President Obama recently unveiled an initiative designed to support the housing market and reduce the catastrophic number of foreclosures. While the GSE-centric plan generally represents an incremental change from earlier programs, its controversial inclusion of a proposal for bankruptcy cram-downs may ultimately aid large numbers of homeowners by increasing the number of loans that ultimately are modified.

Although containing provisions designed to stimulate refinancings and stabilize the GSEs, the proposal focuses on reducing home foreclosures and facilitating large-scale loan modifications. While the Administration will release more detailed guidelines in early March, most of the provisions are similar to Bush Administration initiatives that failed to help many homeowners. In addition, the proposal ignores important attributes of the current mortgage market. For example, provisions to pay cash fees to servicers that modify loans create apparent conflicts of interest in cases where loans were packaged in securitizations. While servicers have a fiduciary responsibility to maximize the proceeds paid to securitization trusts, direct payments to servicers create incentives to modify loans even in cases where a modification might be sub-optimal. The acceptance of such payments could be grounds for investor lawsuits, and suggests that such payments are unlikely to motivate servicers to modify loans aggressively without receiving some form of legal protection. In addition, a provision that would pay "mortgage holders" $1,500 to modify troubled loans before they become delinquent overlooks the complexities associated with securitization. MBS deals don't have one "mortgage holder," but rather tranches with a variety of risk profiles and interests. The plan does not recognize this fact, nor does it address issues such as how incentive payments should be divided among bondholders.

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