Thursday, August 20, 2009

Newsflash: Contracts still matter

From the NYT (emphasis added):
Countrywide, the big mortgage company, had argued that the legislation automatically voided its pledges to buy back loans from investors if those loans were modified for troubled borrowers.
Investors who own mortgage securities receive interest and principal payments from borrowers over the life of the loans. When servicing companies modify those loans, investor payments are typically reduced.

“I view this as an opening salvo and a demonstration that investors do have contractual rights, even when it is politically unpopular,” said William A. Frey, one of the investors who brought the lawsuit. “This is ultimately going to be one of many legal battles over who should pay the hundreds of billions of dollars in losses on mortgages.”
It argued that the matter belonged in federal court and that any contractual obligations to repurchase modified loans were trumped by the Helping Families Save Their Homes Act of 2009. Under that law, servicing companies that agree to modify loans receive some protection from liability arising from the loan changes.

Judge Holwell ruled that the immunity granted under the legislation did not prevent Countrywide’s investors from trying to enforce their rights under the mortgage securities contracts. The investors must prove that Countrywide’s pooling and servicing agreement covering their loans does indeed require it to repurchase mortgages the bank modifies, the judge said, ruling that the case belongs in state court.
The case highlights the potential for conflicts of interest in the loan servicing business. Loan servicers have a duty to investors not to do anything that jeopardizes the income stream to holders of the securities.
Investors in mortgage securities are increasingly concerned that the companies may put their own interests ahead of those of their servicing customers when they modify loans.
As the mortgage crisis has deepened, servicers have also come under immense pressure from the government to modify loans. The goal is to keep borrowers in their homes and curb the flood of foreclosures, but changes to loan terms can put servicers at odds with the investors they have a duty to serve.

I think this is an amazing case. As I understand it, Countrywide/BofA buys servicing rights on a pool of loans it originated. Gets sued for originating bad loans and agrees to modify the loans but tried to foist the losses onto the investor instead of taking the losses themselves hiding behind the safe harbor provided by Congress.

Congress it trying to get servicers to modify loans over the objections of the investors who own them and want a say in the process. Congress has provided a safe harbor shielding the servicers from liability if they modify them in a specific way even if the investors do not agree. The servicers fiduciary duty is to the investor, not the borrower. It is incredible that the investors rights are being trampled like this.

As always I wonder who would ever invest in a mortgage backed security ever again. And of those who would still invest, I wonder why any of them would do so with BofA.

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