Despite calls for loan mods, securitization and other issues have held them back

Richard H. Zahm, founder and principal, Second Angel Bancorp

As published in Scotsman Guide's Residential Edition, February 2009.

At the height of the housing boom, foreclosures seemed to be a thing of the past, and appreciating home values were considered a given. The good ol’ days, however, are history.

Today, a backlog of loan modifications -- caused in part by a challenging securitization environment -- has halted many market forces. Mortgage brokers can help get things moving again by learning the issues at hand and the evolving solutions.

In a simpler world, when homeowners ran into difficulties making their mortgage payments, they’d contact the bank that made the loan, describe their predicament -- e.g., extended illness, job loss or divorce -- and negotiate a loan modification. These alterations could include a temporary decrease in interest rate, a lengthening of the loan term, a refinance or sometimes even a reduction in the principal amount owed. Securitization of home loans changed all this.

Today, securitization and its side effects pose exceptional challenges to the full range of mortgage-market participants. This includes everyone from borrowers to brokers and from lenders to the federal government.

Securitization dramatically altered the borrower-lender relationship. Instead of holding mortgages in their own portfolios, many banks and lenders bundled large numbers of loans into pools that were turned into residential mortgage-backed securities (MBSs).

These securities were divided or “tranched” into different payment-priority tiers, each of which carried a different dividend rate and a different credit rating and were in turn resecuritized into collateralized mortgage obligations. These were backed by mortgage-backed securities rather than the underlying mortgages themselves.

Adding another layer of complexity, collateralized mortgage obligations were tranched. Senior tranches, which stood first in line to recover potential losses, received investment-grade ratings from rating agencies. These ratings allowed these tranches to be sold to institutional investors. Noninvestment-grade components of these obligations were securitized again into what are known as CMO2s.

To make matters worse, the whole process could be repeated again. Often, it was.

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