http://www.nytimes.com/2008/10/30/opinion/30geanakoplos.html
The New York Times
October 30, 2008
Op-Ed Contributor
Mortgage Justice Is Blind
By JOHN D. GEANAKOPLOS and SUSAN P. KONIAK
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
homeowners.
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 holders.
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 underlying loans.
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 they make.
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 lenders.
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.
John D. Geanakoplos is a professor of economics at Yale and a partner
in a hedge fund that trades in mortgage securities. Susan P. Koniak is
a former law professor at Boston University.