House Financial Services Committee Chairman Barney Frank last Friday sent a letter addressed to the four largest providers of U.S. mortgages asking for a write down of second liens to prevent "a deepening crisis" in the U.S. housing market.

Writing down principal is needed to raise the modification success rate but, an obstacle to writing down principal of a first mortgage is the existence of a second mortgage or subordinate lien.

Frank said in the letter, addressed to the chief executives of Citigroup, Wells Fargo, Bank of America and JPMorgan Chase; that taking losses on the second liens is necessary in order to allow modifications of the first mortgages to be made.

“To save homes on a large scale, we must move past temporary modifications in interest rates or terms and focus on permanent principal reductions that result in truly sustainable mortgages," Rep. Frank wrote in the letter.

He is looking for banks to take immediate steps to write down the second liens and allow principal reductions modifications of the underlying first liens to take place.

In their January 29, 2010 edition of Amherst Mortgage Insight, Amherst Securities Group analysts said that one of the largest issues in the mortgage market is that the current form of modifications is not working.

“Lien priority dictates that the first mortgage cannot be written down until the second is extinguished," analysts wrote.

Amherst analysts also said that negative equity is a major problem and it is particularly true for borrowers with second liens.

"You can't solve the negative equity problem without writing down the seconds before the firsts," said analysts. In the nonagency universe, 51% of option ARM borrowers have second liens and 56% of Alt-A borrowers have seconds, according to Amherst.

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, yet accounting rules allow holders of these seconds to carry the loans at artificially high values, with many refusing to acknowledge the losses and write down the loans.

But second liens are not an inconsequential factor, said Amherst, because they appear disproportionately on the books of the largest banks, so the loan's extinguishment would affect the capital position of these institutions.


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