Safe Harbor: Unnecessary, Unfair, Unconstitutional

Apr 28, 2009, 16:03 ET from Investment Coalition

Concerns about 'safe harbor' provision starting to increase

WASHINGTON, April 28 /PRNewswire-USNewswire/ -- A foreclosure prevention bill that could hit the Senate floor this week is coming under increased scrutiny from mortgage investors.

At issue is a provision in the legislation intended to help Americans avoid foreclosure called Helping Families Save Their Homes Act (HR 1106). While the legislation has good intentions, it contains an immunity provision, "safe harbor," that would protect loan servicers from lawsuits filed by mortgage investors.

"The safe harbor provision protects mortgage servicers from lawsuits alleging misconduct in the past and future," said Micah Green, who represents a coalition of investors on the servicer safe harbor issue.

"With regard to the foreclosure issue, the investment community is closely aligned with Main Street -- their responsibility is to the fire fighters, teachers, nurses, police officers and others out there who played by the rules, worked hard and whose pension funds are invested in the mortgage backed securities these banks sold."

The "safe harbor" provision faces growing opposition because:

  • It is Unnecessary -- The majority of the mortgages in the marketplace can already be modified today. Servicers have held up the modification process in order to advance their own interests. We agree with FHFA Director Lockhart's statement that servicers "have more leeway than they're using at the moment" to modify loans.
  • It is Unfair -- To Americans with money in pension funds, 401Ks, mutual funds, college funds or IRAs because it permits servicers and their affiliates to engage in self-dealing at the expense of investors.
  • It is Unconstitutional -- The safe harbor provision constitutes a taking without compensation and prohibits due process for resolving the conflict between investors and servicers.

The bottom line: the "safe harbor" provision provides immunity to any financial institution that modifies loans, even when that institution has practiced predatory lending. This is contrary to the intent of other legislation such as the Fraud Enforcement and Recovery Act (S. 386), which addresses valid concerns.

In addition, the same financial institutions that are receiving a safe harbor for fraudulent underwriting practices also own a significant percentage of the second lien mortgages. The "servicer safe harbor" and the Home Affordable Modification plan allow, in certain cases, servicers to reduce payments on first mortgages which they sold to investors while keeping up payments on second mortgages, thus protecting their investments first.

"Investors want to solve the foreclosure problem by working with servicers, homeowners and the federal government to restructure loans in a way that provides both the ability and the incentive for homeowners to stay in their home and distribute the financial losses equitably," Green said.

The New York Times covered the issue in an article on Sunday, April 26, 2009. The article, "A Reality Check on Mortgage Modification" by Gretchen Morgenson raises concerns about the unintended consequences of the provision.

Here are come excerpts from the article:

"Unfortunately, the bill would not only pay institutions handsomely for each modification they do -- at $1,000 each, a bounty that could reach $10 billion -- but it would also create opportunities for mortgage servicers to profit at the expense of investors who own the loans."

"For example, if the servicer of an abusive loan was also the initial lender, the bill would take that company off the hook for any future predatory lending suits. The safe harbor, therefore, could encourage servicers to modify their most poisonous loans, even if they are not yet near default, just to reduce their legal exposures."

"Another perverse incentive that the bill would create involves the problem of conflicting interests among investors who own the first mortgage on a property and holders of the second liens. First liens of any kind take priority and are supposed to be paid off before secondary obligations are. But many of the companies servicing loans today own second liens on the same properties whose first mortgages are held by investors in securitizations."

"By removing any liability associated with modifying the first mortgage, the banks that own the second liens can expose investors to losses or reduced income while keeping their own interests in the second lien intact."

The preceding was released today by a coalition of investors represented by Weber Merritt.

SOURCE Investment Coalition