Housing Policy Incoherence Part II: Who Should Help?

Part I of this series laid out some potential criteria for determining which borrowers should be helped with their mortgage problems. This part develops a framework identifying who might help them.

Lenders. The obvious counterparty to assist borrowers are their lenders. This is not so simple, because although there are some conventional borrower lender loans out there, in most cases the situation is much more complicated. Here are the lender players:

• Loan Broker. The loan broker is the face of the lending process to the borrower. The brokers sell the programs to the borrowers, assist in completing applications, and shepherd the process to funding. The broker gets paid when the loan closes and doesn't have a continuing role in the loan. Lender. The lender typically underwrites the loan broker's application package, prepares the loan documents, and funds the loan. Sometimes the lender retains the loan, but often the loans were placed into pools, securitized and sold to investors. Here is a link to a more detailed discussion of the securitization process.
• Investors. The investors are the buyers of the mortgage securities. A single pool of mortgages will have multiple securities associated with it based on the priority and timing of the cash flow allocations, so there are often multiple investor classes with an interest in the cash flow associated with each mortgage. The price the investor paid for their security was in part by the rating assigned to it by the rating agencies.
• Servicers. After the loan is sold, the servicer collects the payments, administers the loan for the investors and is the interface with the borrower. Frequently the lender retains the servicer role.

So, when we speak of the lender helping the borrower, what we're probably talking about is the servicer modifying the loan for the borrower on behalf of the investors. The modification typically will postone or reduce interest payments for a period of time, or possibly reducing the principal amount owed. These modifications have an immediate adverse impact on the cash flow for the investors, and will typically have a disproportionate impact on the various investor classes. Although the immediate impact is negative, ideally the modification will result in a higher recovery for the investors than a foreclosure.

Statutory/Regulatory Assistance. Some proposals call for statutory or regulatory changes which will provide relief for borrowers (for example, foreclosure moratoriums or extending the foreclosure period). These proposals are in essence income transfers from lenders to borrowers in that they allow borrowers an additional period of collateral posession without making payments.

Taxpayer Funded Assistance. These proposals come in a variety of forms:

• Direct Assistance (e.g., funding provided to municipalities to acquire foreclosed homes to recycle to worthy owners).
• Assumption/Extension of Risk. Proposals to provide assistance by taking on additional future risk (e.g., liberalized FHA financing terms).
• Tax Breaks. Some of these proposals include liberalized loss carryforward provisions for home builders and waiver of forgiveness of debt income arising out of foreclosures and modifications.

Part III of this series will discuss, why help?