Consequences of the Mortgage Loan Servicer Safe Harbor for Hedge Funds Invested in Securities Backed by Primary Mortgages

One of the primary reasons why troubled loans do not receive meaningful modifications is that the loan servicers fear lawsuits from the investors who own securities backed by the loans.  As a result, the government effort so far to address the problem of troubled mortgages has focused on creating incentives to get loan servicers to begin workouts.  President Obama gained their favor in his housing rescue plan by promising up to $9 billion in TARP funds to cover the fees associated with modification and proposing as part of the comprehensive Housing Act a legal “safe harbor” from litigation that might arise in reworking a deal.  The bill is intended to give loan servicers, including big banks like Bank of America and Citi, breathing room to modify loans more easily without having to worry about investor lawsuits.  But recent reports, including one by the Amherst Security Group, found that many of the supposed loan modifications are simple repayment plans that actually increase the balance of the mortgage and result in bigger fees payable to the loan servicers.  Now, there is another major stumbling block as investors holding mortgage-backed securities realize just how big a threat a servicer safe harbor poses to them.  We provide a comprehensive discussion of the legislative background, the mechanics of the proposed servicer safe harbor, a discussion of the necessity of such a safe harbor and a summary of the Amherst Security Group report.

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