Helping Borrowers as Well as Lenders

Strapped homeowners face a disconnect

Under the $700 billion mortgage lender bailout or rescue bill that Congress reluctantly approved earlier this month, the U.S. Treasury is supposed to purchase massive pools of underwater mortgages at prices high enough to shore up their holders and restore their ability to lend.

Whether this massive government intervention that also includes the purchase of bank stocks will succeed in alleviating the credit crunch that has beset this nation remains to be determined. Yet no matter how much it may do for the faltering U.S. economy as a whole, the bailout figures to enable a lot of financial institutions to escape the disastrous consequences of what are now generally recognized to have been reckless mortgage lending practices over the past several years.

But what about the borrowers who took on zero down payment, escalating interest rate loans to buy houses they can no longer afford? With the bursting of the housing market bubble that was pumped up by all this subprime lending, many of them are now left with houses worth far less than they owe, creating a disincentive to even try to hold on to them. So further declines in home prices, driven in large part by foreclosure fire sales, have created a downward spiral that has no clear end in sight. Yet until it is arrested, more prudent, credit-worthy prospective buyers can't be expected to make purchases in sufficient numbers to get the housing market back on a sound footing.

Some will argue that these overextended subprime borrowers should be left to suffer the consequences of their own folly—just as much of the public believes holders of these defaulted mortgages should be left to stew in their own witches' brew. But as the largest of the subprime lenders, Countrywide Mortgage and its new parent Bank of America, have now conceded in settlement of a lawsuit, predatory lending practices were involved.

Under the settlement, Bank of America has agreed to allocate some $8.4 billion toward modification of the terms of mortgages on which borrowers are now delinquent, primarily by reducing their interest rate and/or principal amount. A group of state attorneys general which brought the suit is now pressing other lenders to follow suit voluntarily, while holding out the threat of further legal action.

A framework for voluntary modification was laid out in what's known as the Hope for Homeowners program that Congress enacted in July. Under this program, holders of delinquent underwater mortgages would agree to reduce their principal amount to 90 percent of a house's current appraised value, both making them more affordable to homeowners and incentivizing them with home equity to protect. In return, the Federal Housing Administration, which administers the program, would guarantee the modified loans, and FHA and the lender would share any gains realized upon a subsequent sale of the house.

Proponents of the program contend that lenders will also benefit by insulating themselves from steeper losses on foreclosures that commonly result in fire sales. And by helping quell the surge in foreclosures, which have more than doubled nationally over the past year, the ultimate benefit can be a lessening of downward pressure on the distressed housing market.

But the workings of Help for Homeowners are anything but simple, and one of the complications is what many specialists in the field see as a disconnect between strapped borrowers and the holders of their mortgages. This disconnect results from the way in which most loans have been packaged by originating mortgage bankers into huge pools of debt obligations that have been sold off to investors around the globe.

The only links between borrowers and lenders are the firms known as mortgage servicers that get paid a fee for collecting and remitting monthly payments. But according to credit counselors who attempt to work with them on behalf of borrowers in difficulty, these servicers are generally ill-equipped to deal with delinquencies and often indisposed toward workouts even though they typically have the authority to arrange them.

"We're not getting any cooperation from the servicers," says Terry Woods, a lawyer with Legal Aid of East Tennessee, which is a federally designated counselor for homeowners. Perversely, Woods asserts, "The servicers have a vested interest in delinquencies in order to get money from late fees." And as agents, they aren't on the hook for losses incurred by the principals and therefore not much concerned about their mitigation.

A new source of pressure on them could arise from the $700 billion bailout legislation under which the Secretary of the Treasury is due to name asset management firms to acquire "toxic" mortgage pools on the government's behalf. The legislation directs each such manager to "implement a plan that seeks to maximize assistance for homeowners and use its authority to encourage the servicers of the underlying mortgages... to take advantage of the Hope for Homeowners program... or other available programs to minimize foreclosures."

Hopefully, this mandate and the ongoing efforts of the State Foreclosure Prevention Group (of attorneys general) will overcome the disconnect and help strapped borrowers as much as lenders.