Back in July of this year a firm called Mortgage Resolution Partners roiled the waters in the world of loan servicing by threatening to use eminent domain to take control of underwater mortgages. In simple terms, the state, town or other jurisdiction would seize the mortgage and compensate investors based on some determination of fair value. The group even predicted other companies may follow them and take the plan national, according to media reports.
I have friends and colleagues who support this, but after consideration have decided that I must oppose the approach as currently framed.
First and foremost, as a banker who is trying to convince investors to return to private label production, advocating the arbitrary taking of existing mortgages is probably not a good idea. Let me walk through some objections to the MRP proposal that, speaking as a banker, seem obvious to anyone who works in the financial world.
The first key objection to the MRP proposal is the selective application. MRP was very clever to pick private label residential mortgage backed securities owned by investors as the place to start. As I have noted in past comments, investors have no mechanism to fight this in court, especially after losing out to the loan servicers and the 50-state robo-signing settlement. Banks and the GSEs, on the other hand, would fight the MRP like demons from hell. I hear that MRP is trying to tweak its proposal to go after the banks and GSEs, but this will lead to nuclear war in the courts. The PLS investors are easier targets.
Second on the list of differences is valuation. MRP made a big mistake, in my view, by proposing seizures of notes at 80% of "fair value." This discount is creating an extraordinary private profit associated with public need at the expense of another private party – namely RMBS investors. The excessive spread in the MRP proposal just makes my point about the continuous, public rape of owners of private label mortgage securities. The assault starts with billions stolen from RMBS trusts by the large bank servicers and goes on to the 50-state robosigning settlement led by CA AG Kamala Harris, who extorted double digit billions from investors and banks.
If states assisted by MRP executed eminent domain seizures at 97% of fair value, on the other hand, the sovereign entities would be working for the normal market profit margins of GNMA originators, which are still start in high single digits. This level of spread would probably be OK in terms of balancing the public good with the private sector interest. There is no question that a problem exists with under water mortgages, just a question as to how or even whether we can craft a solution that does not do violence to the law and investor rights.
Third point is political regarding a default by a sovereign. Opponents of the MRP proposal such as SIFMA and the American Securitization Forum have made a big deal about the threat of "redlining" towns that seize notes from investors. This bluster is politically tone deaf. It would never be agreed to by FHA, VA, GNMA, FHFA and the GSEs, to name just some of the aggrieved federal agencies. But the more subtle point, one which I have made to the MRP team, is that it will be pretty nigh impossible to sell non-conforming loan production from any jurisdiction which goes down this road. An eminent domain seizure is the functional equivalent of a sovereign default.
Fourth point is that the old PLS market is dead a buried a long time ago. The MRP will not make it worse. As any wanderer in Zombie land knows, there is no such thing as "more dead." That said, there are signs of life in the world of non-conforming loan production, but of a sort that is much closer to the December 2010 Open Letter to US Regulators on National Loan Servicing Standards than the old private label model.
While it is 5 years since the last, large PLS deal was done, the servicers/trustees/bondholders have fought every attempt to fix some of the unintended consequences of those flawed deals. This is one reason why the MRP proposal, in order to have credibility, must target all underwater mortgages, bank-owned, GSE-guaranteed and investor-owned. And when the state or town seizes a first lien note owned by a bank, the collateral lien on the second mortgage, if any, is also eviscerated. Have we got your attention now?
The good thing about the MRP proposal, in my view, is that it will force a larger discussion about the very real crisis caused because millions of underwater mortgages are festering and will eventually default. Cities in California are suffering negative consequences resulting from the unwillingness/inability of the private label trusts, (and bank portfolios and GSEs to a lesser degree) to deal with massive numbers of underwater and delinquent borrowers. This is a real issue, a life and death issue in many communities. Hopefully this debate will enable legal and other changes that will allow us to deal with the issue of underwater mortgages in a fair and transparent way.
Christopher Whalen is a Senior Managing Director of Tangent Capital Partners in New York City. His opinions expressed above are his own.