Loan Modification Program Violates Investor's Interests

Class Action Suit against Bank of America's Loan Modification Program

The battle over loan modifications of troubled mortgages has begun. On Dec. 1, 2008, William Frey, a private investor in mortgage-backed securities, filed a lawsuit in New York State Supreme Court, alleging that the proposed loan modification of some 400,000 home loans originally underwritten by the defunct lender Countrywide Financial is illegal.

The lawsuit, which seeks class-action status, was filed against Bank of America, which bought Countrywide in late 2007. It argues that most of the Countrywide loans are not Countrywide's or Bank of America's to modify, but rather are owned by trusts that bought them through securitization - - the process of financing home loans through the public markets by parceling them out to investors.

Frey says that BofA's modifications will short change bondholders of $8.4 billion by reducing borrower payments. While those loan adjustments may help to keep struggling borrowers in their homes today, Frey says those alterations run the risk of permanently damaging the secondary market for housing finance.

He argued that loan modifications are against Laws of Contract. There is no way to alter the mortgage contract, once it has been securitized. "Oh gee, we're going to change the rules. That's a big problem. Taxpayers should to come up with another $500 billion to buy all of the troubled loans from mortgage-backed securities pools in order to keep the public market for financing mortgages viable." (There have been roughly $7 trillion in mortgages financed by global public markets since 2002).

In response, Bank of America spokeswoman Shirley Norton says: "We are, disappointed in this attempt to halt a program intended to keep as many as 400,000 at-risk families in their homes and, together with similar programs across the industry- that will benefits both consumers and investors.

Securitization massively expanded home ownership in recent years by allowing investors to price the risk of less credit-worthy borrowers. But investors in some of the prime securities are angry about having to foot the bill for reworking the most risky mortgages. But these investors were aware of these risks, when they bought those bonds.

To raise money to lend, banks and mortgage players such as Countrywide sold some of their loans via Wall Street. When loans are securitized, Wall Street bankers create trusts that buy them. When borrowers pay interest and principal on their mortgage loans, those payments go to the trusts, not to the lender that initially made the mortgage loans. To raise the money to buy or fund the loans, the trusts sell interests in a pool to investors or bondholders. These notes are securities -- hence the term "securitization." It seems that in this setup, Wall Street Bankers have built-in advantages over the investors, over the borrowers, and over the taxpayers. They earned out of investors money and borrowers' interest; and now, they are being bailed out by taxpayer's money. And the irony of things, they were the ones who conceptualized and created this problem.

Paul Koches, general counsel for Ocwen, largest subprime-mortgage servicing company claims that "loan modifications designed to yield greater cash flow to investors compared to net liquidation proceeds from a foreclosure. These are legally permitted, in a market environment where loss on foreclosures exceeds 50%. Loan modifications are not only a useful tool in protecting investors, but they also keep homeowners in their homes -- truly a win/win result.

Written by Katherine M.

(Summarized from: Investor Sues to Block Mortgage Modifications By Mara Der Hovanesian, Business Week Online)