A reported meeting Tuesday between Treasury Department and mortgage servicing officials focused squarely on the problem of addressing second liens in borrower work-outs, as government officials are realizing that any plan put in place to help borrowers must address the significant challenge presented by second lien holders. The Wall Street Journal first reported on the meeting yesterday, saying that “about 10 lenders will attend,” including representatives from Countrywide Financial Corp. (CFC), Bank of America Corp. (BAC), Citigroup Inc. (C), Fannie Mae (FNM), and Freddie Mac (FRE). The Journal, however, didn’t mention the meeting focus on second liens, saying only that the meeting was part of an overall plan to put more pressure on servicers regarding loan modifications and principal writedowns. Details of the meeting were covered by American Banker, which obtained discussion drafts and a meeting outline:

Much of the six-hour meeting is expected to focus on second liens, which are typically held by a different investor group than the holder of a primary mortgage and would need to be terminated to let a refinancing or modification proceed. Bankers said many second-lien holders are getting no return on their loans amid the housing crisis. Industry representatives said second liens continue to stymie restructuring efforts. Many first-lien holders do not know who owns a second lien, for example. Of subprime loans originated in 2006, more than half had a simultaneous second lien, said Mark Zandi, chief economist and co-founder of Moody’s Economy.com Inc.

Of course, second liens are far from being just a subprime mortgage problem; a large swath of prime borrowers in California relied on a combination of Alt-A mortgages and second liens to purchase their homes during the recent housing run-up. On the whole loan side of the business, sources told HW that second liens are currently trading in the 3 to 5 cent range per dollar. More than a few hedge funds are currently planning strategies to buy up second liens in an effort to both keep a borrower in the home and generate a tidy profit — while risky, the profit potential in second liens could be substantial, we’ve been told. Some of the proposals on the table at today’s Treasury meeting, according to American Banker, included a discussion of the conditions that would be needed to induce second lien holders to resubordinate during a refinance of a troubled borrowers first mortgage, as well introducing “token fees” paid to second lienholders by first lienholders in the event of a short-sale. “Solving for second liens is the single most critical issue on the table right now,” said one source, a senior executive at a national bank that asked not to be named. “If that doesn’t get handled, it doesn’t matter what the FDIC proposes, or what Barney Frank wants done.”