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Columbia Business School and Columbia Law School today announced a new joint proposal to stem foreclosures through loan modifications. The proposal, co-written by Professors Christopher Mayer and Tomasz Piskorski of Columbia Business School and Professor Edward Morrison of Columbia Law School, takes aim at privately securitized mortgages, which are at the core of the housing crisis, accounting for more than 50 percent of foreclosure starts.
Research shows that when these mortgages become delinquent, servicers of securitized mortgages opt for foreclosure over mortgage modification much more often than private lenders who service their own mortgages.
The solution, according to the professors, is to facilitate modification, instead of foreclosure, by:
1) Compensating servicers who modify mortgages. Using TARP funds, the federal government should increase the fee that servicers receive from continuing a mortgage and avoiding foreclosure, thereby aligning servicers' incentives with the interests of borrowers and investors; and
2) Removing legal constraints that inhibit modification. The federal government should enact legislation that eliminates explicit restraints on modification and creates a safe harbor from litigation for reasonable, good faith modifications that raise returns to investors.
By the authors' estimates, the plan would prevent nearly one million foreclosures over three years, at a cost of no more than $10.7 billion. It does not raise any constitutional concerns, because it builds on well-established Supreme Court case law. The authors show that this solution is more effective and less costly than alternatives, including bankruptcy reforms involving judicial mortgage reductions, known as "cramdowns," the recent FDIC servicer incentive and mortgage guarantee program.
Homeowners will benefit as much as servicers and investors under this plan, the authors argue, as it promotes cooperation between servicers and homeowners so that homes go to foreclosure only when necessary.
This proposal, coupled with an earlier proposal advanced by Professor Mayer and Columbia Business School Dean Glenn Hubbard for the federal government to reduce mortgage rates, is part of a two-pronged approach to stabilize the housing market and prevent foreclosures.
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