Obama Administration’s Foreclosure-Prevention Plan Faces Execution Risks

Wednesday, March 04, 2009

The Obama Government came out with details of its new foreclosure-prevention plan that could help up to nine million homeowners keep their homes. But there are implementation hurdles which could make the plan much less effective than Administration officials hope.

The plan is designed to help borrowers refinance mortgages with more affordable payments. Lenders and mortgage investors could do that by agreeing to lower interest payments, reducing principal and other changes.   

"This step forward represents a tremendous coordinated effort between major government and regulatory agencies to help bring relief to America's housing market and homeowners,” HUD Secretary Shaun Donovan said in a statement  “This plan will... help to stop the damaging impact that declining home prices have on all Americans."

The Treasury Department released guidelines to help lenders know how to enroll borrowers in the program announced last month.

However, the ambitious, but complex program could end up helping fewer homeowners than originally advertised because of tough eligibility restrictions, likely delays in execution and possible legal challenges.

President Obama announced the framework of the plan on Feb. 18, saying it could help up to seven million to nine million homeowners facing foreclosure.

One part of the plan would provide subsidies and incentive fees to struggling homeowners, mortgage servicers and investors with $75 billion in funding from the Troubled Asset Relief Program, or TARP.

The second part of the plan would allow certain homeowners to refinance loans at lower interest rates through mortgage giants Fannie Mae and Freddie Mac, which own or insure about half of the nation’s $12 trillion in mortgages. Pension funds, hedge funds, insurance companies and other private investors hold the other half of that $12 trillion, mainly through mortgage-backed securities.

The guidelines focus on delinquent borrowers who could qualify for a streamlined modification process and on homeowners facing “imminent default.” But also could help some homeowners with "solid" payment histories on existing mortgages owned by Fannie or Freddie, which could refinance higher-rate loans for them at lower interest rates. 

The plan “is not intended to prevent every foreclosure or help every homeowner,” a government official said. It is targeted to help those homeowners “willing and able to pay,” he said. “There are going to be some people who don't qualify. There will be some people who qualify, but don't succeed."

Among other things, the plan requires some applicants to document their income and sign an affidavit to legally certify they cannot afford their home loan now.  That provision is designed to prevent financially stronger homeowners from stopping their mortgage payments to try to qualify for government aid -- but also might unintentionally lock out some truly needy families, sources said.

The outlook for Treasury's plan was complicated Tuesday night, as critical pieces of the foreclosure prevention puzzle hung in legislative limbo.

A bill in the House would give bankruptcy judges more power to lower mortgage payments in court. But Democratic leaders rescheduled a vote on the measure from Tuesday to Thursday as members struggled with competing interests and provisions: Financial firms say the bill would raise the cost of borrowing for consumers and would trigger more writedowns of troubled assets at banks at a difficult time, but housing advocates say mortgage lenders and investors won’t get serious about reworking unaffordable mortgages -- through the administration’s new plan or any other -- without the threat of bankruptcy judges changing terms if investors and lenders won’t consider modifying loans voluntarily.

"That's stuck in the mud," said John Taylor, a housing advocate in Washington, D.C.  

Loan servicing companies are also looking for Congress for help. They want lawmakers to approve a legal “safe harbor” for servicers who try to restructure mortgages without explicit permission from investors. Servicers process monthly payments under so-called “pooling and servicing” agreements. While some agreements give servicers some authority to renegotiate lower payments for homeowners, servicers fear some contracts are legally vague and would subject them to investor lawsuits, when a modification could generate less money than a foreclosure.

Service companies are lobbying Congress for federal legislation to give them more protection against investor lawsuits. Without it, they may not participate broadly or aggressively in the Administration's plan, sources said.

 “The servicers really have limited power to make adjustments” to mortgages, said Joseph Suh, a mortgage securities lawyer in New York with Schulte Roth & Zabel LLP. “The investors could suffer…You can’t take private property without due process.”

At least one hedge fund manager, William Frey, founder of Greenwich Financial Services in Greenwich, Conn., agrees. Frey plans to rally private mortgage investors to sue the federal government if they believe a mortgage modification plan with safe harbor provisions for servicers violates their rights and costs them money.

In November, Frey sued Bank of America in New York state court over an $8.4 billion settlement by Countrywide Financial, which BofA acquired in July, to modify up to 400,000 mortgages, most of which the bank services for private investors. The class-action lawsuit charges that BofA seeks “to pass most or all” of the costs of the settlement to investors through modifications.

“I create the template and that is good for everybody,” Frey said of his suit. Frey’s alternative to a government modification plan and any new federal legislation is modifications through class action suits and settlements, or mortgage purchases by the government, which can modify loans it acquires.

The trade association for private mortgage investors like Frey, the American Securitization Forum, declined to comment on the prospects for lawsuits, which could slow and limit government foreclosure prevention efforts.

The threat of legal action further complicates the Treasury plan because private investors control the bulk of nontraditional mortgages causing problems for many homeowners -- so called subprime, “Alt-A” and “Option ARM” loans that mortgage lenders offered with low down payments, low introductory “teaser” rates and sometimes little documentation of home buyer income, employment or assets.

Treasury officials held separate meetings last week with investment management companies, loan servicing companies and lenders to collect feedback on the administration’s plans, financial industry sources said.

A Treasury spokesperson did not respond to requests for comment on the meetings. But Treasury Secretary Timothy Geithner, testifying on the administration’s budget proposals on Tuesday, said, “You have to use a mix of incentive and persuasion” to get investors and lenders to modify mortgages for homeowners. “And, as a condition for government assistance in our new [TARP] capital programs, banks are going to have to commit to adopt foreclosure modifications strategies that meet a set of standards we lay out. That will help with persuasion,” Geithner said. “But you also have to do things that are going to help make it economically, economically compelling for them to do that.”

Despite the potential legal questions, some analysts are optimistic the plan will help many struggling homeowners. They believe that incentives in the Treasury plan, combined with continued falling housing prices, will push some private mortgage investors to participate in the plan to cut their losses.

Frey said he would consider the Treasury plan's provisions and incentives, but added, “Should the government be putting a bounty on people to abrogate their contracts? No.”

He also said the complicated legal provisions of mortgage-backed securities would make the plan difficult to execute among investors in common securities and investment pools. “The Treasury plan, I think, is much ado about nothing,” Frey said. But Congress “clearly can change the bankruptcy code,”he said.

One Treasury meeting participant said the lack of consensus among stakeholders likely means a slower, more limited modification process that reworks mortgages “loan by loan” rather than in bulk, as many housing advocates favor to quickly attack the rapidly rising number of foreclosures caused by growing unemployment and falling home prices.

“There’s not one problem with one mortgage, so there is not one solution,” the participant said. “There is not a silver bullet.”

A government source also said the administration plan would take time to get up and running, leaving some current homeowners struggling now with little choice but to lose their homes in foreclosure or some other repossession option. “It’s not going to become instantaneously operational,” the source said.