Maverick-Backed Securities
posted by Jonathan Lipson
In last night’s debate, John McCain proposed that Treasury purchase defaulted mortgages, thereby providing relief to distressed homeowners.
“As president of the United States,” Mr. McCain said, “I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished value of those homes and let people make those, be able to make those payments and stay in their homes. Is it expensive? Yes.”
How? He didn’t say. But he’d have to overcome a mountain of contractual and legal obstacles in the “toxic” securities (bonds) that these defaulted mortgages were supposed to back (pay for).
Georgetown Law Professor Adam Levitin has done a good job of explaining why simply purchasing the bonds themselves will provide little relief to homeowners: Unless the government purchases a controlling amount and number of bonds–meaning lots of bonds–it will lack the voting power, among other things, to cause any changes to the underlying mortgages.
It is possible the government could do this already under the Paulson bailout plan. in theory, it could also purchase individual mortgages from the trusts that currently hold them (which, in turn, issued the mortgage-backed securities that are said to be “toxic”).
But I am not sure the trustees of the trusts that now own these mortgages have, or want, the power to pick and choose which mortgages to sell to the government. Nor is it clear that the servicing companies that really manage the mortgages have the power–or the incentive–to facilitate these sales. There is some evidence that it is easier (and perhaps more lucrative) for them to foreclose than renegotiate the mortgage.
The real solution, as many bankruptcy hands have been arguing for years, is amending the Bankruptcy Code to permit bankruptcy judges to modify existing mortgages, bringing them in line with the fair value of the underlying property.
Until recently, banking and financial interest groups (and most Republicans) vehemently opposed this as a bailout of profligate borrowers. Banks would stop lending if Congress made this change, and all commerce as we know it would come to an end.
Now that the banks stand to receive in excess of $1 trillion in federal largesse (and commerce as we know it is coming to an end, anyway), I am not sure where they are on this. I have been informed that the Commercial Law League–not exactly a lobbying organization for profligate borrowers–has come out in support of these changes.
In the meantime, I look forward to learning how the Maverick plans to rewrite millions of pages of bond indentures.
October 7, 2008 at 10:50 pm
Posted in: Bankruptcy
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Responses (4)
Brett - October 8, 2008 at 12:56 pm
Jonathan,
McCain’s website now has a few paragraphs about his “Homeownership Resurgence Plan.” It mentions that he wants to purchase mortgages “directly from homeowners.” Do you think it’s possible he’s talking about the government assuming the mortgages as a sort of co-signer so that the related MBS and CDS stay afloat? Is this even possible under the current legislation?
NYU 3L - October 8, 2008 at 1:08 pm
Jonathan,
McCain’s site now describes his plan as directing the Treasury to “purchase” mortgages “directly from homeowners.” He says this will support the value of mortgage related CDS. This is an odd locution – since I believe a homeowner “owes” a mortgage rather than “owning” one. If McCain is referring to the government becoming a sort of co-signer on behalf of certain borrowers, is this even allowed under the current legislation? Do you think there is any downside to this approach?
NYU 3L - October 8, 2008 at 1:10 pm
HA! I thought my first comment didn’t go through. My identity is revealed
-Brett/NYU 3L
Jonathan Lipson - October 9, 2008 at 1:09 pm
Brett–
Good questions.
As I read EESA (the federal legislation), a “troubled asset” is defined to include mortgages, so in theory Treasury already has this power.
According his webpage, McCain proposes the following:
“The McCain Resurgence Plan would purchase mortgages directly from homeowners and mortgage servicers, and replace them with manageable, fixed-rate mortgages that will keep families in their homes. By purchasing the existing, failing mortgages the McCain resurgence plan will eliminate uncertainty over defaults, support the value of mortgage-backed derivatives and alleviate risks that are freezing financial markets.”
http://www.johnmccain.com/Informing/Issues/b9af0d4c-9c0e-4a97-b27f-19df8cfec83d.htm
There are several problems with this (and with any attempt by Treasury to do what it apparently already has the power to do).
First, as you point out, the homeowners don’t **own the mortgages**–they **owe money** on them. They can’t sell their mortgages any more than I can “sell” my credit card bill (although if McCain’s buying, I’m selling). The mortgages are in many (perhaps most) cases **owned** by “trusts” that were formed by the financial institutions that created these structures in the first place.
So, the second problem is that it makes no sense to say that he would purchase the mortgages from the “servicers.” If he wants the goverment to buy mortgages, he has to go to the trusts that own them.
It is true that the trusts, via the servicers, could sell individual mortgages. But to get a sense of how complex and costly that would be, take a look at Countrywide’s Master Pooling and Servicing Agreement, which you can find here.
http://www.sec.gov/Archives/edgar/data/1340491/000090514805006045/efc5-2351_ex991.txt
On a quick read (and these docs are admittedly not quick reads, so I am doubtless missing some subtleties) it appears that Countrywide (as “Master Servicer”) could sell mortgages to the government, but only if it first purchased the mortgages itself. But it could only purchase from the trust at the FMV of the property and book it accordingly. It would presumably then sell the mortgage to the government. I think a big part of the problem is that we have no idea what the FMV of these properties is, and I suspect Countrywide (and its new parent, BofA) don’t want to take these assets onto their balance sheets.
Another possibility would be to amend the PSA, but that requires the support of lots of certificate (bond) holders. EESA already gives Treasury the power to purchase these securities (and thus, presumably, vote them to amend the trust indentures and PSAs). But I don’t see what’s new here, that it’s any more workable, or –most important–likely to make much difference to homeowners.
So, short answer: It’s not new, and it’s not clear practically speaking how this is would help homeowners. This is not a problem unique to McCain’s proposal. It is a problem with EESA. But Paulson did not sell EESA as a way to help homeowners, and it won’t have that effect. If it helps, it will do so by restoring a market for the securities at the back end–not the mortgages at the front end. That may help the capital markets, but it will obviously take time and faith.
A final point: McCain says he wants to bring government spending down. But the whole point of his “resurgence” would be to force taxpayers to absorb a $300 billion loss that should, in many cases, be absorbed by homeowners and/or banks. He makes no distinction between mortgages that might have been procured by borrower fraud or lender fraud, no distinction between prudent and imprudent parties, no attempt at all, in short, to avoid the moral hazard that the government’s largesse to date seems to be creating. If this is what a fiscal conservative looks like, I’d hate to see a liberal.
Durbin’s proposed bankruptcy amendment–that Republicans killed–would have addressed much of this, while saving taxpayers the cost of bailing out bad actors.
I don’t know who’s advising McCain on this stuff, but it certainly doesn’t bespeak good judgment. It sounds like yet another erratic, ill-considered response–cosmetic at best and more likely needlessly costly and impractical–to a very serious set of problems.
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