New Mortgage Bankruptcy Bill Does Not Address Real Problem

The plight of homeowners delinquent on their mortgages has been the focus of much debate lately. There have generally been two major lines of thinking:

• The best course is to let free market principles apply. If homeowners cannot afford the mortgage payment, the old fashioned remedy of foreclose should take place, turning an overburdened homeowner into a renter.
• Those more inclined to assess the loss of a home in terms of human suffering rather than as an economic equation have sought to provide relief to struggling homeowners by modifying the terms of the original mortgage.

As the number of mortgages in default grew, the situation attracted the attention of politicians. Their viewpoint seemed to focus on helping the homeowner stay in the home, regardless of cost.

The governments’ efforts to encourage the banking industry to cure the foreclosure problem through voluntary participation in loan modifications was a failure. For a variety of reasons the loan mods were not working. Data from the Comptroller of the Currency shows that over 50% of modified loans re-defaulted within 6 months. With many loan mods, payments went up for the borrowers and principal was hardly ever reduced. The loan mods actually left many borrowers in a worse position than when they started. In addition, most of them had negative equity before and after the loan mod. The negative equity position locked them into the house, unable to sell or refinance.

Today, from Washington, a new solution - giving bankruptcy courts the power to alter the terms of the original mortgage.

Lawmakers Set New Mortgage Bankruptcy Bill

WASHINGTON (Reuters) - Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.

“Economic conditions have only worsened since we last debated this plan,” said Rep. Brad Miller, a member of the House Financial Services Committee who plans to introduce a bankruptcy reform bill on Tuesday. “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.”

The legislation change would allow bankruptcy judges to modify home loans in the same way that they currently may modify other unsettled obligations, such as credit card debt.

The lending industry has said that allowing bankruptcy judges to modify mortgage obligations would change how they weigh risk. Currently a lender knows that it has recourse to foreclosure if a borrower fails to meet mortgage payments, but the lender does not have to factor in the possibility that the payments it receives could be decreased by a judge.

What will be the impact of allowing bankruptcy judges to discharge (cram-down) mortgage debts? Some of the issues and questions to be considered include the following.

• Interest rates are correlated to risk - that’s the way things work in a free market. If a mortgage loan is made with the risk of principal impairment by bankruptcy, this risk has to be priced into the loan rate. Reducing mortgage principal by legislative fiat may bring unintended adverse consequences.

According to The Mortgage Bankers Association:

It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.

• Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy, cram downs might help less than 5% of mortgaged homeowners. If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.
• According to The Housing Wire, 50% of Americans oppose bailing out troubled homeowners. “These findings indicate that there are significant political barriers to proposals now being drafted in Congress.”
• The bankruptcy discharge of a mortgage balance will be viewed by many as the ultimate bailout. The final compromised bill may result in contorted regulations that ultimately benefit few homeowners.
• The free market has a solution for “troubled homeowners” which is known as foreclosure. Does the free market solution lose all merit merely because the number of foreclosures increased dramatically due to imprudent borrowing and lending?
• According to Rep. Brad Miller, “Until we stop the slide in foreclosures and falling home prices, the economy will get worse still.” Rep. Miller is confusing a symptom of the disease as the cause. Falling home prices did not cause our economy to weaken. The housing asset bubble that burst was due to reckless lending, fueled by a government providing easy credit and obsessed with making everyone a homeowner. Political interference in economic matters usually delays a solution by impeding the free market forces that will ultimately prevail anyways.
• If the mortgage cram down bill is passed, it will drive many homeowners to bankruptcy, lured by the promise of wiping out mortgage debt. The loan modification program allowed the banks to pretend that the amount they were owed would still be repaid over time. When the loan gets reduced in bankruptcy, this illusion will be gone. More write offs by the banks could lead to a self defeating cycle of tighter credit, stricter mortgage underwriting, weaker housing prices and further bailouts.
• How many homeowners that are incapable of handling the burden of home ownership will be allowed to remain in their homes, only to face foreclosure again at a later date?
• Continued massive government support of the mortgage market will be necessary since investor demand for mortgage securities is likely to remain low due to collapsing housing prices and the risk of mortgage debt being discharged by bankruptcy. How does an investor properly price a mortgage security where the asset value underlying the security is declining and also face the risk that the principal investment may be impaired by court decree?
• The Fed is now expected to absorb virtually all of the new mortgage backed securities this year. With the Fed extending its purchases into virtually every asset class, a question comes to mind. As the Fed assumes the losses of all failing economic entities in the country, at what point does the US Government begin to share the credit quality of those being bailed out?

