Behind the Mortgage Market Headlines

by devteam November 1st, 2010 | Share

This article originally appeared in the November issue of the Asset Securitization Report</p

The recent newsrncoverage has returned many mortgage and MBS-related issues, both real andrnillusory, to prominence.  The initialrnheadlines that stemmed from the announcement of problems with GMAC’srnforeclosure filings have morphed into questions about the foreclosure process,rnthe extent and potential cost of loan buyouts and the legal standing of thernsecuritized mortgage market itself.  Thisrnarticle addresses some of the issues currently roiling the financial markets.</p

The Legitimacy of Securitization </p

Stories in major news outlets (including a front-page story in BusinessWeek subtitled “Who Owns YourrnHouse?  A $1 Trillion Crisis of Faith”rnhave suggested that unknown huge numbers of mortgage loans are floating aroundrnin cyberspace.  Everything I’vernencountered suggests that these concerns are grossly exaggerated. </p

First, much speculation has resulted from thernunfounded assumption that the deterioration in underwriting standards afterrn2004 also infected the process of creating the securitization trusts andrntransferring assets.  Moreover, thernreports ignore the 30-year history of the securitized mortgage market, alongrnwith the fact that the Uniform Commercial Code (UCC) has language governing therntransfers of notes into securitization trusts adopted by all 50 states.  The best analysis I’ve seen of the issue wasrnwritten by the law firm SNR Denton, which concluded that “the recentrnallegations of possible wholesale failures to convey ownership of mortgagernloans to private-label RMBS trusts are baseless and unfounded.  All parties to these transactions…clearlyrnintended that the transactions convey ownership of the loans to the trusts, andrnappropriate steps were taken to effect such conveyances in accordance withrnwell-settled legal principals governing transfers of mortgage loans.”</p

The Foreclosure Mess</p

Therernare many complex and interrelated issues associated with the foreclosurerncontroversies, which were started by revelations that employees of servicersrnhave improperly signed off on affidavits initiating foreclosures inrnjudicial-foreclosure states (in which judges must approve foreclosures).  Clearly, serious irregularities (such asrnallegations of forged paperwork) must be addressed.  Nonetheless, the essential issue with so-calledrnrobo-signers is procedural in nature; in fact, the majority of states havernnon-judicial foreclosure procedures that don’t require an affidavit to bernpresented prior to foreclosure.</p

It is easy to takernservicers to task for their failings.  However,rnit’s increasingly clear that the servicing industry has the wrong economicrnstructure to operate effectively in the current crisis.  Servicing operations were designed andrnstaffed to handle huge numbers of transactions in an efficient and cost-effectivernfashion.  The system was never intendedrnto handle large numbers of nonperforming loans, nor manage the decisionrnprocesses necessitated by the various foreclosure-prevention and modificationrninitiatives.  The industry has neverrnfunctioned efficiently under stressed conditions, and its problems can be only partiallyrnmitigated by additional staff and resources.</p

Thernunprecedented volume of nonperforming loans has exacerbated the industry’srnproblems.  Combined with the delaysrnimposed by the various modification efforts, a huge backlog of seriouslyrndelinquent loans (that have yet to enter the foreclosure process) hasrndeveloped.  According to the MBA’s mostrnrecent delinquency survey, 9.9% of all loans (out of the 44.5 million in theirrnpopulation) are delinquent, and 6.3% (or roughly 2.3 million loans) arerndelinquent for 60 days or more.</p

One of the mostrnvexing issues facing the economy has been the question of when and how thernindustry will make progress in processing the pipeline of seriously delinquentrnloans.  This has weighed on home pricesrnthrough the huge hangover of “shadow inventories;” it has hurt servicers byrnrequiring them to fund advances; and it has hurt investors by delayingrnprincipal recoveries and increasing loss severities.  In this context, the calls for a nationwidernmoratorium on foreclosures are entirely misplaced.  In addition to damaging the legitimaterninterests of bondholders and financial institutions, it would introduce newrnuncertainty to a housing market that continues to struggle with high unemploymentrnand huge inventories.</p

It also seemsrnclear that few unjustified foreclosures have taken place due to paperworkrnerrors.   The errors cited by the press,rnsuch as incorrect street addresses and misspelled names, are trivial under therncircumstances.  Borrowers that haven’trnmade any payments in over a year (as Bank of America’s chairman stated was therncase in 80% of the bank’s second-quarter foreclosures) cannot retain theirrnproperties through procedural loopholes. rnRather than impeding an already stalled process, legitimate foreclosuresrnmust proceed, while initiatives designed to mitigate the pain (such asrnrent-back agreements pioneered by Fannie Mae’ Deed for Lease program) should bernexplored.  </p

