The Mortgage-Freeze Plan: Still Very Little Litigation Risk

Yves Smith today plays gotcha with the American Securitization Forum, the private-sector group which was instrumental in putting together the mortgage-freeze plan officially announced yesterday. It turns out that the plan is at odds with earlier ASF guidance on loan modification, which said that "the ASF is opposed to any across-the-board approach to loan modifications".

Taking a very prosecutorial approach, Smith then lays out various "lines of attack" which an aggressive lawyer could use should a mortgage bond investor be inclined to sue loan servicers for loss of income as a result of this scheme.

Smith is at pains to point out that just because investors can sue does not mean that investors will sue. But the whole post strikes me as going so far into the realm of the theoretical and hypothetical as to be really rather unenlightening when it comes to the plan as announced. So a group of well-intentioned private-sector individuals might not have dotted every i and crossed every t in putting this plan together? That's a good thing.

It's worth remembering that any given investor is extremely unlikely to hold only the few tranches which are unambiguously damaged by this scheme. Mortgage bonds are held in mortgage-bond portfolios, and demonstrating damages on a mortgage-bond portfolio is going to be very hard. This is not like, say, the Argentine default, where a lot of small investors put all their eggs in one basket and saw them all broken. Of course, a bond investor suing a servicer would sue on losses on a given tranche, not on his overall portfolio. But the court might not have a huge amount of sympathy for such an investor, especially if faced with dozens of amicus briefs from the likes of the ASF, the FDIC, and Treasury all saying why the lawsuit is horrendously misguided and has no legal basis. Meanwhile, the investor would face being ostracized from the ABS community, as would the investor's lawyers. It all sounds like a very high-risk strategy for a relatively small potential payoff.

When I said yesterday that lenders would love this mortgage-freeze plan, the disagreement in the comments came not from bond investors but rather from people renting homes who are hoping for prices to fall further so that they can afford to buy. Personally I doubt that a plan like this which works only at the margins is going to have much effect on overall home prices, although it will (hopefully) reduce the number of homes being foreclosed. And of course Dean Baker is right when he says that it's home prices which are ultimately responsible for default rates, not resets.

In the final analysis, then, the main driver of mortgage-bond valuations was, is, and will always be home prices, at least for the foreseeable future. Any investor seeking to blame mortgage-freeze proposals for mark-to-market losses is delusional.