The Senate Banking Committee today hosts U.S. Treasury Secretary Henry Paulson. At the top of the list of questions committee members must ask is why the federal government cannot do more to prevent home foreclosures at the root of this ongoing crisis.
There is bipartisan agreement today that stemming foreclosures and restructuring troubled mortgages would slow the downward spiral harming financial institutions and the real American economy. What’s more, Treasury now boasts unprecedented powers to act.
The Hope for Homeowners bill enacted last summer allows the Federal Housing Administration to refinance troubled mortgage loans. The Emergency Economic Stabilization Act allows Treasury to buy up troubled mortgages and refinance them with a federal guarantee. Fannie Mae and Freddie Mac are under government conservatorship, which means both of these mortgage securitization giants can help out. And the Federal Deposit Insurance Corp. is serving as receiver of failed banks with broad authority to address risk to the system.
If Paulson can nationalize much of the housing finance system and even large swathes of banking in America, why can Treasury not slow the tide of foreclosures?
What’s missing is a way to get servicers, who control these loans on behalf of mortgage-backed securities investors, to restructure the loans themselves or sell the loans to the Treasury at a discount, so the loans can be refinanced. To date, Treasury’s efforts have failed. Owing a duty to countless investors with conflicting interests, servicers are paralyzed by fear of liability, restrictive tax and accounting rules, and the wrong financial incentives.
What’s more, the contracts typically bar servicers from selling underlying mortgage loans out of loan pools. Instead, servicers are foreclosing at alarming rates, dragging down our economy with them.
Since January of last year, the Center for American Progress has been arguing for a modern-day Home Owners Loan Corporation, which helped American homeowners out of the Great Depression. To work today, servicers need to sell the mortgage loans out of the securitized pool, so the loans can be restructured.
Although Congress added provisions to the bailout bill to require Treasury to use its new authorities to exhort servicers toward more loan restructurings, we are pessimistic that these powers will suffice. What is required is a way to liberate the servicers from the conflicting requirements and give them an incentive to sell mortgages to Treasury for refinancing and foreclosure avoidance. Here’s how it would work.
Servicers managing pools of loans for investors are generally barred by contract from selling the underlying mortgage loans, but the trust agreements also provide that servicers must amend the agreements if doing so would be helpful or necessary to stay in compliance with tax rules under the Real Estate Mortgage Investment Conduit statute. We propose to modify the REMIC rules to ensure that servicers have the authority and incentive to sell the mortgages to Treasury.
Specifically, we would provide that contract provisions that have the effect of barring servicers from selling or restructuring loans under Treasury’s programs are not consistent with REMIC. Servicers would then have a legal obligation to their investors to modify the agreements to stay in compliance. We also would urge the accounting standards board to make necessary changes to accounting rules for this limited public purpose. Servicers could then sell loans to Treasury for restructuring. Participation in the Treasury program would remain voluntary, but the key legal impediments to participation would be removed.
In the meanwhile, Treasury can get the ball rolling with existing authorities by offering to guarantee troubled loans held by servicers if they make deep principal write-downs to bring loan-to-value and debt-to-income ratios in line with prudent underwriting. While such an approach would leave restrictive servicing agreements in place, at least in some circumstances the guarantee will be sufficient to assure servicers they are acting in the investors’ best interests in modifying troubled loans. If Treasury is too swamped with other priorities, they can contract with the FDIC to implement this now.
Secretary Paulson needs to be asked why Treasury seems to be without a plan to get loan modifications going. And Congress needs to return in the lame duck session to enact a plan to entice servicers to sell these mortgages to the Treasury or modify them in place. Only stemming foreclosures will provide real relief to America’s homeowners and a real prospect of restoring stability to our credit markets.
Michael S. Barr, a former senior Treasury official, is a Senior Fellow at the Center for American Progress and a professor of law at the University of Michigan Law School. Sarah Rosen Wartell, a former HUD official and Deputy Economic Advisor to the President, is Executive Vice President of the Center. To learn more about the Center’s housing policy proposals please go to the Housing page on our website.