FDIC’s Bair: Let the Servicers Service, Or Else

FDIC chairman Sheila Bair said late last week that investors need to be willing to work with servicers to allow for a higher volume of loan modifications, implicitly suggesting that some investors have been fighting the government’s efforts to support a voluntary “rate freeze” program from some subprime borrowers.

“Some servicers have told us that they are afraid to systematically modify loans for fear that investors will sue them,” Bair said in remarks delivered to the Venture Silicon Valley Network State of the Valley Conference in San Jose.

“My hope is that investors wake up to what’s going on and push hard for loan modifications, not fight them.”

The apparent relunctance of some investors to allow for loan modifications comes after the Securities and Exchange Commission gave the green light in early January for fast-tracking loan modifications under the so-called “rate freeze” program announced by President Bush in December.

While the SEC’s clarification means that modifying loans likely won’t jeapordize the off-balance-sheet treatment of most securitization trusts, sources suggest that investors are still divided over whether such loan modifications are in the best interest of bondholders.

At issue here is the differing objectives between where a bondholder sits. Junior bondholders want to see the freezes put into effect, protecting at least some of their cashflow; more senior bondholders tend to see the rate freeze program as detrimental at worst, and risky at best, to their overall position, said one source that spoke with HW.

Housing Wire covered the issue of trigger events and how the loan modification program might impact investors in an earlier story, available here.

Bair suggested that Congress may need to step in to protect servicers from investors, if the issue continues to be a problem.

“If need be, Congress could step in to protect loan servicers from investor lawsuits by clarifying that systematic loan modifications are consistent with, if not required by, their fiduciary obligations to investors,” she said.

She also suggested that servicers may face investor lawsuits later for failing to modify loans now, as junior bondholders’ losses continue to increase. “[T]he smarter question that loan servicers ought to be asking is whether there’s a bigger risk of a lawsuit if they don’t do modifications,” said Bair.

“Given today’s market conditions, foreclosure will likely cost investors a lot more money than the lower returns they would get from modified loans.”