Disclosure: no positions.

Comments

[Smalltownba...:]

In answer to your last question, It already does.

You have pretty accurately summed up the consequences of this legislation however if passed we may never have a private market for mortgage backed securities again. If we do it will be many years down the road after performance is tested through government ownership.

Those seeking Jumbo mortgages will find few if any options and those with impaired credit will be permanent renters. If you think lending is tight now just wait until this bill passes. It could eliminate 20+% of those currently qualifying to purchase.

Jan 07 08:22 AM

[nobull:]

Brad Miller's the real problem...lets vote him out

Jan 07 09:58 AM

[mr_subprime:]

To reverse the tide, homeowners should be taking their lenders to court and defending their property. Banks wrote predatory loans because THEY COULD! The majority of these lenders wrote bad loans knowing the risk had been assigned upstream to investors. They got paid back on the funds they lent PLUS their commission from the aggregator. You want to see the economy inprove? Extinguish the predatory mortgages, give these people their homes, and let the banks take it on the chin!! Now, you'll have a bunch of lower- and middle class consumers with paid off homes, good credit, and purchasing power!

Jan 07 10:41 AM

[DougM:]

I agree this cram-down idea is terrible and likely to backfire. Plus all of us who didn't overpay for houses, didn't buy houses we couldn't afford, are paying our mortgages on time, or (heavens to betsy!) renting are effectively screwed to bail out people who were greedy, foolish, or both. A better idea might be to allow the banks (or government) to have an option-like ownership stake in any house where the loan is crammed down. If the homeowner ever sells, the bank has a claim on a portion of any profits above the loan balance.

Jan 07 10:46 AM

[sourceview:]

Well, first, there is no such thing as a "free market" That is a pollyana dream of greed mongers, i.e. mortgage brokers and finance institutions, or a cynical refrain from profiteers in the hopes of minimizing regulatory legislation. In the absence of market regulation, the rich players themselves form oligarchical cartels that function to reduce market forces more tightly than a regulatory economy could.

What we now have is a Corporate Welfare State, pretending to be a market economy, where corrupt and incompetent corporations and their officers change their spots overnight so that they can stick their tongues out the following day for taxpayer holy communion from a Congress priesthood in their pockets.

Second, there is no such word as "anyways". These two factors lead me to question not only the tired old ideology of the writer and his abject followers (no doubt confining their communications to twits), but his educational attainment (lack of education and untenable ideologies seem to go hand in hand).

Third, mortgages are not priced according to risk, and do not function adequately on a macro level. The extant computer models are priced based on individual-based algorithms, and include "all the market will bear profits", plus outright greed (fostered by illegal and unethical tactics of financing sources) and racial and geographical discrimination.

Fourth, who cares if down payments are higher (that is a prudent factor which the lack of has cost us dearly), and interest is 1.5% higher (even at that level it is lower than anytime in our history since 1945!)

Fifth, our housing debacle is the result of a private market, that in the absence of competent regulation, went terribly awry. Good riddance.

Sixth, pouring money down the throat sewers of financial institutions is not the answer. They are already laughing all the way to their vaults, and still hanging onto their welfare gains by not loaning.

Seventh, come back to housing in 120 days, when the credit debacle hits. Regardless of a stricter bankruptcy law, you still can't squeeze blood out of turnips. Wait until it gets through to beleagered and buggered taxpayers that they can literally walk away from their phoney no-recourse mortgages, and since they won't ever be able to buy a house again, screw their 34% credit cards too*! Most will not have the money to go into bankruptcy, and lending institutions for a time will spin their wheels trying to collect, but the default will be so massive, more banks will dissolve in front of your face.

And like the recent overwhelming corporate welfare, any giveaway laws to consumers Congress will enact will only keep their jobs intact and have minimal impact on our false economy.

Just like the American People were lied to for a full year (We are NOT in a recession) they are now being lied to again - we are truly in a depression, except for the crooks.

