality is that most modifications haven’t worked. The latest government report shows that nearly 60 percent of all loan modifications re-default within six months. No less amazing, 45.8 percent of all modifications leave payments either unchanged (27.3 percent) or actually higher (18.5 percent).
- Rising unemployment levels, caused in part by the mortgage meltdown, are a sure sign of additional foreclosures to come.
The Countrywide decision and the efforts to modify mortgages also mean that a lot of people have not been hurt. For instance, loan officers and lenders who reaped huge profits by selling costly subprime mortgages to borrowers who qualified for cheaper conventional financing are doing just fine. Few if any bank or brokerage executives have been forced to give back bonuses which were earned from revenue inflated with toxic loan profits. Predatory lending is still not a federal crime. Regulators who didn’t regulate are still on the job. And the ratings agencies which vouched for the quality of mortgage-backed securities have not had to give back a dime to investors who relied on their reports.
The central issue raised by the Countrywide suit is who will pay for the massive losses which remain within the financial system. Mortgage investors say they have contract rights which need to be respected — and so far at least one judge has agreed with them.
“The final outcome is likely to very different than what has been seen so far in court,” says Jim Saccacio, chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure properties. “Ultimately one can see servicers, borrowers and investors coming together to acknowledge that the agreements between them simply don’t fit today’s circumstances and that new accommodations need to be developed. Given the gravity of the economic situation, one would hope this can be done as soon as possible rather than arguing about it for years in court.”
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.