Tuesday, March 17, 2009

The Obama Housing Plan and Second Mortgages

This topic is a huge issue since most of the guidelines are for the first mortgages with the encouragement of lenders to extinguish the second liens. Since many of the same lenders have both first and second liens it is in their best interest to get the most money they can through modifications and refinancings.

The system is a mess, some might even claim its broken. But cleaning things up can be even messier. From this article in BusinessWeek titled New Bank Powers Concern Wall Street we read about some issues involving second mortgages in the new Housing Plan. Lets take a look -

Wall Street has had about a week to assess the U.S. Treasury's new plan on loan modifications. Most institutional investors—the pension managers, mutual funds, and hedge fund players who financed the housing market by buying securities tied to mortgages—have been fixated on what is now commonly called a "cram-down." That's when a bankruptcy judge has the power to usurp a bank's authority to modify mortgages. If the interest or principal on mortgages are modified, that means the investors who bought the mortgage paper in the secondary market see less income from their investments.


But underlying the proposed changes is a radical disruption of contract law that some observers believe threatens to destabilize the markets for years to come. "I think it's a problem precedent for the government and for the abrogation of contract law," says economist and market strategist Edward Yardeni, president of Yardeni Research, an independent investment consultant. "Contracts are sacred in a capitalistic society, and if you start having the government intervene and break contracts, what do we have left? It's a real turn-off to the private sector to provide capital where it's needed, which is necessary for the long-term health of our markets and our economy. The government has managed to create chaos of our credit markets."


The four (Bank of America, Citigroup, Wells Fargo, and JPMorgan Chase) held $347 billion of residential revolving lines of credit, or 52% of all such loans held by Federal Deposit Insurance Corp.-insured institutions, says Laurie Goodman, a structured finance analyst at Amherst Securities, a New York firm that analyzes and trades mortgage portfolios for institutional investors.


The government's plan could allow loans in a first-lien position to be modified, leaving loans in a second-lien position untouched. As a result, Goodman worries that these institutions, which also own servicing rights on the first liens, have the opportunity to abuse their power and modify even good loans where borrowers are making payments. She says the banks have "huge incentives" to collect restructuring fees and thereby increase the value of their servicing business to the detriment of other stakeholders, among other things.


A Treasury Dept. official, who would speak only on condition of anonymity since he was not authorized to speak on the record, said the government is not trying to undermine contracts between investors and loan servicers. "Our program explicitly, right up on top, says you need to service to these guidelines unless there is a prohibition in the contracts. We certainly want this to be a market-based solution in terms of keeping…as many as 3 million to 4 million homeowners in their homes," he said. The Treasury recognizes that "second liens do create challenges" and is working on new rules governing the second liens, he added.

The 4 banks argument is that if the property does not get modified or refinanced the owner could easily end up with a short sale or in foreclosure, thereby forfeiting the second liens holders to their income.

But even for us non-banking experts it obviously is a messier area. And what did we learn, that if your HELOC or HEL is held by one of the big 4 banks listed above the extinguishing of the second mortgage will be more likely to occur. Either the government is going to just issues rules and mandates about second mortgages which will lead to quick solutions that may make many unhappy. Or they will spend time working with various lenders to try to appease the investment and contract issues thereby prolonging the issuance of the detailed guidelines.

Once again, it all comes down to who your lender is.


Anonymous said...

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