*try a disabled person with a limited income that Bank of America allowed to mass a $50,000 balance, whose mortgage is 225,000 more than the value of her house.

Jan 07 10:48 AM

[Guero:]

You know, the lenders bear a lot of responsibility for this mess. They have had their heads stuck in the sand for too long. Who loans money to someone without any proof of income or assets? US bankers did for many years, and now they want to point the finger at the consumers and ask "where's the personal responsibility?"

Then they had a chance to redress their past misdeeds and write some real loan modifications that really lessen the burden on the borrowers, and instead they chose to engage in smoke & mirrors, with many accounts of modifications resulting in payments being lowered by a dollar or two.

Now they are crying like stuck pigs when they are being threatened with cram-downs, which will after all only be reflecting the new reality of lower property values.

How about the lenders agree to a deal....the type of deal they make borrowers when asked to, for example, drop PMI. If they don't like the value that a certain property is being crammed down to, they can go pay for an independent current appraisal that backs up their claim that the property is still worth what they think it is worth. If that appraisal comes back at their value, no cram-down. If however, it comes back as lower, then commence the cram-down. Something tells me they won't like their own medicine, though.

Jan 07 11:24 AM

[thatguy57z:]

I see that banks and real estate are blaming the home owners for the bad lending, BS they caused it and now company are cutting jobs and home owners are failing behind on there mortgage payments, think now you lost your job and your kids have to eat you need electric and water and fuel to find a job that aren't there anymore. there trying to sale home to new home buyer at a rate of 4.5 interest rate, where the greed from the lenders now. the homeowner the put his or her down payment and had a legal ID and proof of income are the ones now taken in the ass. And for these that haven't lost your jobs you will soon a reduction in pay or on your why out, because you think corporate is going to lose there lol think aging your next. The stock market are just numbers they can make them go up or down, just like put everyone in a home and said where not in a recession.

take a look at this and see the names of the banks.

www.youtube.com/watch?...

Jan 07 11:44 AM

[msoori:]

How would the 95% of mortgaged homeowners wind up paying for the losses thru higher interest rates? Are you proposing that the lender re-adjust the interest rate of those 95% in order to cut their losses? If I have a fixed rate mortgage, how is the lender going to increase my rate??? This is an article written by the bankers for their best interests. I say let the home owner that has been shafted pull it out and give right back to the banker. Bankers knew their risk when they made the loans and hid it under the CDSs, so they can profit from both sides. Get the house and collect the losses from the CDSes. I feel no pity for the bankers here. xmplary.blogspot.com/2...

Jan 07 12:01 PM

[Jon Smirl:]

Why is this so hard for everyone to understand? If you don't pay your rent you get evicted. If you don't pay your mortgage you get foreclosed. If mortgage cram downs are allowed why not rent cram downs? It's obvious, if a landlord is vulnerable to rent cram downs they are going to raise all of their rents to cover the costs. Same for a lender. Cram downs raise the costs for the responsible people and only benefit the irresponsible ones. I'd prefer to be in control of my own charitable giving and not have it done for me.

The answer is making the foreclosure process faster and less painful. Mortgages are a thirty year problem, applying a band aid for a year is just going to cause a redefault a year later. If the occupant is in a house beyond their means it is highly unlike that the situation will be any different a year from now. In the long run fast foreclosures minimize the pain for everyone.

And stop whining about sticking it to the "corporations". Corporations are not physical entities. The only real thing in the world is people. People ultimately own everything. Sticking it to the corporations is ruining my retirement investments and probably yours too. Us 'people' own these corporations whether you realize it or not.

Jan 07 01:09 PM

[Socialism c...:]

I think I'm gonna head for somewhere remote in Montana or Alaska...where no assessor can physically get to...and build me a nice log cabin on government land. I'm done paying through the nose for this socialist government crap!!

Jan 07 01:40 PM

[axelrod608:]

Oh, terrific. Let's drive a few extra millions of Americans into bankruptcy court. The lawyers win again.

And the BR court ordered writedowns will torpedo the lenders' bottom line, so they will sue. The lawyers win again.

For people who can afford everything but their house, the absolute best option is to walk away. Start over with a rental they can afford.

The problem is in the assumption that this mess can be fixed. That there;s some magic plan out there that will keep millions of Americans in homes they could not afford to buy and cannot afford to keep. Faulty assumption. This will work out over time regardless of what harebrained bailouts get approved.

