Foreclosure gridlock threatens economy

But it remains to be seen whether the investors who bought the bonds backed by these high-rate loans will agree to give up the return they expected. Though the loan servicers managing these portfolios have some discretion to make changes in individual loans, they have to show that any changes improve the overall performance of the portfolio. By cutting rates — and return — on too many mortgages, the loan servicer who agrees to new terms with borrowers risks the wrath of investors, according to Zoretich.

Last month, Federal Reserve Board Chairman Ben Bernanke told Congress' Joint Economic Committee that pushback from investors is another reason why lenders need to set up standard guidelines to modify mortgages in greater volume.

“By providing a systematic approach to addressing these mortgages, (lenders) actually protect themselves against claims by investors or others who feel that they are arbitrarily changing or modifying the loans,” Bernanke told the panel.

So far, those guidelines have been devilishly difficult to establish, in part because there are so many different types of loans and parties involved in servicing them. 

For example, after an explosion of second mortgages during the lending boom, many borrowers facing default have more than one lender to contend with, and those lenders may have conflicting interests. A lender holding a first mortgage who wants to modify terms may face opposition from a holder of a second mortgage, who may be left with little equity to cover the loan.

With the industry unable to develop strategies for heading off bad loans as fast as they wrote them, some loan servicers have apparently focused on coping with the aftermath of bad loans rather than negotiating new terms to keep the homeowner current. As a result, some borrowers facing big payment increases say they're being told that there’s nothing that can be done until the loan is in default.

“They’re being urged to miss their payment, and then they can do a workout with the lender,” said McGee. “(The lender is saying) that they don’t have the authority to do anything until people start missing their payments.”

One proposal making its way through Congress could provide some relief. Under current bankruptcy laws, a borrower can ask the court to work out a new payment schedule for all debts — except a primary mortgage. If Congress changes the law, homeowners could declare bankruptcy and ask a judge to modify their loan terms. If the judge agrees, lenders would have no choice but to go along.

Consumer advocates say the change could speed up loan modifications without even getting the bankruptcy courts involved, as lenders face the prospect of negotiating their own new terms — or having a judge do it for them.

“The lender needs to show up in court," said Harnick. "There’s none of this put somebody on hold forever, because the ship is going to sail without you if you don’t. It’s the judge who gets the final say as to what’s reasonable, as opposed to the lender.”

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