Mortgage Cramdowns: A Disaster in the Making

Does it strike anyone else as somewhat strange that so much time and effort was put into getting Citigroup (C) to be the lead dog on the cave in to bankruptcy mortgage cramdowns.

I know that it’s not unusual for this sort of legislation to get hammered out in the backrooms of Congress. No problem with that from these quarters, it’s just the way business gets done in Washington. But usually it is a negotiation between the functionaries and the lobbyists, not one publicly carried out with just a single participant of an industry. So, the question arises as to why it was handled in this manner.

I suppose that Citi was chosen to be the first to bow simply because it’s the biggest ward of the state. Frankly, I can’t imagine that there was a lot of blow-back from them on this issue. It appears as if a fig leaf or two was tossed their way to create the appearance of negotiation but the whole charade is a bit hard to swallow.

But forget that and look for a second at the details. Two things strike me:

1. Why are existing mortgages the only loans that will be eligible? If this is good policy then it shouldn’t have limitations. Is it therefore something else? Is there a fear that there could indeed be negative ramifications if it were to become established procedure? In fact, is this just a way to kick the can over to the courts and thus relieve Congress of the onus of passing some sort of costly mortgage relief plan?
2. The legislation is supposed to allow for invalidation of creditor claims due to Truth in Lending violations of a major nature. Given the propensity of Congress to draft lose legislation, a close eye will have to be kept on this one. Done too broadly and with discretion ceded to the courts you could see a lot more forgiveness than modification.

Tempting as it is, I won’t get up on my soapbox about this subject. If you want to see prior thoughts just put cramdown into the search box and you’ll find the previous posts. Most of the blogs I read seem to have come to the conclusion this is a good thing. I’ll hang out with the minority and predict it’s going to be a disaster.

more: here

Comments

[dick streich:]

I agree. It will be a disaster. Just imagine what it will do to the courts dockets that are already jammed, with waits to have a current case tried for as long as 2 years.

Jan 09 09:25 AM

[bosun.j:]

Just imagine how many good hard working Americans that were duped by the likes of Cuntrywide and Downey will be able to stay in their homes.

I'm all for anything that will make the Banksters feel the sting.

Jan 09 09:58 AM

[Edward Harr...:]

Tom,

I have great respect for your analytical abilities. And I also appreciate your skepticism about Congress. I have taken the pro-cramdown tack on my blog, however. Largely, I see cramdowns as a necessary evil? Why: price discovery.

Look, the housing market needs to bottom out. This will happen more quickly if prices are written down more quickly. Both homeowners and banks are resisting this because of the losses associated with these writedowns. One reason banks are not doing modifications now is they have no capital to deal with this.

In my view, a good quid pro quo would be TARP money only if and after you have done mods and/or cramdowns. As it stands now, we are just seeing banks get free money. And they will be coming back for more. What should the government response be when the banks have their hands out again?

I disagree here but, nevertheless, appreciate your analysis and other posts.

Thanks, Tom

Jan 09 10:17 AM

[HankWest:]

Your free-association, republican neocon rant is thoughless twaddle. You don't even offer any kind of alternative in the body of your rediculous, waste of time article. So, Smart Guy, I ask you- What is the alternative? Seems to me, you wouldn't be satisfied until the entire country has fallen into complete and utter economic and social meltdown. Geez, I can't believe Seeking Alpha gives you any space to write at all. Cleary, you have nothing to lose.

Jan 09 10:22 AM

[User 334263:]

If you want to write about something relevent,try exposing " MaidenLane III".This is the real reason loan modifications are not being made.In Nov and Dec 08 the fed put $15 billion of our tax dollars along with $5 billion of AIG's money (our tax dollars given to bailout AIG) to set up a shell game,Maiden Lane III, to purchase the CDO's that AIG had insured for your banks toxic mortgage securities at approx. 43 cents on the dollar along with $26 billion in insurance payouts on the CDO's. The banks couldn't sell these toxic securities and WOULD have had to try loan mods to recover some debt. The Fed has used your taxepayer dollars thru TARP to "save" AIG and further screw the homeowner by paying the banks in full for the toxic securities thru Maiden Lane III.They don't care if they foreclose now at even half the value of you home as the cash only shores up the banks balance sheet.In other words,your government has used your tax dollars to make it easier for the banks to foreclose on your home.Thank god the politicians are right and only legislation will stop foreclosures.Good luck finding out what banks got money from Maiden Lane III.

