Members of a House Financial Services subcommittee are at odds over how to address conflict of interest issues involving the servicing of first and second mortgages.

Since the housing bust, many borrowers have remained current on their second mortgage (HELOC) while falling behind on the first mortgage, which seemed unusual at first. But now investors blame it on the megaservicer banks that own hundreds of billions of dollars worth of second mortgages.

A bill, sponsored by Rep. Scott Garrett, R-N.J., to restart the private-label securitization market would prohibit banks from servicing a first mortgage if they own the second mortgage.

Garrett chairs the Capital Markets and GSE Subcommittee, which voted 18-15 last week to pass his bill and send it to the full committee for further action. During the markup session it became clear that both Republicans and Democrats had issues with the conflict of interest language in Garrett's “Private Mortgage Market Investment Act” bill.

Several Republicans expressed concerns that the conflict provision would prevent community banks from making second mortgages to their customers.

Rep. Steve Stivers, R-Ohio, offered an alternative that would allow banks to service the first and second mortgages. But Rep. Bill Posey, R-Fla., raised concerns that Stivers' amendment requires the banks to initiate a workout, modification or foreclosure once a loan becomes 120 days delinquent.

Rep. Brad Miller, D-N.C., noted that the conflict of interest does not start when a loan becomes delinquent. The conflict starts when a bank places a second lien on a first mortgage that it's servicing for other investors. At that point, the servicer becomes more interested in the performance of the second mortgage than the first mortgage.

Miller's amendment would prohibit servicing banks or their affiliates from making a second lien on a first mortgage that it services for investors.

Garrett urged lawmakers to work together on a compromise that could be offered during a markup in the full committee. Miller and Stivers agreed, withdrawing their amendments.
Some industry groups are hoping lawmakers will recognize that the conflict of interest issue is complex and difficult, and that maybe banking regulators should be given the authority to address it.

The subcommittee approved only two amendments to the private mortgage bill. All amendments by Democratic members were rejected. The subcommittee approved an amendment from Rep. Donald Manzullo, R-Ill., that eliminates a provision in the bill requiring notification when a second lien is placed on a first mortgage.

The main thrust of the Garrett bill is to revive the private mortgage market.

It authorizes the FHFA to establish underwriting standards for classes of mortgages that could be securitized through a TBA (to be announced) market. It also requires the GSE regulator and the Securities and Exchange Commission to draw up standardized pooling and servicing documents, along with representations and warranties that require binding arbitration to resolve disputes between investors, issuers and servicers.

“Standard reps and warranties will provide the certainty that investors are looking for to get back into the market,” Garrett said at the markup. The Garrett bill prevents regulators from requiring servicers to write down the principal amount of a mortgage and repeals the risk retention requirements in the Dodd-Frank Act (DFA). It also clarifies the “qualified mortgage” provisions in the DFA and directs regulators to provide lenders with a safe harbor from lawsuits when they originate “high quality” mortgages that meet Federal Housing Finance Agency (FHFA) underwriting standards.

The Garrett bill does not address the future of the GSEs. But it is designed to advance the development of a private mortgage market while regulators wind down Fannie Mae and Freddie Mac. This worries several industry groups because they fear that without government support, the mortgage market could collapse again.

In a letter to Garrett, the National Association of Federal Credit Unions noted that his bill is a “well-intentioned effort to restore the private mortgage securities market.” However, creating a secondary market without a government guarantee would be “detrimental to the fragile housing market. Therefore, NAFCU does not support this legislation in its current form, as it does not include the explicit government guarantee necessary to facilitate a reliable flow of credit for credit unions and other stakeholders in the marketplace.”

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