The Difficulty of Modifying Second Mortgages

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One of the many obstacles to resolving the housing mess is that so many people during the boom used their houses as piggybanks, taking out second mortgages and helocs that were often originated by different banks from the originator of the first lien mortgage.  In order to do a short sale--or much of anything short of foreclosure--you need to get the second lien holder on board.  This is even harder than getting your first mortgage holder to help you, since there's usually nothing in it for the second guy in line except a sure and certain loss.  The Obama administration has made some efforts to pull the second lien servicers into the process, but the results have been even more pitiful than the single-loan modification process.

This was a problem in the Great Depression, too, though the conflict was less between banks than between individuals who often issued or bought individual mortgages as investments.  No good way to resolve the problem was found, and thus it is still with us.  I'm toying with the notion that we should ban second mortgages by any except the first mortgage holder, but this would turn the first mortgagee into an effective monopolist, and also effectively kill securitization.  Plus I don't know what you do with an insolvent bank if all the first and second loans have to be sold as packages.

Still, it would be nice if we could figure out something to do.  We need to figure out how to resolve the housing mess sometime before the turn of the next century.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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