In Capitol Hill's rush to aid borrowers and stem the tide of foreclosures, are investors being thrown under the bus?

Many industry participants have been wary of Congress meddling too much in a market recovery plan, so it's probably no surprise there would be some backlash to a proposed bill by House Financial Services Committee Chairman Barney Frank (D-Mass.) that aims to increase loan modifications by protecting servicers from investor lawsuits. The bill, as reported by ASR's sister publication American Banker, could be included in a broader housing rescue plan that Frank is expected to introduce before Congress adjourns for its Easter vacation.

To be sure, Frank's proposal does come with restrictions. The bill stipulates that the servicer must be "acting in the best interest of the securitization vehicle on behalf of all investors and holders of beneficial interests in the pooled loans." This means accepting a short sale of the property or implementing a loan modification only "if the servicer reasonably believes it will realize a net present value greater than it would through a foreclosure."

Despite the limitations embedded into the proposed bill, some market participants still remain wary.

"The whole premise that servicers were hired by investors to collect payments and work in their best interests has been turned upside down," said an industry source who spoke on the condition of anonymity.

The source added that "the threat of litigation is the only thing investors have to ensure that these servicers are acting in the best interests according to the documentation that we entered into with them."

Consumer rights groups have been pushing Congress to help troubled borrowers avoid massive foreclosures. Senate Republicans shot down the Foreclosure Prevention Act on Feb. 28, a bill that Democrats argued would prevent more than a half-million foreclosures.

"While many members of Congress are working hard to prevent foreclosures, some members of the lending industry are preventing legislation that Americans desperately need," Michael Calhoun, president of the Center for Responsible Lending, said in a statement.

No to Homeowner Rescue

Even as the pressure mounts on Congress to save borrowers from losing their homes, there has been a feeling among some market participants that ultimately a lot of homeowners are beyond saving.

"I think the deeper fantasy is that the bulk of homeowners in trouble are qualified to own their homes," said Lou Barnes, an owner of Boulder West Financial Services, a Colorado-based mortgage servicing company. "They're not. The vast bulk of people in trouble today cannot be saved by any reasonable workout."

Barnes, who does not sell subprime loans, said that the mortgage workout plans that have been proposed thus far equate to "bad public policy mistakes." While he said that the high level of foreclosures is "awful to watch" he also argued that the current banking crisis requires that assets are moved away from "weak hands."

"Even if you achieve a workout that lets them make a monthly payment on a home that has no equity, they don't have the free cash flow to maintain the place," he said.

Barnes said that neither Republicans nor Democrats are willing to address the real issue that is troubling the market: the lack of new credit.

"The policymakers must deal with the credit spiral where standards for new loans are choking off the demand that would absorb the foreclosures," he said. "It's new credit that we're missing. Attempting to keep people who fundamentally can't afford their houses is a waste of time."

But the industry source who spoke on the condition of anonymity said Frank's bill could negatively impact the infusion of new credit. "Unfortunately, they're not going to get more credit flowing into the sector when their solution is to stick investors, who are currently experiencing very high losses, with even higher losses in the future," he said.

The source added that it becomes difficult to keep investors in the market "when the rules of the game have been changed midstream." He argued that there could be to some extent a lack of appreciation for the role investors play in providing financing for the mortgage market.

"The more pressing thing is what is politically convenient and we're in an election year and we're in a situation that is relatively ugly and I think they are grasping at straws here to do whatever it takes in the short run to limit the downside," he said.

But in a speech at a community bankers' convention in Orlando on March 4, Federal Reserve Chairman Ben Bernanke said that litigation threats are preventing servicers from pursuing loan workout options that are "in the collective interests of investors and borrowers." He said that a plan for removing the barriers to loan workout plans should be a part of future discussions in order to limit costly foreclosures.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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