Why The Government Cannot Modify Mortgages If It Purchases $700BN of MBS

[Joanne98]

posted by Adam Levitin
I've written a short explanation of the why even if the Treasury buys $700BN of MBS it will be unable to modify the underlying mortgages. The explanation, which is more detailed than any of my previous postings on the subject, is available here.

At core it is a Trust Indenture Act problem, where the bonds cannot be modified absent a specified majority vote and consent of bondholders whose payment rights are affected. And here is no possibility of doing an exchange offer to get around it; there is simply no mechanism for an MBS trust to do an exchange offer. (For the classic discussion of Trust Indenture problems, see Mark Roe's article, The Voting Prohibition in Bond Workouts.) The solution of Trust Indenture Act problems with corporate bonds is...you guessed it, bankruptcy modification!

http://www.creditslips.org/creditslips/2008/09/why-the-governm.html

[whistle]

1. It's a Paulson and White House hose-job....NO BAILOUT!

...the better solution would be to force the guilty to pay.

Congress could enact and immediately begin collecting a 1.5% to 3.0% surtax on all stock trades which on the NY Stock exchange represents 300 million to 450 million shares a day. Those surtaxes would be withheld and submitted to the Federal government weekly or even daily and placed into a trust fund for these investment banks to apply toward bailing out their most toxic paper until all losses are eradicated. Then before the tax can be repealed, Wall Street and for that matter the global trading investment community could have put in place regulatory safeguards and oversight which would prevent this from happening again.

Congress could then take the $700 billion plus the recoup the $350 billion Paulson gave away last week and create jobs and long term capital projects to restore the U.S. physical economy.

[upi402]

4. There are so many good ideas on our side

why why WHY are we letting the TV fool the sheep again?

[gopbuster]

2. Holy Comoly........I'm beginning to think NO F'ing Bailout as well

These bastards need to be fucking locked up to rot in hell>

Including distressed homeowners will not be as easy as it would seem:

Problem 6. REMIC Tax Problems from Modification Would Destroy MBS Resale Value
and Cost Taxpayers Money
Even if the government could somehow modify the underlying mortgages by purchasing
MBS in spite of all the obstacles mentioned thus far, modification would result in serious
negative tax consequences for the MBS that would make them hard for the government to resell
and would penalize MBS holders who could not or did not participate in the bailout.
The value of MBS depends heavily on their tax treatment. MBS are structured to enjoy
REMIC (Real Estate Mortgage Investment Conduit) status under the Internal Revenue Code,
which enables the MBS to avoid double taxation of income. Absent REMIC status, federal
income tax would apply to the SPV as well as to the dividends paid to the MBS holders. REMIC
status gives an SPV pass-thru status, so federal income tax only applies to the MBS holders on
the dividends received from the trust. In order to qualify for tax-advantaged REMIC status, the
pool of loans securitized in a REMIC must generally be treated as a static pool.4 This usually
precludes large scale modification of loans in the pool.5 Thus, significant mortgage modification
by servicers could cost an SPV its REMIC status and result in double taxation of the MBS.
Because of this concern, many PSA place significant constraints on modification of mortgage
loans as well as modification of the PSA itself.6 Once REMIC status is lost, it cannot be
regained, so any government action that would cost an MBS its REMIC status would seriously
impair its resale value.

The Government Will Be Unable to Modify Mortgages Simply By Purchasing Billions of
Dollars of Mortgage-Backed Securities. Bankruptcy Modification Provides the Only
Guaranteed Method of Widescale Mortgage Modification for Distressed Homeowners
Only bankruptcy law changes can require the trust to go along with a loan modification
and deal with the junior lien problem. Already Chapter 11 bankruptcy is used for the same
effect. Because of the Trust Indenture Act, it is very difficult to engage in a consensual
modification of corporate bonds. As a result businesses that need to restructure their bonds often
find it necessary to do in bankruptcy. Amending the Bankruptcy Code to permit modification of
all mortgages would also make voluntary modifications more likely, because a trust could defend
any lawsuit by asserting that the borrower could have gotten the same deal (or one less favorable
to the trust) in bankruptcy. Thus, permitting bankruptcy relief may well cause it to be
unnecessary in many cases.

[NoUsername]

3. Another great post.

Thanks for digging up these great articles. Lots of good info here.

Have you thought about posting this in GD? This type of into needs to get out to a wider audience.

[upi402]

5. We citizens can't be stakeholders in the firms "we" bail out?

We can never be the bearers of Mortgage Backed Securities? What if the new "Democrats" who may be elected change the law, could it be retroactive?

[Chees67]

6. Bush

Hi,

I was on holiday in the US in August and really love your
country and all the friendly people but sensed also the crisis
in the Air. Last wednessday this was in the news in Holland
and needs attention. Guess most of you forgot but Bush himself
announced a programm for minority home ownership himself in
2002. Read here his speech:
http://www.whitehouse.gov/news/releases/2002/10/20021015-7.html#

Also see here the highlights in a Video:
http://nl.youtube.com/watch?v=GkAtUq0OJ68

This means the suprime morgage crisis is result of failed
government policy and not the banks, wall street, etc. Its the
same government that now is working on a plan to finance the
failed policy with your Tax money.

Regards, Ron (netherlands)