WASHINGTON — Fannie Mae and Freddie Mac may soon have to speed up and improve efforts to facilitate loan modifications for troubled borrowers, the Federal Housing Finance Agency said Tuesday.
Director James Lockhart, who now directly controls the government-sponsored enterprises, said the agency is "looking into the loan modification programs of the two companies" and will discuss them with senior officials at Fannie and Freddie.
"We have been discussing loan modifications over the last nine months with the companies, and we have prodded them to be creative and aggressive," he said in a response to questions posed by American Banker.
The agency, which effectively controls roughly $5 trillion of mortgage-related holdings, could do on a grand scale what the Federal Deposit Insurance Corp. is trying to do for IndyMac Bancorp Inc. borrowers. The FDIC announced last month it would try to alter mortgages systematically for up to 60,000 borrowers of the failed thrift.
Consumer advocates were already pushing the Finance Agency and the Treasury Department, which helped engineer the GSE takeover, to use it to speed up the modification process.
Though Fannie and Freddie have said they are committed to that process, their top executives, who were ousted Sunday, had expressed reservations.
"Altering basic contracts would have a high price," Dan Mudd, who was Fannie's chief executive, said in January. "Investors left with the losses would not easily return to the market. That inevitably would shrink the pool of credit."
Supporters say the Treasury, which has long advocated voluntary loan workouts by the industry, now has a chance to follow its own advice. "There will be no excuses now," said Bruce Marks, the president of the Neighborhood Assistance Corp. of America.
Treasury Secretary Henry Paulson "will no longer be able to claim that he tried but the servicers refused," Mr. Marks said. "Paulson is now able to put in place the modifications that he's advocated."
Other observers were less positive about whether Fannie and Freddie could improve much on the programs they already have in place. For one thing, Fannie and Freddie never serviced loans directly, and the mortgages they own are mostly part of mortgage-backed securities. Moreover, complex legal arrangements between servicers, the GSEs, originating banks, and investors in GSE securities may make such modifications difficult, and a broad government workout program would complicate mortgage-backed securities valuation, observers said.
"Once you start modifying the underlying object, it's a free-for-all over what those securities are worth," said David Gibbons, a former deputy comptroller and chief credit officer at the Office of the Comptroller of the Currency, who is now a special adviser to Promontory Financial Group LLC. "You could impact pricing and liquidity in these securities, which are on many banks' balance sheets."
But supporters of wide-scale modifications said a government-driven workout plan through the GSEs' portfolios would solve a critical servicing challenge that has hampered modifications. Many servicers are reluctant to restructure loans because of fears of investor backlash. But here the GSEs, supervised by the government, would be the investor.
"They're in the driver's seat, and they control" the portfolios, said John Taylor, the president and CEO of the National Community Reinvestment Coalition. "They can continue to rescue institutions, which is going to give some comfort to investors. But the truth is the foreclosures will continue to mount until they really devise a system that will have a wholesale modification of hundreds of thousands, if not millions of loans, to prevent those from going into foreclosure."
Parts of the government are already trying to improve the process. Last month FDIC Chairman Sheila Bair, the government's most vocal supporter of mass modifications, unveiled initial plans to target 25,000 loans on IndyMac's $184 billion servicing portfolio for workouts as part of the management of the thrift, which failed in July.
The FDIC said it would use a standard formula to assess whether a modification on a loan is workable to achieve the most workouts, capping loans at a 6.5% interest rate and aiming for a 38% debt-to-income ratio.
Consumer groups said the Treasury and the Finance Agency could follow Ms. Bair's lead.
"Look what Sheila Bair's doing — she's walking the walk, as well as talking the talk," Mr. Marks said. "Now we need Secretary Paulson to walk the walk, as well as talk the talk."
An FDIC spokesman said any efforts to expand modifications are worthwhile. "We did work with Fannie and Freddie closely as we developed our loan modification views. That was before Sunday, and we expect those conversations to continue" with the Finance Agency.
Modifications are "a positive both for their performance and adding value, and also for keeping homeowners in their home on a long-term sustainable basis," the spokesman said. "Any more momentum for that approach would be welcomed by us."
But skeptics said the Treasury and the Finance Agency have other primary concerns, such as stabilizing Fannie and Freddie.
"If they were to make a quick knee-jerk reaction, it could be more disruptive to the mortgage market," said Lawrence Kaplan, an attorney at Paul, Hastings, Janofsky & Walker LLP. "What they should be doing is seeing how the dust settles before they start making wholesale changes."
Bob Caruso, the former head of Bank of America Corp.'s home loan division, said a wholesale modification plan at Fannie and Freddie could do more harm than good.
"To do it en masse without some level of controls and thought will probably extend the semi-recession or the property depreciation event, because more customers over time are going to be looking for more workouts," said Mr. Caruso, now an executive vice president at Lender Processing Services Inc., a spinoff of Fidelity National Information Services' mortgage business in Jacksonville, Fla.
