Solving the Housing Crisis in Bankruptcy Court 19 comments
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So how are you going to feel when your neighbor who paid about the same as you for your house and borrowed about the same amount as you did gets his mortgage chopped down by a bankruptcy court? That’s likely to be reality within a month or two.
The WSJ has an article that argues what a lot of others including me have for some time. Cramdowns are going to be a center point of the Obama/Congressional scheme to turn around the economy.
If you are unfamiliar with the term, here’s how the Journal describes the process:
In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it. Lenders hate it because they have to absorb the loss. Bankruptcy judges currently have the ability to modify certain personal loans and even mortgages on vacation homes, but they can not cram-down mortgages on primary residences.
President-elect Obama indicated his inclination to bankruptcy reform to allow cram-downs during his campaign, and two main Congressional players -- Barney Frank and Christoper Dodd -- have made no secret of their affinity for the program. Given that sort of backing and the Democratic majority, I think you can call it a done deal.
There are only a few problems with the idea.
Think about how the courts are going to handle this. There will be a tidal wave of BKs. No way on earth that they can handle the crunch of say ten or twenty million petitioners. As the cases wind their way through the system, the payments will likely be stayed and a lot of people will live mortgage payment free while the owners of the mortgages, many of whom we have already bailed out, will get hammered.
Neither the bar nor the American consumer is a fool. This will be a bonanza for the legal profession that will likely rival the asbestos saga. The consumer will look at it and say, why not? Miss a couple of payments, suffer a recoverable hit on your credit report, and get a hundred thou knocked off what you owe. How hard a decision is that? Who knows, Congress may outlaw reporting the mortgage delinquencies with enough pressure for a double win.
And of course, no investor in his right mind is going to invest in any American mortgage security again without a substantial risk premium. So unless we want to see mortgage rates in the neighborhood of credit card rates, the government is going to have to subsidize the business from here to Kingdom come. Which one of those options do you think is going to come about?
One more little problem. If you happen to go out shopping for a home, how are you going to figure out what it’s worth? Sure you can look at comparable sales, but if the records say a guy bought his house for $250,000 but he got $75,000 knocked off by the courts, what’s it really worth? Do you really think that the appraisers or lenders are going to search the bankruptcy discharge records for that many transactions?
So when your neighbor smiles at you one morning as he climbs into his brand new car, you might be wary. You might also be a bit put out when he sells his house for less than you owe and walks away with cash in his pocket.
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This article has 19 comments:
I think the judges getting the authority will provide just the incentive lenders need to properly modify loans. It will have the effect of curtailing foreclosures, reducing the inventory of homes, and getting this housing mess back onto the road of recovery.
Will there be some big losses, you bet, but they already took place, on paper. Rates will not go through the roof, instead, they will provide stable loan products with qualifying borrowers who will give stability to a marketplace that has performed extremely well for decades instead of hybrid products and liar loans which tanked the market in just a few short years.
This does not even require a taxpayer bailout, it passes on the loss to where it belongs, the lender who controlled the gold and the rules. Yes, borrowers are wrong too but none of those loans would have ever been available unless the rules had been changed, which the borrower had no control over the rules.
As republican as I am... this democrat proposal for once is actually right on the money.
No question the spread in rates will increase, hopefully substantially for ARMs. For them not to would be to acknowledge that this crisis never happened.
On Dec 31 10:38 AM ArnoldCountry wrote:
> Interesting piece but contains a ton of fear and speculation based
> on non-fact. Giving the courts that type of power will solve the
> problem pretty fast. Right now, servicers cannot modify loans because
> their pooling and servicing agreements have huge limitations and
> if they go outside of those limitations, they are required to buy
> back the loans from the pool. However, if they can show the consumer
> threatened bankruptcy and their modification gave them the same result
> but at lower cost (no legal fees in bankruptcy), the investor pool
> would have a tough time getting them to buy back the loans.
>
> I think the judges getting the authority will provide just the incentive
> lenders need to properly modify loans. It will have the effect of
> curtailing foreclosures, reducing the inventory of homes, and getting
> this housing mess back onto the road of recovery.
>
> Will there be some big losses, you bet, but they already took place,
> on paper. Rates will not go through the roof, instead, they will
> provide stable loan products with qualifying borrowers who will give
> stability to a marketplace that has performed extremely well for
> decades instead of hybrid products and liar loans which tanked the
> market in just a few short years.