Jan 09 10:54 AM

[sajincc:]

Tom: mortgage cramdown has been a part of the bankruptcy code for 100 years. In all context except consumer home loans it has a protection called the 1111(B) election that prevents cramdown in bad times and when the market recovers, a windfall to the debtor at the expense of the creditor. Credit Card lobby and financial interests controlled the bankruptcy reform act making financial "involuntary servitude" a new reality beginning in 1995. Why not learn a little more about the bankruptcy code, and await the proposed legislation to see how it is proposed. As it stands today, consumers have no possible bankruptcy relief from home loans made by the "bubble creating" financial wizards and mortgage brokers. This is not a problem started by bad home owners and they should not suffer the brunt of the fix.

Jan 09 11:35 AM

[redeyeant:]

To qualify mortgage reduction, the debtor should be reallocated to another cheaper foreclosure house. Suppose he owes 600K and house he own worth 400K, then the bank can move him to a 150K condo and he can ref. to a 350K loan that he can afford. Thus reduce foreclosure homes and doesn't cost tax payer's money.

Jan 09 12:53 PM

[Anandakos:]

What a crazy idea! How would forcing a family of six in a $600K home into a $150K single bedroom condo going to help reduce foreclosures? The family will say "f you" to the bank and let the house go.

And if you will do some very simple math, you will see that the LTV ratio goes from 1.5 to 2.33 in your scenario. You're not only depriving the owner of a superior asset you are making it LESS likely that she or he will ever recover the $200K loss.

You're not just a shill for the banks; you're a DUMB shill for the banks.

On Jan 09 12:53 PM redeyeant wrote:

>
> To qualify mortgage reduction, the debtor should be reallocated
> to another cheaper foreclosure house. Suppose he owes 600K and house
> he own worth 400K, then the bank can move him to a 150K condo and
> he can ref. to a 350K loan that he can afford. Thus reduce foreclosure
> homes and doesn't cost tax payer's money.

Jan 09 01:13 PM

[joof:]

see Sajinnc-


The ONLY exception to cramdown is a homeowner after the credit card company sponsored bankruptcy update . Any owner of any other asset with secured debt can get a cram down on a plan filing


A cramdown option may ulimately be in everyone's best interest - the lender takes a lesser hit on the loan vs. foreclosure , the homeowner keeps the house with a supportable liability structure ( a lower price paid for the asset) , neighborhoods remain more stable , and the govt has to deal with fewer foreclosed assets as part of GSE support

Jan 09 01:15 PM

[Asbytec:]

Well, Bosun, I am with you on this one. I am for anything that stands a chance of stabilizing home prices. That being said, free markets are a good thing, too. So, if prices stabilize...let them float naturally, again. Yea, a close eye needs to be held on this development.

Stable home prices should help thwart the fall into deflation. That is, if banks begin lending and jobless claims curtail. That's a tall order, but without some measure of stability the housing market can fall much farther. The ends justify the means in this case...at least temporarily.

Jan 09 01:22 PM

[redeyeant:]

No need to name calling, better dumb than rude.
Just do some modificatons it might work for some responsible and unfortune people. Such as reduce loan amount (to 250K in this case).
And not all family has six members.

On Jan 09 01:13 PM Anandakos wrote:

>
> What a crazy idea! How would forcing a family of six in a $600K home
> into a $150K single bedroom condo going to help reduce foreclosures?
> The family will say "f you" to the bank and let the house go. <br/>
>
> And if you will do some very simple math, you will see that the LTV
> ratio goes from 1.5 to 2.33 in your scenario. You're not only depriving
> the owner of a superior asset you are making it LESS likely that
> she or he will ever recover the $200K loss.
>
> You're not just a shill for the banks; you're a DUMB shill for the
> banks.
>
> On Jan 09 12:53 PM redeyeant wrote:

Jan 09 02:11 PM

[rm:]

[I’ll hang out with the minority and predict it’s going to be a disaster.]

I'm with you.

Once again, as with all proposed foreclosure legislation, big numbers are thrown around, promising that "hundreds of thousands" of homeowners will avoid foreclosure.

