A 'Cliff' of Their Own: Extend the Mortgage Servicer Safe Harbor Now or Face a New Wave of Home Mortgage Foreclosures in 2013
By Robert Hockett
With so much attention now focused on the so-called 'fiscal cliff' negotiations between the White House and Congress, Americans might be forgiven for failure to notice another 'cliff' we are set to go over come New Year’s Day. On that day, absent Congressional and Presidential action, an underappreciated provision of the Helping Families Save Their Homes Act of 2009 is set to expire: the servicer safe harbor provision. It would be difficult to overstate the significance of this little-discussed piece of home finance policy – or of why it is crucial that it be extended past 2012.
Most Americans know that our nation has recently passed through a housing price bubble and bust, and that securitized mortgage loans had something to do with them both. Most also have heard of the Home Affordable Mortgage Program ('HAMP'), which has prevented some securitized loan foreclosures but has accomplished much less than – and would accomplish still less in the absence of – the safe harbor rule. Few seem to know, though, the critical role played by securitized mortgage loan pooling and servicing agreements ('PSAs') in preventing smooth market adjustment to post-bubble pricing realities – or of the safe harbor’s role in addressing that challenge since 2009.
The key problem here is that many of the mentioned PSAs, drafted as they were during the heady bubble years when too few appreciated that housing prices that go up can likewise come down, often prohibit or otherwise prevent loan servicers from modifying adequate numbers of mortgage loans when borrowers run into difficulty, after the bust, keeping current on mortgage loan payments. Because the bust has left so many of these homeowners 'underwater'– owing more on their home loans than their homes are now worth – the absence of such modification authority harms not only mortgage loan debtors, but also their ultimate creditors: those who hold bonds issued by mortgage loan securitization trusts.
The reason for this is straightforward: Deeply underwater homeowners default at high rates, no matter how hard they struggle to stay current on their loans. In consequence, many securitized mortgage loans can be rendered more valuable through modification, since modifications lower default risk. This means that bondholders and homeowners alike benefit by careful loan modifications – precisely what the aforementioned PSAs tend to prevent or prohibit.
In recognition of this wasteful double-bind, Congress passed, and the President then signed, the mortgage servicer safe harbor provision in 2009. This provision authorizes securitized loan servicers who wish to do the right thing to modify mortgage loans under certain carefully specified conditions, provided that such modifications can reasonably be expected to prevent imminent borrower defaults and thereby maximize loan values for bondholders. The provision does not, strictly speaking, immunize servicers against all possible lawsuits that might be filed by occasionally disgruntled minority bondholders. But it does constitute a legal defense against such suits – a sufficiently robust defense as can prompt the many loan servicers who wish to do right by investors and homeowners to go ahead and modify loans under many circumstances in which they would otherwise have to fear lawsuits.
This, then, is why Congress and the President must act now to extend the servicer safe harbor provision. Our nation’s underwater mortgage loan crisis is anything but over. Fully 11 million – that’s nearly one quarter – of our nation’s outstanding mortgage loans remain far underwater and accordingly subject to high default risk unless modified. A halt in such modifications – already too few as is, even with the safe harbor – would guarantee a spike in defaults and foreclosures. That would in turn bring a new wave of evictions and all of the social and economic dysfunction that these household calamities entail, as well as confronting our housing markets with a new downward price shock just as we now see some tentative signs that recovery might be nigh.
To be sure, the safe harbor is no panacea – nor will its extension be. Many servicers remain too risk-averse or conflicted to make meaningful, value-salvaging modifications to mortgage loans even under the safe harbor’s protection. That is precisely why some American municipalities now are considering use of their eminent domain powers to sidestep the servicers and modify mortgage loans on local properties themselves. If we are to avoid a dramatic increase of resort to such “last resort” methods come 2013, however, we must extend the mortgage servicer safe harbor as quickly as possible.