Purchasing Mortgage-Backed Securities Does Not Give the Government the Ability to Modify Mortgages Backing the Securities

The residential mortgage-related assets that the government is proposing to purchase in  the bailout plan are for the most part not mortgages themselves.  Rather, the assets are mortgage backed securities (MBS).  An MBS is a security issued by a trust (SPV) that has been specially  created for a securitization transaction.  The SPV will purchase large pool of mortgages from a  financial institution.  The SPV pays for the mortgages by issuing securities.  These securities are collateralized by the mortgages owned by the SPV, hence they are “mortgage-backed” securities.  These MBS are typically referred to as “certificates,” and most are debt securities that entitle the  holder to a series of regularly scheduled payments, as with a corporate bond.

By purchasing MBS, the government will not become the direct owner of the mortgages. Instead, it will simply hold securities of an entity that owns mortgages.  This is insufficient to  give the government the ability to modify the mortgages.  Just as corporate bond holders have no right to control the bond issuer’s management decisions, so too do MBS holders have no right to control how the SPV’s management of the mortgages.

The decision to modify mortgages held by an SPV rests with the SPV’s agent, call the  servicer.  The servicer to performs the day-to-day tasks related to the mortgages owned by the SPV, such as collecting payments, handling paperwork, foreclosing, and selling foreclosed  properties.  These servicers, including many “mortgage companies” like Countrywide and Wells Fargo owned by bank holding companies, are the entities that actually consider loan modification requests.  Confusingly, the servicer is often, but not always, the originator.

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