The battle over the mass modifications of troubled mortgages has begun in earnest. On Dec. 1, William Frey, a private investor in mortgage-backed securities, filed a lawsuit in New York State Supreme Court alleging that the proposed modification of some 400,000 home loans originally underwritten by the defunct lender Countrywide Financial is illegal.
Investor Sues to Block Mortgage Modifications – Yahoo! News.
At first glance, you’re probably thinking what I was (well, maybe not…) but seriously, why would some mean hearted investor want to prevent Bank of America from helping 400,000 home owners stay in their homes?
Let me attempt to explain:
- Countrywide wrote the loans and sold them on the secondary market.
- When they sold them, they didn’t sell them in 1 piece, they sold sections (called tranches) to a multitude of different investors and investment companies. It’s actually possible that parts of one mortgage end up being owned by 30 different “parties.”
- The parties who bought these loans bought them as contracts that had a prepayment risk but didn’t buy them with a modification risk.
- When a loan gets modified, it changes that contract which inherently changes the value of the investment.
- The investors who are suing to stop it are saying that if you start changing the contracts, you are going to effectively ruin the secondary mortgage market because suddenly the value of the loans that are sold becomes an unknown.
- If the secondary mortgage market dies, then the housing market dies. It’s just that simple, without mortgage money, the party is over.
Are the investors saying that the loans shouldn’t be modified? No they aren’t. What they are saying is, “I didn’t buy this investment with the thinking that it could be modified going forward.” So if you, Mr. B of A, want to change the terms, that’s fine, buy it back and change the terms.
The investors are, it seems to me, hoping for one of two results:
- That Bank of America will buy the loans back (with our help of course).
- That they take their chances with foreclosures. Given the report that the National Association of Realtors issued earlier on Mortgage Modification Defaul Rates of 50%, that’s not a compelling case for loan modifications.
So are the mean, evil heartless investors really that bad? Nope, they made a contract with Bank of America and they are saying that there is something bigger at stake than modifying a “few” loans.
Stay tuned, it’s going to be an interesting thing to follow…..
J Boyer Summit NJ says:
I see their point and think that a contract is a contract. If B of A or the government want to modify then buy the contracts back.
December 2, 2008 — 2:48 pm
Frank Borges LL0SA- Broker FranklyRealty.com says:
Hey Tom,
Thanks for the story.
What I don’t get is how these loan modifications work.
McCain was initially recomending that the principal just be cut down to the market rate. But the problem with that is, in theory, somebody that is $300k underwater can sell their home in 2 or 3 years and possibly “profit” $50k. That just seems crazy.
Seems more realistic to turn the loans into Negative Am type loans. So the Principal is the same, but the monthly is cut drastically, but the balance is tacked onto the end. So yes, they won’t be able to sell the home for 10-15 years, but it is better than foreclosing and being homeless, AND the investor still gets paid… eventually.
Frank
December 2, 2008 — 3:00 pm
Tom Vanderwell says:
J – I’m with you on that one.
Frank – modifications are typically done (I’m not an expert on them) on a case by case basis. If it appears that someone can make it work by just getting a break on their payment for a couple of years, then they’d take it on at the end and rather than a 30 year loan, you’ve got a 34 year loan. If it’s obvious that the only way that the home owner can “make it” is by means of a principal reduction, they might “tack that on” as a second mortgage that needs to be paid off when sold.
Anyone else know more about them and care to chime in?
Tom
December 2, 2008 — 6:01 pm
Bob says:
That works both ways when “they didn’t sell them in 1 piece, they sold sections (called tranches) to a multitude of different investors and investment companies. It’s actually possible that parts of one mortgage end up being owned by 30 different “parties.””
It is pretty easy to stop a foreclosure when the above scenario is the case. The thing few know this and loan servicers end up foreclosing on properties where the foreclosure could be set aside by asking the right questions. The lenders know this, so the loan mod can solve the problem. CW has done over 175k to date, and the number being processed right know is more than that. Very few mods are principle reduction. Most are rate reductions.
December 2, 2008 — 8:11 pm
Thomas Johnson says:
@Frank Theoretically, you are correct, however the investor bought a contract with certain payback conditions, like when they get the cash back and how much they are due. If that investor is a pension fund, insurance company, or government entity (Norwegian villagers) those assets are matched to a liability in the future, principal and interest.
We are glibly modifying your Dad’s 401k, your or my life insurance policy, or maybe that bridge you drove on to get to work this morning. I can see it now, “Mrs. Johnson, we are so sorry the bridge collapsed with your husband on it. We had to modify our life insurance reserve portfolio, and your husband’s policy was reduced. By the way, your house payment is due.”
If you want to see gazillion (is that after trillion?) dollar bailouts, start modifying pension funds’ assets around the world after having their equity positions chopped in half this year. Their actuarial assumptions would require, by law, massive infusions of cash, or the trustees would have no choice but to toss the pension funds in the lap of the Pension Guaranty Board which is more drastically under funded than the FDIC. I for one would not like to have the UAW or the Teamsters after me after I chopped their pension assets.
I am just not smart enough to understand how anybody can take mortgage modifications seriously unless the investors get a very profitable put. The trustees or the fiduciaries are on the hook for their performance.
In today’s market, I think many investors would rather sit on a 7% coupon with a 25 year maturity and possibly get the house than take paper from a too-big-to-fail bank with Hank Paulson as the only discernible asset on their balance sheet.
Oh, and one more thing, if we don’t have contracts that mean anything, we don’t have capitalism as we know it. The State (the guys with the most guns and the brown shirts) will be selecting the winners and the losers- Statist Fascism or is that Fascist Statism? Greg, please help me out here…
December 3, 2008 — 1:32 am
Bob says:
I know at least with WAMU that the only mods they can do without investor input are their asset/portfolio loans.
December 3, 2008 — 8:48 am
B.E. says:
I sat in the office of a friend who ran one of the biggest mortgage companies in our Valley.
His excited loan broker comes in, enthused because he has loan papers on a nail technician who makes $29,000 a year…..for a $250K house…..oh, no problem, he says, we can get her a loan !!!
They used to call that category, not “sub-prime” but “fuhgettaboudit !!!”
Originator did not have to hold any paper, so he had no vested interest in the quality of the loan. No oversight….just lots of free flowing money and pens writing paper…..for the future “deadbeats” of America who wanted a free toaster from the latest savings and loan opening.
—B.e.
December 3, 2008 — 9:19 am
Bob says:
@ B.e
That would be the free flowing money from the same investors who are now suing. The investor could have insisted on an actual underwriting standard prior to funding that loan.
December 3, 2008 — 12:17 pm