Nationwide Foreclosure Settlement In The Works Involves Loan Modifications

Federal agencies and state attorneys general are reportedly working on a comprehensive deal to force banks to write down principal balances and resolve foreclosure problems.

If an agreement is reached, the results could be huge. Banks would reduce billions of dollars worth of principal balances, and states would end their investigations of bank foreclosure practices, possibly allowing foreclosures to go ahead.

Both The Wall Street Journal and The Washington Post had articles on the possible deal in the works today. In additional to mortgage principal write downs, a settlement could cover fines for improper foreclosure proceedings being investigated by state attorneys general.

Reaching a settlement and getting the banks, federal agencies, and state attorneys general to agree would be difficult. The large number of people and the complex issues involved make the talks especially difficult.

Still, the Post said negotiations are getting closer to reaching an agreement.

The Wall Street Journal postulated that an agreement could help clear the backlog of foreclosures and help the housing market eventually recover.

So far, details of a possible settlement are skimpy. The Journal did mention that investors owning the mortgage-backed securities, who are the real mortgage lenders, will not bear the cost of writedowns.

Banks and their servicers, who are paid to administer mortgages, have been roundly criticized for not modifying enough mortgages and improperly foreclosing on homeowners, notably not have the right paperwork when foreclosing.

Most loan modifications have involved decreasing mortgage rates or extending loan terms to lower the borrower’s monthly payment. Banks and servicers worry that if they write down principal balances they’ll get an even larger flood of homeowners trying to lower their mortgage principal, even if they are capable of meeting their monthly payments.

The newspapers didn’t mention that the real problem is how servicing of securitized mortgages is set up. When mortgages were packaged and sold as mortgage-backed bonds, the servicers were hired to collect payments from large numbers of homeowners, and then pass those payments onto investors as cheaply as possible. The system was not designed to modify loans or handle large numbers of foreclosures.

And unlike banks holding loans on their own books, mortgage servicers are constrained by their agreements with their investors and have limited authority to modify loans.