Now Wait A Minute

Earlier this year, when the idea of rescuing troubled mortgage borrowers was first bandied about, I questioned the morality and legality of doing so from the standpoint of investors. The vast majority of mortgages are not held by banks, but have been securitized (MBS) and sold to investors. In many instances, banks are merely mortgage servicers.

Investors are questioning the morality of changing the terms on mortgages for which they are creditors. Investors believe that the decision is there's not the banks. I questioned a friend who is a mortgage expert about the legality of banks changing mortgage terms without the consent of investors. He told me last week that most mortgage contracts provide for such changes. An article in today's Wall Street Journal discusses this topic.

The Journal states that a provision known as delegated authority. Unbeknownst to many investors, banks can change the terms of a loan without the consent of investors, who are the actual creditors. Investors believe they should have been consulted nonetheless.

Banks may have the legal right to change the terms of mortgages. Such changes my ultimately benefit investors in the long run, but I am willing to wager that such provisions will keep many investors away from the private label MBS market.

Why just private label MBS? With agency-backed MBS, the agency involved guarantees the return of principal (explicitly government guaranteed with GNMA and implicitly guaranteed by FNMA and FHLMC). With private label MBS, the issuing / servicing bank is not responsible for the return of principal to investors. If enough mortgages default to return 60 cents on the dollar to investors, so be it. Banks to not guarantee their MBS in any way.

As with non-cumulative preferred stock, private label MBS may be another dead market.