The nation’s four biggest banks collectively own about $448 billion in junior liens — those loans taken out on a property in addition to the more standard first-lien mortgage, like second liens, home equity loans and so forth — as of Dec. 31, 2009, according to regulatory filings with the Federal Reserve. That’s nearly 45 percent of all outstanding junior-lien home mortgages in the U.S., Federal Reserve data show.
The problem is that it’s those holdings that are complicating efforts to modify home mortgages. Nearly two-thirds of all home mortgages are held as securities by investors worldwide, most of which are based on first-lien debt. Banks only hold a bit more than a quarter of all outstanding home mortgage debt, Fed data show.
If a borrower loses his home to foreclosure, the first lien is repaid first off the subsequent sale. Whatever proceeds are left go to second and subsequent liens; if nothing is left — for instance, if an underwater borrower is foreclosed on and the sale of the foreclosed home doesn’t even satisfy the outstanding first lien — then the second and subsequent liens are worthless. They don’t get a penny.
Based on that priority of payments, holders of first lien mortgage debt argue that those holding junior liens should take the first hit when it comes to modifying mortgages — after all, if the home enters foreclosure, that’s how it will play out.
Since nearly all mortgage modifications involve homeowners who are likely to default, investors argue that the second-lien holders should write down their holdings, take their losses, and get out of the way so troubled homeowners — free of junior-lien debt obligations — will have a chance to stay in their homes. Investors, after all, want homeowners to stay in their homes so they can continue getting paid; a foreclosed home rarely results in a profit to investors.
Megabanks, thus, should reduce the amount borrowers owe them on those junior liens, argue investors, economics, consumer advocates and mortgage bond analysts.
Their argument is “quite reasonable,” White said.
But the big banks that own that junior lien debt aren’t going to cut mortgage principal and take losses on their holdings without a fight, as emphasized by JP Morgan Chase’s Lowman in his remarks.
“Realistically, as the process winds through, those second [liens] are going to get wiped out,” White said. “[The banks are] just in denial about that.”
The problem is so huge — $448 billion huge — that if the banks were to write down their positions and take the appropriate losses, some think it could necessitate a second bailout.
But until those homes are actually sold in a forced sale — like a foreclosure sale — the banks can keep pretending their holdings are worth more than they really are, White said.
“I guess the banks would rather keep getting those monthly payments,” he said. “And if they can get payments for another six months to a year, they figure, why not?
“The problem with that logic is if the home is foreclosed, the second lien is going to go away,” White said.
Last year lenders foreclosed on more than 2.8 million homes, according to real estate research firm RealtyTrac. The firm estimates three million homes will get foreclosure notices this year; more than one million of them will be repossessed by lenders.
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