Humpty Dumpty already fell.

Jan 07 01:45 PM

[notforgreed...:]

Let's use our heads people. If the lenders foreclosed on the property they would end up losing more monetary wise than if the cram down were to happen and keep the people paying (with interest) for 30 more years. It's a win win situation. The lenders have been greedy and protected for too many years. They caused this to happen with lax regulation on their part now crying because they are forced to actually WORK WITH the homeowners! No interest rates will be raised that's a bunch of bs. Farms and luxury yachts and millonares vacation homes are already allowed to be modified and there hasn't been an increase in primary residences. Use your brain people. Greed is greed. Get bailout money, don't help the home owner and now cry because they are forced to help out! That's sick. I can't wait for the day that law passes. I'm glad I voted for Obama and the Democrats every year until I die. The guy who wrote this article probably works for a lender or servicer. Let the law pass!

Jan 07 03:54 PM

[oldsuretyguy:]

To save the American homeowner and make this current mortgage disaster fair, we need bold steps to be taken immediately such as....the gov. should freeze and consolidate all mortgages in place so that no single borrower is at an advantage measured against any another borrowers. Give the mortgage borrowers a three month deferral on their mortgage payment, add to the loan principal a max of three months past due sums, drop all mortgage interest to a max of 1 1/2% for five years and 2% for the remainder of the loan. All utilities would reduce their charges by 30% and eat any unpaid sums. All previously foreclosed properties would revert to the gov. until prior homeowners would be restored to their homes at the above terms and any remaining homes sold and proceeds split between the various mortgage lenders(investors). Then you would see a real and immediate economic shot in the arm for the recovery and for our sagging real estate values.
The current banking/lending system gets no sympathy if they come out the loser since they are lending with little or no risk carrying next to a zero reserves.They take in a dollar and loan it out times nine to ten times its value and make interest off every loan. Additionally, they can run to the Fed window for short-term funds after they make a loan - sell the risk and take a profit from interest, fees and commissions. The system is broken and the players have no incentive to see rule changes as long as mortgage lenders can act like brokers.

Jan 07 05:54 PM

[Can'tSpotAB...:]

A repost of my comment on a similar subject:

This scenario is part of the problem. When will people understand that a contract is a contract. The lender and borrower have specific remedies to all contingencies stated in the contract. They may not be pleasant remedies, but they are spelled out in the contract at the time of inception nonetheless.

If America chooses to go against over 230 years of contract law precedent, the long term ramifications are very detrimental to the future of this country.

Jan 07 06:32 PM

[scotty1560:]

this is one tough subject and one big problem for this country to move forward..
No sympathy for the lenders that stood by and gave out 100%+ financing..

Here in Florida people bought primary and vacation homes in good faith...now they are down 40-60% and cornered? what would you like them do? many of these folk put down 20% and have paid sky high taxes and insurances for five years..how pain do wish them to absorb?

Prices here are 2001-2002 prices for land cost...looks like more downside...so unless you bought 10 years ago you are close to negative..

imo...let the government support the primary or 2nd residence owner....
not crazy about the loan restructure unless there is reduction in mortgage..
so either let them walk with some ability to start over or reduce the
mortgage to affordable levels...re-appraise the home..

the investors are different and should be treated different...I'm saying when you
roll prices back 50-60% you are wiping out the majority of the buyers who
bought in a ten year span....most of these buyers bought in good faith..

On a final note...imo this economy will not find a bottom until this foreclosure
situation is remedied...this was the driver in the economy for the last
10 years....so all the tough talkers will find the equity markets and gold and oil markets are all joined at the hip at this stage of the game....I'm saying we
need to put a floor down and let the real estate market base for a few years...
many of you posters underestimate the damage this historic drop is causing.

the longer this drags out with the foreclosures...the bigger chance we risk
of depression scenario....when you mess with peoples homes you make it personal...just my opinion..

one final comment...unless local and state government addresses the
property tax and insurance costs...I see the golden goose as dead..
A million dollar home can easily run 50K a year in property tax, insurance,
utilities, maintenance....tell me how the second or even primary market
can continue to absorb the brutal attack on ownership....expect a lot more
pain until our local governments decide they are part of the problem.

