Mortgage Securitization Hinders Subprime Relief

One can debate whether and how much aid subprime borrowers deserve, but a pair of articles Wednesday illustrates how difficult it will be to come up with any form of relief.

In an underreported story, the FDIC hosted a session that included banking and mortgage industry leaders, legislators, investment bankers, and representatives from the SEC, the Federal Reserve, Freddie Mac, Fannie Mae, and the Treasury Department to discuss how to deal with the prospect of large numbers of subprime borrower defaults. (In fairness, the Journal does mention the meeting in passing, but only relays the comments the FDIC made in Congressional testimony).

What may not be obvious is how extraordinary a session like this is. The only comparable event, of a regulator calling a closed-door session that included attendees outside its regulatory purview, was when the Fed summoned 24 leading broker-dealers to devise a bail-out of Long Term Capital Management. The LTCM meltdown had the potential to trigger a collapse of the financial system. By contrast, the subprime debacle does not pose a systemic threat, but if nothing else, the parties involved want to fend off damage to housing markets that have high concentrations of subprime borrowers, as well as the political fallout from large numbers of foreclosures.

But as a Wall Street Journal on relief efforts makes clear, it will be hard to do much for the great majority of subprime borrowers whose paper is no longer in the hands of the originator. It is well nigh impossible to renegotiate loans that hav, “ef to borrowers, setting up the procedures would be a bureaucratic nightmare.

So it is likely as these assistance efforts progress that the results will seem capricious. A small portion of relatively lucky borrowers will be able to restructure their deals. The Neighborhood Assistance Corporation has also said it will give $1 billion to “rescue the victims of predatory lenders,” but even if they can obtain this much money (how?), the money won’t go all that far. If you assume $10,000 per borrower, which in many cases won’t even cover a year of interest and tax shortfall, and no administrative costs, that equates to 100,000 cases. The American CoreLogic study on adjustable mortgage resets by Chris Cagan, the most comprehensive work on this topic, projected that subprime defaults would lead to 1.1 million foreclosures with losses of $112 billion. And we found several of his key assumptions to be optimistic.

First, the AP story on the FDIC jawboning session:

A high-level group of federal officials, bankers and mortgage industry executives meeting Monday agreed on a goal of keeping deserving borrowers with high-risk mortgages in their homes at a time of rising foreclosures, a key banking regulator said….[Sheila] Bair [chairman of the Federal Deposit Insurance Corp] organized the unusual seven-hour meeting at FDIC headquarters on the turmoil in the market for so-called subprime mortgages

There was consensus among the regulators, Wall Street executives, bankers and others in attendance that “it will be in everyone’s interest to keep borrowers in their homes,” Bair said in a telephone interview after the closed-door meeting….

The meeting comes against a backdrop of mounting pressure on Congress and regulators to do something about rising foreclosures among homeowners unable to meet high payments. Millions of homeowners are said to be at risk of losing their homes in coming years. While a number of politicians, consumer advocates and community activists are clamoring for Congress to act, industry interests and some Republican lawmakers are warning that new restrictions on mortgage lending could choke off credit to those who most need it….

The Journal article, “Lawmakers Press Lenders for Subprime Relief,” streses the practical obstacles created by securitization:

Congressional lawmakers appear resistant to calls for a federal bailout of distressed subprime mortgage borrowers, joining regulators instead in ratcheting up pressure on lenders and investors to cut vulnerable homeowners some slack.

But while a consensus is emerging on the need to aid delinquent borrowers, particularly by convincing lenders to restructure troubled loans in an effort to reduce foreclosures, the fact that most subprime mortgages are pooled together and sold as securities remains a major obstacle to providing widespread relief….

In recent days, attention has focused on how the federal government can help the most vulnerable subprime borrowers, particularly those who have taken out adjustable-rate mortgages that are due to reset to significantly higher interest rates in the months ahead. One proposal, floated by consumer-advocacy groups, has been to place a temporary moratorium on foreclosures. Another line of thought being championed by Sen. Charles Schumer of New York, chairman of the Joint Economic Committee, and Democratic Sen. Jack Reed of Rhode Island, is to channel funds to groups that help borrowers struggling to make payments escape foreclosure.

Democrats and Republicans have been careful to say they won’t legislate a “bailout,” which ostensibly would pay off the balance of delinquent loans to protect people’s credit. While other legislative approaches are debated, Congress is pushing regulators and the industry into action….

Now, with so many subprime loans going bad and worries mounting that other credit markets will be affected, the emphasis is pushing regulators to get lenders, and the investors that buy most subprime mortgages that have been packaged into securities, to modify individual mortgages. Risky adjustable-rate mortgages, for example, could be restructured into the greater predictability of a 30-year fixed-rate loan.

Testifying at a hearing in the House Financial Services Committee yesterday, Federal Deposit Insurance Corp. Chairman Sheila Bair said banks and investors contributed to the boom in subprime lending with exotic products and loose standards, so they should be held accountable now that times are tougher. “I think we should hold the servicers’ and investors’ feet to the fire on this,” Ms. Bair said. “It was clear to investors that these were high risk. I think everybody needs to share the pain now.”…

But roughly 75% of subprime loans were packaged and sold as securities in 2006, so there are limits to how many troubled loans can be modified. With subprime loans being purchased and sold in global securities markets, it can be difficult to track down loans so they can be extracted and restructured. Moreover, agreements governing the creation of mortgage-backed securities can limit the ability of loan servicers to modify mortgages. Thus, many subprime borrowers and lenders will be restricted in restructuring loans….