Loan Buybacks and Putbacks</p

The notion that financial institutions will have huge liabilitiesrnresulting from violations of the representations and warranties embedded inrnprivate-label deals (contained in the deals’ pooling and servicing agreements,rnor PSAs) has recently resurfaced.  Whilerna full examination of the issue will have to wait, the topic is highlyrncomplex.  Major questions include thernlanguage in the PSAs that defines potential violations (which differs acrossrnoriginators), the ability of investors to gain access to a particular deal’srnunderwriting files and the portion of losses that will be borne by the banks.</p

Most industryrnpeople I’ve questioned believe that the process will be long and arduous, thernfinancial equivalent of urban warfare. rnUniversal settlements are increasingly unlikely, and claims will bernfiled, negotiated and settled on a loan-by-loan basis.  For example, it is not enough to simplyrnidentify a violation for a loan that has gone into default; it still must berndemonstrated that the defect directly contributed to the default.  In addition, the bank may be responsible for onlyrnpart of any loss.  An example might be arnloan with an understated LTV attributable to a flawed appraisal.  In that case, the loan might need to bernbought back, but the bank may absorb only losses associated with the amount ofrnthe LTV discrepancy.</p

 Thernmarkets were recently rocked by reports of legal action filed against Bank ofrnAmerica (the successor company to Countrywide) by a group of large and powerfulrninvestors constituting “investors with standing” (i.e., holders of more thanrn25% of each deal), which included the New York Fed.  The group’s lawyers sent a letter to BofArnaccusing it of failing in its duties as the master servicer of 115 separaternCountrywide-issued deals backed by prime, subprime and alt-A loans.  The “Notice of Non-Performance” sent to thernbank (along with the Bank of New York, the trustee for the deals) raised arnvariety of issues, including the (dubious) claim that the bank kept “defaultedrnmortgages on its books rather than foreclose or liquidate them, in order tornwrongfully maximize its Servicing Fee…” rnIt also claimed that loans modified as part of a settlement with a grouprnof state’s attorneys general should be bought out of the trusts, since thernsettlement was based on evidence that the loans were predatory.  (A similar suit was recently decided inrnBofA’s favor, as a judge ruled that the investors did not have legal standingrnto sue.)</p

Morernimportant than the merits of the notice’s claims is the nature of the remedy tornan “Event of Default” by the servicer. rnIn such an event, the PSAs require that servicing be transferred awayrnfrom BofA to a third party (or to the trustee, if no other servicer can bernfound).  Given the current unprofitablernnature of the servicing business, it’s unlikely that a new entity could bernfound to take on the role of master servicer for these deals. Moreover, arntransfer of servicing would be highly disruptive to all investors in therntransactions, including the investor group. Servicing transfers are problematicrnunder the best of circumstances, and are typically plagued by glitches such asrnlost files and misplaced payments. In the current environment, the normalrndisruptions would be magnified by REO inventories, large numbers of loans inrnforeclosure and loans in various stages of modification.  This suggests that if the requested actionrnwas actually carried out, it would damage the interests of the investorsrninvolved in the action. </p

Thisrnleads to questions regarding the motives of the investor group.  One possibility is that they expect thernservicing to be transferred to parties more agreeable to allowing access to thernunderwriting documents, which is necessary to directly pursue rep &rnwarranty claims. The more likely explanation is that the letter was intendedrnsimply to pressure the bank to negotiate buyback settlements, in part byrnpushing its stock price down.</p

Also noteworthyrnwas the involvement in the action by the New York Fed, as owners of non-agencyrnMBS held in their Maiden Lanernfacilities. In my view, the involvement of the Fed is extremely troubling.   If the transfer of servicing were actuallyrnto take place, all incomplete modifications would almost certainly be halted, arnresult contrary to the policies of the Obama administration.  While unlikely, it is also conceivable thatrnthe notice could trigger unforeseen events that eventually destabilize thernfinancial system, an outcome directly at odds with the Fed’s responsibilitiesrnin ensuring financial stability.</p

Finally, thernaction highlights the major conflicts associated with the Fed simultaneouslyrnacting as investor, regulator and central banker. It’s difficult to imagine howrnthe Fed is supposed to effectively regulate a bank that it is separatelyrntargeting with legal action; could, for example, BofA refuse to turn over documentsrnand data based on the NY Fed’s adversarial role in any legal action?  In my opinion, the multiple roles beingrnplayed by the Fed risk its independence and credibility; in particular, thernrole of activist investor could damage the Fed at a moment when it is embarkingrnon controversial and risky measures designed to boost the economy.</p


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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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