Last week, we learned that the Obama administration is considering other alternatives to stop foreclosures. Today, we have some color on what one of these efforts might look like. It would encourage servicers to reduce struggling borrowers' mortgage balance. Although banks have fought such efforts in the past, it seems that the program could benefit everyone involved. And the best part: it wouldn't take any taxpayer dollars.
How is this possible you ask? Rich Miller at Bloomberg explains:
Of the residential mortgage-backed securities outstanding, about $1.3 trillion are so-called private label notes that were issued by banks and other financial institutions, according to data from the Securities Industry and Financial Markets Association. "That's where a lot of the trouble is sitting," Lockhart said.
Many contracts governing such securities cap the percentage of loans that can be modified or prohibit reductions of principal, according to the paper by Dorchuck, Lockhart and Mills, managing director of Mortgage Banking Initiatives Inc. in Alexandria, Va.
To get around that, they want the Treasury to help clear the way for sales of delinquent or defaulted loans out of the securities at a discount to outside investors.
Because they would buy the loans at less than face value, these investors would be more willing to renegotiate the terms, including writing down principal, the plan's backers say.
No government money would be needed, Dorchuck said. The Treasury would have to provide the banks servicing the loans with legal cover against lawsuits by designating short-sales as "qualified loss-mitigation activity" under legislation passed in 2009.
For those wondering, James Lockhart is a former regulator of Fannie and Freddie, Jordan Dorchuck is an executive at a major mortgage servicer, and Pete mills is a housing consultant. The assertion lying beneath this explanation is that the only thing standing in the way of as many as one million principal reductions -- and foreclosures prevented -- is a tiny legal barrier.