WASHINGTON — Efforts to tame the housing crisis by modifying troubled subprime loans have exposed a fracture between several of the nation's largest banks and the government-sponsored enterprises.
The rub: modifying mortgages that are still being paid on time.
The Bush administration struck a deal with the industry in early December to freeze interest rates for borrowers who are current on subprime hybrid adjustable-rate mortgages but facing an unaffordable reset. So far the results have been underwhelming.
Servicers say Fannie Mae and Freddie Mac are partly to blame because of their policies that prevent servicers from agreeing to changes to mortgages that have not yet become delinquent.
With lawmakers considering changes that would free the GSEs to expand by raising the size of loans they could buy, guarantee, and securitize, Fannie and Freddie can ill-afford to be seen as creating roadblocks for homeowners.
"They're trying to push raising the conforming loan limit," said Brian Gardner, a political analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc. "Clearly they want to be on the right side of things. … It would not help them with their allies if they're seen to not be helping out."
Bankers would not discuss the matter on the record, saying they fear upsetting the dominant buyers of their mortgage assets. But in background interviews, servicers claimed Fannie in particular adheres to restrictive rules that reduce the number of loans that may be modified. They say Fannie will not agree to a modification of a loan it has securitized until the loan has been delinquent for four months.
"That's a very arbitrary policy," said Bert Ely, an independent consultant in Alexandria, Va., and a frequent GSE critic. "There's no reason they couldn't do it much sooner. They do have a fair amount of latitude as to how dynamic they can be in managing their pools of securities."
The policy is linked to an accounting rule that requires a company to reflect modified loans from a securitization pool on its balance sheet. But that analysis of Financial Accounting Standard 140 is beginning to change in response to worries that some securitization pools may include subprime mortgage assets that should be modified earlier.
In a July 24 letter to House Financial Services Committee Chairman Barney Frank, Securities and Exchange Commission Chairman Christopher Cox wrote that companies could begin modifying assets when default seems "reasonably foreseeable," instead of waiting four months.
Brian Faith, Fannie's managing director of communications, said in a written statement that the GSE "maintains a long-standing commitment to give all of our servicers flexibility to keep borrowers in their homes."
Fannie will do "trial modifications" by restructuring a mortgage on a temporary basis during the first three months of delinquency. If the borrower proves able to handle the modified loan after three months, the restructuring can become permanent.
In his statement, Mr. Faith said Fannie is working to ensure its servicers — particularly the largest ones — understand this is an option.
"The company has recently increased the flexibility of its servicing guidelines to allow servicers to utilize all loss-mitigation options, including trial modifications, as soon as a borrower becomes delinquent on both … [mortgage-backed securities] and portfolio loans," he wrote. "This has been communicated to our top 10 servicers, which service nearly 80% of our portfolio. As systems are updated early this year, this flexibility will be extended to all 1,400 active Fannie Mae servicers."
Steve Bailey, the managing director for loan administration at Countrywide Financial Corp., said Fannie had required a loan to reach a certain level of delinquency before a servicer could start negotiating a modification. But, he said, "I think Fannie Mae has made a lot of changes" and is no longer "a problem."
Both GSEs concede their modification efforts largely focus on delinquent loans.
Robert Padgett, Freddie Mac's director of loss mitigation, said that is because most borrowers do not contact their servicers to discuss workout plans until a delinquency has occurred.
"If you think about it, the borrowers have some sort of hiccup in their income stream … and it causes them to get behind, and that's usually what gets them to make the inquiry," Mr. Padgett said.
"If a borrower who is current with their payments contacts their servicer about the possibility of future delinquency, we encourage our servicers to work with the borrower right away," Mr. Faith wrote.
A Treasury spokeswoman did not respond to requests for comment, but the GSEs' regulator, the Office of Federal Housing Enterprise Oversight, said the government is not asking companies to violate agreements with investors in securitized pools.
"We agree that earlier is better than later for any needed modifications," an agency offical wrote in the e-mail. "OFHEO does not have any authority to dictate when or even if loan modifications are made, although we do have some indirect influence on the process, through our safety and soundness regulation. We have encouraged the enterprises to take advantage of all permissible options when evaluating delinquent loans or loans that are reasonably foreseeable to become delinquent."
Nevertheless, the GSEs' modification of troubled loans may not have much of an impact on the mortgage market, because the companies invest mostly in safer mortgages.
"With the Fannie and Freddie loans, the underwriting is usually pretty tight," said Lawrence White, a professor at New York University's Stern School of Business. "You don't hear many stories about Fannie and Freddie loans where the borrower was subjected to aggressive predatory lending on the part of the broker, and I think it's the dealing with the predatory situation that has caused the [Bush] administration's program to focus more on mortgages before they start going down the toilet."
Paul Miller, an equity analyst with Friedman, Billings, Ramsey & Co., chalked the dispute up to the long-running rivalries and suspicions between large banks and the GSEs.
"It's the basic battle between Fannie and Freddie and the big banks," he said. "I just don't think loan modifications are the fix everyone thought they would be."
