Today, in addition to Treasury Secretary Henry Paulson’s expected announcement of a major mortgage modification plan through the $700 billion TARP, Barney Frank’s House Financial Services Committee is holding a hearing entitled “Private Sector Cooperation with Mortgage Modification.” However, despite the word “cooperation” in its title, it’s clear from letters Frank and others sent out that the hearing will be confrontational rather than cooperative. Specifically, Frank and some fellow committee members seek to villify investors in mortgage-backed secuties who assert their property rights under contracts with banks servicing the mortgages.
The harsh tone was set in a letter that Frank and fellow committee Democrats, including Carolyn Maloney, D-N.Y., and Maxine Waters, D-Ca., sent to investor William Frey. The representative wrote that they were “outraged” the Frey was opposing their “voluntary efforts” to “achieve a dimuntion in foreclosures” through the Federal Housing Administration refinancing plan mortgage bailout passed this summer. They then urged him to “reverse his position of trying to obstruct the operation of the bill.” So much for “voluntary,” huh.
But all Frey was doing was asserting the basic American property right of having a contract upheld. Because of securitization, many mortgages are not the banks to modify. Instead they are owned by investors, including pension funds holding the savings of the very middle-class families Frank and others are trying to help. In my OpenMarket post a few months ago, “Abrogating Peter’s Contract to Pay Paul,” I noted that according to investment bank Credit Suisse, 14 percent of MBS are owned by pensions and mutual funds that serve middle-class savers. So a big bailout, I wrote, “not only ‘robs Peter to Pay Paul,’ through taxpayers’ bailout of bad loans by banks and borrowers. It can also be said to ‘abrogate Paul’s contract to Peter.'”
Despite being all fired up in their letter to have investor Frey tesify, he was apparently dropped from the hearing after he submitted his written testimony. Perhaps Frank and others didn’t want to be shown up by the stength of Frey’s arguments unapolgetically defending the property rights of investors. Frey’s testimony, which I have obtained a copy of and will link to as soon as it is online, states forcefully that the issue is “not about a few rich guys [who] get hurt when mortgages are restructured,” but about the fact that “contract rights are an integral part of the US economy.” Frey stresses that “investors from around the world are watching and asking: if they buy U.S. securities, will they need to factor in a risk that they never before anticipated — that the U.S. government will alter the contracts supporting their investments without compensation.”
Many contracts have their own mechanisms spelling out how to restructure in case a borrower defaults, and investors have strong incentives to restructure to avoid the cost of foreclosure. But neither Paulson nor Frank nor any other poltician should push a “voluntary” or mandatory plan that would have the effect of abrogating thousands of private contracts. Such an action would force a big hit to the middle-class savers with mortgage-backed securities in their pensions and mutual funds. And it will be an even more devastating hit to the ability to write mortgages and other loans in the future if investors don’t believe their property rights in their contracts will be upheld.