- The Washington Times - Monday, May 18, 2009

ANALYSIS/OPINION:

White House Chief of Staff Rahm Emanuel has said, “Never let a serious crisis go to waste.” Four large banks - Bank of America Corp., Wells Fargo & Co., Citigroup Inc. and JP Morgan Chase & Co. - have taken his advice to heart. They threw their weighty support behind a bill called the “Helping Families Save Their Homes Act of 2009.” It should be called the “Middle Class Wealth Destruction Act of 2009” because of an insidious provision called “Servicer Safe Harbor.”

As enacted, this provision will provide mortgage servicers the opportunity to avoid taking losses on loans on their balance sheets and instead pass loan losses to insurance companies, pension funds, individual retirement accounts, 401(k)s and other middle class investors. It will transfer untold billions of dollars from middle class families to large banks while destroying the securitization market that is the backbone of our economy. The beneficiaries of this legislation will be the aforementioned largest banks in the country, now commonly referred to as TARP banks, in recognition of the billions in dollars they have received from the Troubled Asset Relief Program.

How will this transfer of money from family retirement accounts to the TARP banks be accomplished? Through the conflict of interest between the TARP banks’ role as mortgage servicers - including assigning losses among investors - and the fact that these same TARP banks carry more than $440 billion of second mortgages on their balance sheets.

TARP banks originated both first and second mortgages during the go-go years of the housing and mortgage bubble. They have sold off most of the first mortgages through securitization, while retaining ownership of the second mortgages. In the past, this made sense, as second mortgages carried higher interest rates than first mortgages, and rising real estate values kept credit losses on the second mortgages low. This is crucial because, under the current law, when a property goes into foreclosure and is subsequently sold, any losses (the difference between monies received at foreclosure sale and total outstanding principal balances of mortgage liens) are first borne by the junior liens, including second mortgages. In other words, before a first mortgage holder takes a loss on his investment, all junior liens on the property must be wiped out.

See the conflict? TARP banks own more than $440 billion of second mortgages while acting as servicers for more than 50 percent of first mortgages. In their capacity as servicers, modifying mortgage debt for needy homeowners (50 percent of whom have second mortgages) would require them to write down the value of second mortgages they own, further weakening their balance sheets. But this legislation allows mortgage servicers to keep second mortgages intact while writing down the value of first mortgages, without fear of lawsuits.

In other words, TARP banks can avoid taking losses on the risky second mortgages they own, as the current law requires, and will instead pass these losses to first mortgage investors - middle-class Americans who have invested their pension, college fund and retirement money through various institutions in the expectation that their senior lien position would provide a margin of safety. This is nothing but a multibillion-dollar giveaway to TARP banks, paid for by taxpayers.

It is clear that a properly administered loan modification program may help mitigate foreclosures, reducing the downward spiral in residential real estate values. But these modifications should be enacted in a manner consistent with existing contractual agreements, including recognized lien priority. If in doing so the TARP banks find themselves in need of additional capital (as we know they are), this capital should be raised through willing investors, not expropriated from the retirement savings of millions of Americans.

In a related situation, I have filed suit against Bank of America because of a settlement they struck with 15 state attorneys general over the predatory lending practices of their subsidiary, Countrywide Financial Corp. The settlement called for up to $8.7 billion in “mortgage relief” to borrowers. The problem is that less than 2 percent of the cost of the settlement will be paid by Bank of America. The remaining $8.5 billion will be paid by bondholders who had nothing to do with the origination of the predatory loans, which directly violates Countrywide’s contract with the bondholders.

The American economy’s success has been based in large part on the sacrosanct nature of contracts. American credibility will be challenged if banks can simply pay for their reckless loan activity by seeking federal bailout legislation like Servicer Safe Harbor or by shifting to others the penalties assessed by the state attorneys general - actions that sacrifice the interests of American families and middle class investors for political expediency.

Without faith in the rule of law and the inviolability of contracts, the $13 trillion securitization market, the engine of American capital investment, will wither and die.

William Frey is chief executive officer of Greenwich Financial Services LLC and has been a recent advocate of bondholders’ rights in modifications of mortgages in securities.

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