The American housing market that in crashing started the current financial crisis can be rehabilitated by making local bankers responsible for mortgage rate adjustments, according to economics professor John Geanakoplos ’75.
In an op-ed written in Thursday’s New York Times, Geanakoplos and former Boston University law professor Susan P. Koniak LAW ’78 argued that shifting the responsibility of managing homeowner mortgages and reevaluating mortgage rates from large corporate “master servicers” to local bankers will benefit both homeowners and financial backers by clarifying the true value of mortgage-backed securities and keeping more homeowners out of foreclosure.
Geanakoplos said in an interview with the News on Thursday that he published the piece to amplify his own solution to the financial crisis.
In the op-ed, “Mortgage Justice is Blind,” he and Koniak wrote that “master servicers” — entities with the power to manage and “re-work” loans in order to prevent foreclosure — choose not to modify the terms of a homeowner’s mortgage because of cost, conflict of interest and potential legal repercussions. But servicer inaction leads to foreclosures. And in a depressed housing market, bond-holders often earn only 50 cents on the dollar when the foreclosed home is sold.
“Most anything a master servicer does to rework a loan will create big winners but also some big losers among the security holders to whom the servicer holds equal duties,” they wrote. “So the servicers feel safer doing nothing. By allowing foreclosures to proceed without much intervention, they avoid potentially huge lawsuits by injured security holders.”
Since mortgage-backed securities started losing value, master servicers have acquired many of the bonds, creating a conflict of interest for the servicers: They are forced to balance maximizing return on bonds the company holds with the greater good of all investors holding loans in the pool.
To eliminate conflict of interest, decrease foreclosure rates and maximize each mortgage’s rate of return, Geanakoplos and Koniak proposed legislation to create a network of local, government-appointed trustees who would evaluate each mortgage and decide, based on the homeowner’s individual situation, whether a renegotiation of rates or a home foreclosure would bring the most money for the bond-holder.
“These trustees would be given no information about which securities are derived from which mortgages, or how those securities would be affected by the reworking and foreclosure decisions they make,” Geanakoplos and Koniak wrote.
Geanakoplos faced sharp questioning Thursday from CNBC correspondent Diana Olick, who cast doubt on the legality of transferring the right of mortgage renegotiation from private firms to the federal government. Koniak said her research proved transferring the right to “re-work” loans was legal.
“What we’re doing is saying that the person who had that understanding isn’t capable of acting,” she said by telephone Thursday. “So we’re giving that power — which you always knew you had — to another agent who can act.”
Geanakoplos said he has been considering the economic principles underlying the editorial for some time. After meeting with Federal Reserve Chair Ben Bernanke on Oct. 3, Geanakoplos said he felt his ideas needed to stand out from other proposed fixes to the financial crisis. But while Geanakoplos had ironed out the economics of the plan through his work on the leverage cycle, he was not sure whether such a move would be legal.
For legal advice, Geanakoplos worked with long-time friend Koniak, who met Geanakoplos through a mutual friend while she was studying at Yale Law School.
Geanakoplos is the James Tobin Professor of Economics at Yale and a managing director at the Old Greenwich-based hedge fund Ellington Capital Management, where he is the head of research and development.