Thursday, March 5, 2009

Legal Aspects of Mortgage Jubilee

A debt jubilee could occur with a simple act of Congress. The law would simply have to declare forgiveness of debt, and include a clause to prevent lawsuits. It is that simple. As the following article indicates, the threat of lawsuit by investors is keeping many mortgage servicers from modifying notes. Unless they have legal protections from lawsuits, people are not going to put themselves at risk. A Jubilee Proclamation would have to contain language preventing lawsuits.

WASHINGTON -(Dow Jones)- The success of the Obama administration's plan to cut mortgage payments for millions of at-risk homeowners hinges on congressional action to shield mortgage servicers against lawsuits from investors, a top mortgage industry official said.

The plan, which the administration kicked off Wednesday, is heavy on incentives for mortgage servicers and borrowers, but provides no protection for servicers against lawsuits from mortgage investors who might become angry about the modifications.

Roughly 60% of seriously delinquent U.S. mortgage loans are concentrated in " private label" mortgage-backed securities, or MBS, which are not issued by Fannie Mae (FNM) and Freddie Mac (FRE).

Such mortgages "probably won't be modified until there's a safe harbor," David G. Kittle, the chairman of the Mortgage Bankers Association, said. "The incentives are not enough to protect anyone from a lawsuit."

Under the program, the government would pay mortgage servicers a $1,000 one- time fee to reduce borrowers' mortgage payments to 38% of their income for five years. The government would then match the cost of further interest rate reductions or other measures intended to bring mortgage payments down to 31% of borrowers' income.

The government would make generous annual payments to servicers and borrowers if the loan stays current. The only incentive for mortgage investors is a $1,500 payment for modifying loans that are not yet delinquent.

The program does nothing to address what has been one of the biggest impediments to loan modifications during the housing crisis - the misalignment of the interests of mortgage servicers and mortgage investors in private-label securities.

Companies servicing pools of mortgages packaged as private-label securities are bound by contracts with investors in the securities. The contracts vary, but typically require servicers to act in the best interest of the investors. That is often not a simple calculation. For example, a loss modification action by a servicer could potentially benefit some investors of the pool at the expense of others.

Mortgage investors have mounted lawsuits against servicers who have performed loan modifications they deemed against their interest.

Under the administration's program, participating mortgage servicers are required to "use reasonable efforts" to waive the contracts where they bar modification. However, the program does not override the contracts.

The administration, which estimates its program could help as many as 3-4 million people obtain more affordable mortgage payments, supports legislation pending in the U.S. House that would give mortgage servicers a safe harbor against investor lawsuits. "We would expect the legislation process to continue, " a senior White House official told reporters during a background briefing Wednesday.

Some housing experts said the program is likely to reach its targets despite the lack of a safe harbor because the payments to servicers are so generous they will tip the scales in favor of modifying a loan.

"They need the servicers to cooperate. They've sweetened the pot enough that that's going to happen to a large degree," National Community Reinvestment Coalition President John Taylor said. He called the lawsuit issue an " exaggerated problem."

Thomas Lawler, a housing economist from Leesburg, Va., said the incentives would spur mortgage servicers to modify loans by giving them the funds to staff up. Servicers haven't been aggressive "because they haven't been adequately staffed and they haven't been incentivized to do so" in a tanking housing market, he argued.

A feature of the program that would institute a "net present value" test could also help spur more loan modifications by giving mortgage servicers some cover from investors, Taylor said.

Participating servicers must run all loans that are at least 60 days delinquent or deemed at risk of imminent default through the test. They are required to modify loans where the net present value of the cash flows under a modification scenario exceed the net present value of the cash flows in the absence of modification.

The mortgage industry offered praise for the plan. Officials have exhorted borrowers to be patient with lenders as they cope with an expected deluge of modification requests.

"The plan appropriately balances the interest of homeowners, mortgage servicers and investors," Jamie Dimon, chief executive of JPMorgan Chase & Co. ( JPM), one of the largest servicers, said in a statement.

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