Distressed borrowers at risk of losing their homes

US mortgage service firms may be unable to stop a wave of evictions, writes Eoin Callanin Washington

The fate of the US housing market is increasingly in the hands of an opaque part of the financial system normally associated with moves to evict families from their homes.

Mortgage service companies, which are responsible for calling on Americans to keep up with their loan payments, have assumed a pivotal role in President Bush's market-oriented strategy for dealing with the pending wave of foreclosures in the sub-prime mortgage sector.

An estimated six million high-risk sub-prime loans, worth a total of more than $1,000 billion (€730 million), are outstanding, which will in many cases reset to higher interest rates in the next 18 months, putting more than 2.5 million Americans at risk of foreclosure.

"It is sort of like being in New Orleans a month before Hurricane Katrina hit when you know there is a storm coming," said Guy Cecala, of Inside Mortgage Finance.

Economists fear that a wave of evictions of borrowers unable to afford the higher payments will blight neighbourhoods, hit home prices, deepen the worst housing downturn in 16 years, and harm the wider economy.

The response to this crisis outlined by the president, places considerable faith in the ability of mortgage servicers to mitigate this blow by helping distressed borrowers to stay in their homes.

Edward Lazear, chairman of the Council of Economic Advisers, said: "I believe, and I think the president believes, that markets are very good at finding ways to solve problems."

But many experts claim that the mortgage service sector is not fit for this purpose.

They argue it does not have the capacity to perform this role, and lacks the personnel, financial resources, technical tools, experience, incentives and oversight to deal with an economic crisis of this scale.

"Theoretically, it makes sense, but not in the real world," said Scott Syphax, a director at the Federal Home Loan Bank of San Francisco.

"These institutions are not built to handle this scale and volume of problems,"

"The notion that federal regulators can urge services to reach out and contact borrowers who may face distress is unrealistic," said Mr Cecala.

The mortgage market's success rate where it does modify loans is also poor. About half of loans that are modified still wind up in foreclosure a year later.

In past housing downturns, large banks have been able to retool their mortgage servicing operations to adapt to conditions.

But shifts in mortgage finance and innovations in the financial sector mean that most sub-prime loans are no longer handled by federally-regulated banks.

Most have been issued by specialist lenders that have sold the mortgages on to secondary markets through complex financial instruments.

The job of servicing many of these loans has also fallen to the myriad of smaller companies that have no contact with the ultimate owners of the loans and are themselves coming under stress.

American Home Mortgage services about $50 billion of loans and filed for bankruptcy last month. A court order has given the sub-prime lender until October 31st to sell its mortgage servicing operation.

But as more service companies fall into the hands of vulture investors, the task of co-ordinating a national response is likely to become complicated.

"The fixes being proposed by the president are not going to result in Americans being rescued from their homes, quite the opposite," said Richard E Gottlieb, a lawyer who specialises in mortgage servicing.