If the top five mortgage servicers begin to abuse bond investors under the foreclosure settlement write-downs, the attorneys general would consider some protections, according to Iowa AG Tom Miller.
Miller faced down banking executives and analysts during a panel at the REthink Symposium Thursday. The $25 billion settlement signed in March forces servicers to meet roughly $10 billion in principal reductions, which could swell higher because in some instances the full dollar written down will not be credited.
Servicers will get full credit for reducing principal on loans they hold on their own portfolio but receive 45 cents for every dollar written down on mortgages held in private securities.
“To try principal reduction in a targeted way and find out if it works is good for the housing market,” Miller said. “We know what (the banks’) plans are. Two have said they wouldn’t do write-downs on private securities. But we could have some discussions about something to reassure investors.”
But analysts in the room raised serious concerns in a question-and-answer session afterward. Banks, they said, would abuse the investors and write down principal on bonds wherever they could.
“There should have been a cap or an outright prohibition,” said Amherst Securities analyst Laurie Goodman.
“There wasn’t a cap because the thinking was that it would be a very small amount,” Miller replied. “There are contractual restraints, fears of litigation. Banks have an even greater fear of doing principal reduction on the investors. The banks really don’t want to get into a fight over that.”
The settlement is still pending approval from a district court. The Association of Mortgage Investors plans to intervene in the case.
“Under the PSAs, the investor can be frankly abused by changes to the net-present-value assumptions,” one analyst said. “There’s been no model put forward.”
Miller tried to persuade the audience. In the end, he pitched the settlement as an experiment of sorts for principal reduction, which he called the last tool that hasn’t been used. There’s a $700 billion negative equity hole in the economy right now. More than 11 million borrowers are underwater, according to CoreLogic (CLGX).
The problem is waiting on either house prices to recover or Fannie Mae and Freddie Mac to adopt principal reduction as a serious tool. One appears to be an ever-distant destination, and the other may only be a mirage.
“If it works for others then they should be doing it. Fannie and Freddie should be doing principal reduction,” Miller said. “We didn’t have any leverage over them as part of the negotiations.”