THE current American economic crisis, which began with a housing collapse
that had devastating consequences for our financial system, now threatens the
global economy. But while we are rushing around trying to pick up all the other
falling dominos, the housing crisis continues, and must be addressed.
We start with this simple fact: Too many families are being thrown out of
their homes when it makes more sense to let them stay by “reworking” their
mortgages — adjusting terms to make it possible for the homeowners to meet their
responsibilities. In many cases, adjusting loans would help the homeowners and
the lenders: the new mortgages would have lower monthly payments that homeowners
could afford to pay, and would end up giving the lenders more money than the 50
cents on the dollar that many foreclosure sales are bringing these days.
The presidential candidates have proposed plans to help some homeowners and
mortgage-security holders by buying out loans or putting a moratorium on
foreclosures. We have a plan that would be much less costly than buyouts and
more comprehensive than a moratorium.
In the old days, a mortgage loan involved only two parties, a borrower and a
bank. If the borrower ran into difficulty, it was in the bank’s interest to ease
the homeowner’s burden and adjust the terms of the loan. When housing prices
fell drastically, bankers renegotiated, helping to stabilize the market.
The world of securitization changed that, especially for subprime mortgages.
There is no longer any equivalent of “the bank” that has an incentive to rework
failing loans. The loans are pooled together, and the pooled mortgage payments
are divided up among many securities according to complicated rules. A party
called a “master servicer” manages the pools of loans. The security holders are
effectively the lenders, but legally they are prohibited from contacting the
In place of the bank lender, the master servicer now holds the power to
rework the loans. And, as we have seen in the current crisis, these servicers
aren’t doing that, as house after house goes into foreclosure.
Why are the master servicers not doing what an old-fashioned banker would do?
Because a servicer has very different incentives. Most anything a master
servicer does to rework a loan will create big winners but also some big losers
among the security holders to whom the servicer holds equal duties. So the
servicers feel safer doing nothing. By allowing foreclosures to proceed without
much intervention, they avoid potentially huge lawsuits by injured security
On top of the legal risks, reworking loans can be costly for master
servicers. They need to document what new monthly payment a homeowner can afford
and assess fluctuating property values to determine whether foreclosing would
yield more or less than reworking. It’s costly just to track down the distressed
homeowners, who are understandably inclined to ignore calls from master
servicers that they sense may be all too eager to foreclose.
Yes, the master servicer is paid to oversee the mortgages, but those fees
were agreed on during the housing boom, and were based on the notion that
reworking mortgages would be a relatively small part of the job and would carry
little litigation risk.
Last, some big master servicers are part of, or have now been bought out by,
the very companies that own the securities that can be affected by the reworking
or foreclosure decisions the master servicer makes. This conflict further
increases the chances of litigation and contributes to inaction.
Thus it is no surprise that so few mortgages have been reworked, with
devastating consequences for the economy. It is also no surprise that trading in
the securities tied to the mortgage pools has drastically declined, because
potential buyers cannot be sure what the servicers are going to do with the
To solve this problem, we propose legislation that moves the reworking
function from the paralyzed master servicers and transfers it to
community-based, government-appointed trustees. These trustees would be given no
information about which securities are derived from which mortgages, or how
those securities would be affected by the reworking and foreclosure decisions
Instead of worrying about which securities might be harmed, the blind
trustees would consider, loan by loan, whether a reworking would bring in more
money than a foreclosure. The government expense would be limited to paying for
the trustees — no small amount of money, but much cheaper than first paying off
the security holders by buying out the loans, which would then have to be
reworked anyway. Our plan would also be far more efficient than having judges
attempt this role. The trustees would be hired from the ranks of community
bankers, and thus have the expertise the judiciary lacks.
Americans have repeatedly been told that the distressed loans cannot be
reworked because these mortgages can no longer be “put back together.” But that
is not true. Our plan does not require that the loans be reassembled from the
securities in which they are now divided, nor does it require the buying up of
any loans or securities. It does require the transfer of the servicers’ duty to
rework loans to government trustees. It requires that restrictions in some
servicing contracts, like those on how many loans can be reworked in each pool,
be eliminated when the duty to rework is transferred to the trustees.
Under our plan, servicers would provide the homeowner’s name and other
relevant information on each loan to a central government clearing house, which
would in turn give trustees the data on homes in their local area. Once the
trustees have examined the loans — leaving some unchanged, reworking others and
recommending foreclosure on the rest — they would pass those decisions to the
government clearing house for transmittal back to the appropriate servicers.
The servicers would then do exactly the same work they do now, passing on the
payments they collect from the reworked mortgages to the securities’ owners in
each pool. The servicers would also foreclose on those properties the trustees
had decided did not qualify for reworking. For performing those tasks, the
servicers would continue to receive the fees due under their existing contracts.
The rules governing the trustees must ensure that only homeowners in true
financial distress qualify to have their mortgages reworked, so that homeowners
do not see the program as a free ride to a cheaper mortgage. Luckily, there is
already a rough set of guidelines in place for making these sorts of
loan-modification decisions, thanks to the Hope Now Alliance, a joint effort of
the Treasury, the Department of Housing and Urban Development and private
Our plan would keep many more Americans in their homes, and put government
money into local communities where it would make a difference. By clarifying the
true value of each loan, it would also help clarify the value of securities
associated with those mortgages, enabling investors to trade them again. Most
important, our plan would help stabilize housing prices.
We need an innovative approach to overcome the gridlock that plagues our
housing markets. Otherwise, we imperil millions of homeowners and — through the
alchemy of derivatives — the American and global economy.