Why the Government Will Have a Hard Time Being a Foreclosure White Knight

If you think it’s simple for the government to swoop in and stop home foreclosures, think again. There were an awful lot of moving parts in the machine that built this mess — just ask Alan Greenspan* — and therefore it’s no easy matter to clean things up.

Consider one wrinkle explored in an article headlined “Some Hedge Funds Argue Against Proposals to Modify Mortgages” in yesterday’s Times:

Hedge funds are fighting proposals to ease the terms of home mortgages, arguing that such a move would hurt their investments. Two funds recently warned mortgage companies that they might take action if the companies participated in government-backed plans to renegotiate delinquent loans in a way that undercut the funds’ interests.

The saber-rattling highlights the conflicting interests of various players in the mortgage arena and suggests that tensions are likely to intensify as government intervention in the market widens.

The two funds — Greenwich Financial and Braddock Financial — hold securities backed by mortgages, and they argue that the terms of the underlying loans cannot be changed without their consent.

Mortgage securities have plummeted in value as growing numbers of homeowners have struggled to keep up with their loans. But if the mortgages behind those investments were renegotiated, the holders of the securities, particularly the low-rated investments, stand to lose even more.

William Frey, the president of one of the funds, Greenwich Financial Services of Greenwich, Conn., said that he was acting to protect the firm’s investments. “Any investor in mortgage-backed securities has the right to insist that their contract be enforced,” he said.

I received first-hand evidence of this kind of problem the other day. I live in a New York City co-op, which means that instead of holding a deed, I hold shares in the building.

My apartment is made up of two formerly separate apartments, A and B. The building’s managing agent still sends out two maintenance bills each month since the shares of A and B used to be separate. This has led to much confusion in the managing agent’s bookkeeping department — they routinely deposit both checks into one account, or the wrong checks into the wrong account — so I recently asked them to combine the two bills into one.

The managing agent told me that I’d have to start that process with the bank that holds my mortgage. So I wrote to my contact at the bank, Wells Fargo. He is a great guy, always helpful and responsive. He wrote back to say that it would probably cost me a lot of money to make this happen and that I would probably have to refinance the entire mortgage.

Huh? He explained why:

Co-ops are complicated, with the stock certificates involved as collateral. As has become apparent in the last six-plus months, the mortgage process is quite complicated due to the secondary market of investors on Wall Street who are buying mortgages behind the scenes.

When a lender attempts to make any changes to a loan that has already been closed and is being serviced (even when the loan was closed and serviced by the same lender as yours), there are investors behind the scenes who do not like to have any details changed from the original loan package that was underwritten to their specifications.

It all comes back to the basic idea of the property being collateralized for the loan. Any changes to the underlying collateral causes concerns for the investors regarding the value of their original loan, [and] can lead to a much more complicated process.

A simple change like the one you mentioned can cause a lender to consider a complete refinance into a new loan to again create a loan package that is again underwritten to meet the investor’s specifications and guidelines.

I believe it is the multi-level secondary market of mortgage loans that is causing much frustration with the borrowers, who today are facing foreclosure and are looking to have their loan terms adjusted to satisfy their current situations.

Even if Wells Fargo, for example, wanted to make sweeping alterations in order to keep all of its current struggling mortgage customers in their homes and current loans, the investors on Wall Street would lose the loan packages that were originally sold to them, and it gets complicated.

In other words, in order to get one monthly bill instead of two, I would need to disassemble the entire mortgage-backed-security industry.

Kind of makes me long for the days of the abacus.

*Greenspan’s would-be blockbuster, The Age of Turbulence, seems to be suffering along with the reputation of its author.

Since its paperback release about six weeks ago, it has sold fewer than 14,000 copies, according to BookScan, whose data are said to represent about 70 percent of overall U.S. sales. As I type, it is currently ranked No. 1,543 on Amazon. When it was released in hardcover a year ago, it was the No. 1 New York Times best seller; as far as I can see, it is not currently on the paperback best-seller list at all.

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  1. Craig Leary says:

    Mortgage lenders always tell you to refinance, even when it is not necessarily the best financial decision. For most people, they’d be better off taking the $5K cost to refinance and simply paying their mortgage down faster. We recently looked into Voyant (http://www.planwithvoyant.com) and modelerd a lower mortgage rate. It made less of an impact on our financial plan than simply paying the loan down! Mortgage rates in the last 5 years are still at historic lows. Worry less about a marginally improved rate and more about paying your loan down.

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  2. Chance says:

    My comment is only somewhat related to the post, and is more of a question.

    In August of 2009, the post 9/11 GI Bill will take effect. One of the provisions is that the former service member will recieve a housing allowance, equal to the BAH for the area the school is located in if they are attending full time. In my case, and the case of many others, this will be the equivilant to the government paying my mortgage directly. I suspect many will still keep a part time job, especially those doing online college courses. What kind of impact if any is this going to have on the mortgage crisis?

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  3. jacob says:

    is the hassle of having 2 bills more expensive than the time value of your money. you could probably prepay a years worth of bills to avoid the hassle every month.

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  4. Andrew says:

    If you have good credit and a solid payment history, $5,000 is much too high to refinance. You should be able to refinance for under $2K if you shop around. My wife and I have our mortgage through ING and are very pleased with their rates, low closing costs, and transparency.

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  5. James A says:

    Funny that the hedge funds would rather cut off their nose to spite their face, then attempt to renegotiate in good faith with lenders. The fact of the matter is that the market is pricing those securities as worthless paper anyway, so why not improve them by renegotiating deals and keeping the cash flow going, then by losing x% of your cash flows because you’re too stubborn to deal?

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  6. RZ says:

    “Hedge funds are fighting proposals to ease the terms of home mortgages, arguing that such a move would hurt their investments”

    Such a move would also slow the much-needed housing price correction.

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  7. frankenduf says:

    saber-rattling by the hedge funds? against whom? the US government??- that’s pretty much the definition of treason- maybe if the financiers who created this mess were jailed, we wouldn’t have to worry about their saber-rattling, just the rattling of their empty tin cups against the iron bars

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  8. MikeM says:

    I’m actually glad the hedge funds might be in a position to stop this nonsense. If we have a government that can step in and rewrite the terms of contracts between two parties, not only does this undermine some of the core principles at the heart of our financial system, but maybe even the rule of law that upholds it. This isn’t our justice system scrutinizing the terms for fairness, it’s the Treasury. This is exactly the kind of “governance” that the Constitution was framed to prevent.

    I don’t know the nature of the assets these two hedge funds hold, but I doubt it is as #5 suggests, that the funds are doing this out of spite. Hedge funds are in the business of making money and literally exist for no other purpose whatsoever. The idea that a hedge fund would sacrifice a buck for some principled notion of justice for itself is hilarious.

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