Federal Deposit Insurance Corp. (FDIC) chairman Sheila Bair is calling on Treasury officials to streamline the loan modification process and require writedowns of second mortgages.

Junior liens have been a major obstacle to effective loan modifications, the FDIC chairman told the Senate Banking Committee Wednesday. "We must finally tackle second liens head on, by requiring servicers to impose meaningful writedowns on second lien holders when a first mortgage is modified or approved for a short sale," Bair testified.

The nation's megabanks — which also happen to be the largest residential servicers — own billions of dollars in second liens, which means a significant writedown on these assets could sap their capital strength.

Sen. Bob Corker, R-Tenn., said second liens can create a conflict of interest for the servicer. "That is a huge issue that we do need to deal with," he said. "In many cases, they are putting their interest ahead of the first mortgage holder, which inverts and greatly changes property rights."

Bair suggested that in the future servicing contracts should spell out the servicer's responsibility if the first mortgage gets into trouble and the servicer owns the second too.

The FDIC chairman also called for a streamlined modification process that allows servicers to act at the earliest stage of delinquency, reducing the interest rate and principal balance as needed to make the payments affordable.

"In exchange for the creation of highly-simplified modifications, mortgage servicers should have a 'safe harbor' that would give them assurance that their claims will be recognized if foreclosure becomes unavoidable," Bair said.

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