I haven't seen ONE person mention the exorbitant failure rate of Chapter 13 filings.

The proponents (Schumer, etc.) talk about this plan as if it's a "no-brainer," and it is... but not for the reason that they think.

Jan 10 09:52 AM

[M-P:]

I can see a loan mod (vs. forgiveness) if it's a good investment (there is a business case) and the homeowner has some skin in the game - a plan, a stake, a path. I was not in favor of the auto companies getting money, but at least there were some convenants and responsibilities on their part before the money was loaned (cf. to some of the financial firms). This legislation needs to be monitored very closely and it needs to be tight and specific. There will be some legal challenges - no doubt - with the final verdict taking years to come to fruition.

Jan 10 10:48 AM

[ArnoldCountry:]

Bankruptcy cramdowns are a good thing but it only assists those in trouble. If you have the ability to repay your mortgage or have sufficient assets, you will not qualify for a Chapter 13 reorg. Cramdowns have been used for years in secured transactions using very strict rules. Bankruptcy judges have been quite fair for decades on this process. It was allowed on principal dwellings until the 2005 bankruptcy reform.

Jan 10 11:07 AM

[prudentinve...:]

Let us not forget that there are young, responsible individuals who have been saving for a downpayment and waiting to buy a home at a reasonable price and on terms they understand and can afford. Some of these responsible people were unable to buy a home due to price competition with irresponsible buyers who signed onto funny mortgages without considering the consequences.

I would suggest it is ethically questionnable that society should subsidize the irresponsible to prop up home prices, and continue to penalize the prudent and responsible members of society.

Jan 10 11:33 AM

[know nothing:]

Why doesn't the gov't come up with another trillion dollars and just pay the mortgages off, disguised as a tax credit? Then the home owners would have a clean mortgage and could open a new line of credit to borrow against which would start the consumer spending on goods and services,which would jump start the economy. Then in time we could start the cycle all over again. After all we are a consumer based economy,aren't we? Now that I think of it the democrats could raise taxes to pay down the trillion dollars that were used to bail out the consumers, instead of tax cuts that are currently being discussed,like the current tax cuts are going to be enough to make a difference anyway! Actually eventually the gov't could create more jobs for the purpose of printing money, thats a great Idea!

Jan 10 07:54 PM

[Seen All It...:]

Once upon a time, consumers could understand and negotiate loan contracts. Homebuyers had to have 20% down or purchase PMI to protect the lender against the risk of default. Whatever happened to those pesky loan-to-value ratios? The Appraisers inflated the home's value to compensate for the mandatory 10% borrower equity (else the banks were supposed to pay higher FDIC insurance premiums when the banks were at risk) If the loan docs were really egredious, then a class action lawsuit would make it too expense for that bank or mortgage broker to continue doing business. The last resort was bankruptcy to correct the bad assumptions and poor underwriting of the lender. It is only right to bring back the cram-down rules that banks and their powerful lobbyists forced upon the consumers. This is the quickest way to find bottom of the housing market.

Jan 11 12:16 AM

[Econ 101:]

Prices of houses should be allowed to fall to where they would be if not for government interference. The "Community Housing Act" and congressional pandering to minorities that allowed massive price inflation of housing screwed peoplewho werent dumb or dishonest. If the govt would let prices fall and deflation take place we could get out of this mess. All this tinkering will put us in a long Japan style depression.

Our freedom is being stolen by the republican and democratic elites who think of most Americans as chattel. Government is corrupt and nothing more than the modern equivalent of "Circus Maximus".

Jan 11 02:14 AM

[sickofthehype:]

How about pay your f-ing bills or lose your f-ing house.

Jan 11 05:18 PM

[bcncv:]

You're right about forced cramdowns being a horrible idea. Too many people don't see the unintended consequences of completely abandoning the principle of contract law. What good is any contract in this society if Congress can "magic" the price lower retroactively?

Where legislation CAN have an impact is on homeowners that have a loan owned by multiple people (CDO packaged). In numerous cases, it is in the best interest of both the debt holders and the homeowners to re-negotiate the loan. However, if 30 people own parts of the loan, there is no mechanism for re-negotiating it. This is where legislation could actually help the process.

Granted, I'm no expert on CDO's. Still, this seems like the most common sense option.

Jan 13 03:09 AM