As the feds get ready to announce a rescue plan for subprime mortgage borrowers, Blawgletter has a question:  How can the government rewrite the terms of debt securities to force the investors in those securities to accept lower interest payments from the borrowers?

The plan calls for a five-year moratorium on interest rate increases for certain subprime borrowers.  The mortgages provide for "resets" of the rates periodically, including when the introductory rate expires.  Investors bought securities for which the mortgages provide collateral and serve as the source of interest income.  The scheme would halt the resetting of rates and therefore deprive the investors of the larger income stream that higher rates would bring — assuming of course that the borrowers don’t default.

That last bit — the assumption — may provide the answer.  The rescue plan aims to avoid defaults that would otherwise occur.  Perhaps the trust indentures (or whatever the Wall Street folks call the things) allow those who have the job of enforcing the mortgages some flexibility in how they maximize the return to investors.

If not, we may see yet another species of subprime litigation — this one for breach of contract or fiduciary duty against the servicers who let borrowers get away with not paying according to the terms of their mortgages.

Barry Barnett

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