>
> This does not even require a taxpayer bailout, it passes on the loss
> to where it belongs, the lender who controlled the gold and the rules.
> Yes, borrowers are wrong too but none of those loans would have ever
> been available unless the rules had been changed, which the borrower
> had no control over the rules.
>
> As republican as I am... this democrat proposal for once is actually
> right on the money.
And why should someone in bankruptcy be permitted to stay in a mansion they could never afford? I hope this never happens.
Voter don't think of themselves as GM or AIG though. They lump all of these companies into the "other" or "fat cat" category. If the Democrats start picking and choosing individual winners and losers, the anger will move from nebulous to personal. The AIG bailout will fade in people's minds by 2010, but their neighbor will serve as a daily reminder.
This is done in Chapter 11 bankruptcies all the time.
On Dec 31 04:53 PM mallarde wrote:
> Another giveaway to speculators at the expense of responsible Americans.
> Those that sat on the sidelines will be forced to pay higher interest
> rates due to the new uncertainty lenders must face.
>
> And why should someone in bankruptcy be permitted to stay in a mansion
> they could never afford? I hope this never happens.
yes i do because the lending institutions will pool data for their own protection.
tom, overall you raise some good issues. the sooner we get to the end of the housing crisis - the sooner we can start building economic recovery.
I recently concluded a national survey which was conducted by the National Association for the Self-Employed (NASE). The survey results confirmed my research that these small business owners (16.2 million in 2007 according to the SBA) fell prey to the "toxic" mortgages that are expected to "Reset" in 2009 and may result in foreclosure. It is a tragedy when a homeowner loses his/her home, but the tragedy is magnified when that homeowner is also a small business owner employing 1-10 employees.
I believe that these small business owners should have priority as their mortgages are modified because these small business hold the fate of our economy. As small business goes, so goes our economy.
When there is foreclosure the home buyer has lost it all. Whatever equity they thought they had. And they have to move to something they can afford to pay for when renting. It is a valuable learning experience for them and for their neighbors.
The lesson that the "cram down" will teach is that it is OK to screw the person who trusted you to pay back a loan. That will have very bad consequences.
Lender risk is above that. However, this is not a normal market.
I find it pretty funny how everyone seems to come around and blame the homeowner. While it is true, the lender is expecting them to perform. More important, they control the evaluation of that risk. They took huge risks in doing piggy back loans to 100% loan to value and they knew that risk. Now that the risk has bit them, they want to cry foul. Blame the homeowner???? This was so predictable and preventable by the lenders.
There is a risky industry called hard money. They lend to folks in foreclosure, bankruptcy or with impossible credit scores. Traditionally, a very very business but they would only lend to 70% or 75% LTV max. They practically went out of business the last 10 years because banks were making loans that they would never make. High LTV with high credit risk borrowers.
Once the banks became so aggressive that they surpassed the bottom feeders, they were the bottom feeders. The best rule in lending is to allways have enough room in your lending so someone else can take you out when trouble comes. I am sorry, but their lending practices had no room and now they lose.
We should not bail them out, let them take their losses.
On Jan 01 12:09 PM Augustus wrote:
> The proposal will destroy the low downpayment mortgage, at least
> in the private market. Consider that every 95% loan is under water
> at closing due to the Real Estate commission going in and out. The
> lenders make the loans because the homeowners are supposed to be
> responsible and make the payments. When making the payments become
> optional, the downpayments will go up dramatically. 25% down may
> not be enough to get the job done.
>
> When there is foreclosure the home buyer has lost it all. Whatever
> equity they thought they had. And they have to move to something
> they can afford to pay for when renting. It is a valuable learning
> experience for them and for their neighbors.
>
> The lesson that the "cram down" will teach is that it is OK to screw
> the person who trusted you to pay back a loan. That will have very
> bad consequences.
they should have that mark on them for life...
There is evidently some controversy regarding the numbers that you present here and elsewhere. I would refer you to Felix Salmon's post on Portfolio.com www.portfolio.com/view.... In the interest of open and honest discourse, you may rebut them here or if you like email me the rebuttal and I would be happy to publish it on your behalf, with my own appropriate analysis, of course.
Cramdowns would be unfair to sellers, and also to owners whose neighbors get breaks while they go on paying unadjusted mortgages. I see only one solution: let Uncle Sam buy mortgages on request, pay off the sellers, and adjust the mortgages to present vaue at interest rates the homeowners can afford to pay.