Jan 07 11:46 PM

[Steven Hansen:]

if the government absorbs low interest rate mortgages - what happens when interest rates rise. it is easy to get to a scenario where the payments from the mortgages are lower than the cost of financing the government debt.

the more and more low interest paper the government buys or issues is locking the good ole usa into a japanese style zirp economy. the economic burden barrier to inflation is these low cost loans.

Jan 08 02:21 AM

[Kunst:]

The government will keep pumping money into the economy until prices are forced up. The "solution" is higher house prices, an attempt to return to the good old days of 2005. Everybody has equity again, rising cheaper-dollar incomes can handle the mortgage payments, mortgage-backed assets get relatively detoxified. The dollar will be devalued, making Americans poorer but more competitive.

Or maybe you think all this debt is really going to get paid back?

Jan 08 02:28 AM

[GoAfter:]

Loan Mods failed, because they were set up to fail. Lenders need to follow Wells Fargo, which is going back to borrowers, converting them to LOW FIXED rate loans for as long as 40 year terms into the loan. Some may say this isn't right, but what about the homeowner who qualified for a loan, is paying on time, but has a community LOADED with foreclosed homes. Foreclosures do nothing but devalue a community. They hurt everyone.

Jan 08 06:54 AM

[Bryan Kavanagh:]

If we reduce taxes on people for working and increased property taxes on real estate speculation we'd eliminate real estate bubbles and financial meltdowns. Is it just coincidence that New Hampshire, with the highest property tax, is the US's best financially performing state? We've been stupid enough to ignore what Henry George showed 130 years ago to be the cause and cure of economic recession and depression, so we continue to suffer the consequences. Homer Simpson would make an excellent economist: "Doh!".... "Doh!"...."Doh!"....

Jan 08 05:53 PM

[ECB:]

How many of you borrowers knowingly inflated your income in order to get approved so you could buy that McMansion you should have known you couldn't afford?! Then you bragged about how much you earned on your investment, as you took out a home equity loan to finance that new Hummer you also couldn't afford. Now the party is over, and you're all victims, and its the lenders who are at fault and the homeowner who was scammed and deserves a bailout. Housing "crysis"? Ponzi "schemes"? The real crysis and true scam is our government who continues to fuel the fire, driving our once great nation 6 feet under the ground.

Great article. I truly hope the 50% of us who oppose said homeowner bailouts make themselves heard and this propsal goes up in flames.

Jan 09 01:52 AM

[sdgirl:]

Many of you comment on a situation that you clearly have no experience and are judging unfairly. What's the saying...? "Until you've walked in my shoes...". I will not pretend to play "dumb" like so many others have. I knew what I was getting into and I knew what I was signing. I have an ARM, that I purposely had a fixed rate for the least amount of time I could get (2 yrs). Why? Because in Southern CA, at the time, I could afford only a condo, but wanted a house. My plan was to show that I was responsible and able to pay my mortgage so that at the end of the 2 yrs I could re-sell it (profit or not, I didn't care) and get into a house. Unfortunately, shortly after my purchase, the housing went down, down, down... I can still afford the condo, but I never wanted to live here this long. If I could sell it (for no profit) I woud. I see in Midwestern states houses that banks are selling for $1000, $5000, etc.in auction, because it would cost too much money for them to go through the whole marketing/selling process. All of you complaining about the "cramdowns": What is wrong with re-adjusting to the current market value and still being obligated to pay based on a new contract? Paying the bank back for the current value is better than the bank letting it go for $1000 right? And I'm still not being let off the hook, I'm just paying the real value rather than a bloated value that's 50% higher than it should be. That's better for the economy than foreclosing and letting it go for $1000 to the next person. If you're worried about people still foreclosing later, how do you know that will happen? And as far as the banks go, regarding loan mods, forget it. My bank doesn't care. I've tried to talk to them. They aren't any help at all.

Jan 13 04:42 AM

[sdgirl:]

In addition to my earlier comment: Why is it "ok" that the rich who own yachts, vacation homes, etc., who clearly need no help (especially if they are so greedy) are allowed to have their contracts re-negotiated? As usual, more help for the greedy, less help for those of us who just want something of our own. I work hard for my money. How is that fair??

Jan 13 04:48 AM