Citi's Flip-Flop on Mortgage Cramdowns: A Really Bad Idea

Whoa. Citigroup (C) really has become a wholly owned agency of the federal government. How else to explain the bank’s sudden willingness last week to support the Democrats’ disastrous mortgage-cramdown bill? I understand corporate executives occasionally lose sight of the interests of their shareholders. But in this case, Vikram Pandit hasn’t just forgotten his shareholders’ interests; he’s put Citi in a position to oppose them outright. This is what happens when the federal government becomes your biggest shareholder: people like Dick Durbin and Chuck Schumer get a hand in running things, and they don’t always have profit maximization (or even fiscal prudence) at the top of their minds. Instead, they seem to want to turn Citi into a publicly traded version of ACORN.

If the term “mortgage cramdown” sounds vaguely unattractive, it may be because, from the lender’s perspective, it is—and costly, too. In particular, the Democrats’ bill in Congress would give a bankruptcy judge the right to unilaterally alter the terms of a bankrupt borrower’s mortgage loan. The judge, of course, would be accountable to no one. Yet he could arbitrarily lower the principal balance, for instance. Or cut the loan’s interest rate. Which is to say, the judge would have the right to vaporize a bank’s assets with the stroke of a pen, and without recourse by the lender. Vikram Pandit now somehow seems to believe this is a wonderful idea.

What in the world can he be thinking? A loan, recall, is a contract, willingly entered into between a lender and a borrower. Usually the loan gets paid back on time and in full. But sometimes it doesn’t. And when it doesn’t, the lender takes a loss. That’s the way business works.

But the misbegotten bill Citi now supports would take that balance between borrower and lender and tip it decisively in the borrower’s favor. That would be a disaster. Depending on what gets churned out of the maw of Congress, borrowers will be sorely tempted to file for bankruptcy solely to get a break on their mortgage terms. It’s as if the Democrats are inviting borrowers to legally steal from banks.

In fact, the consumer groups who support the bill—now Citi’s allies—have things completely backwards. “It is painfully clear,” a group of them said last week in a press release endorsing the bill Citi just agreed to support, “that the continuing, and indeed worsening, foreclosure crisis is perhaps the single largest impediment to economic recovery.”

That’s ridiculous. Rising foreclosures aren’t much of an impediment to recovery at all. The worst-case estimate I’ve seen says that 5 million foreclosures will occur over the entire cycle. That may sound like a lot, but remember that they’ll occur in a country made up of over 100 million households. So the overwhelming majority of people simply aren’t directly affected by the foreclosure spike. In the meantime, mortgage lenders need to have recourse to foreclosure if they want to make affordable loans that are also profitable. Yet Citi has now allied itself with groups that seem to have the wacky idea that foreclosures should be stalled at all costs. The bank seems to have forgotten who its friends are—and who its adversaries are, as well.

Remember what got the industry into this mess. During the height of the housing bubble, a lot of idiotic lenders lent money to people who didn’t deserve it. Now that the bubble has burst, the lenders have seen their mistake and are taking their lumps. Why should borrowers (who include not a few speculators and fraud artists, by the way) suddenly get a break? Why is it supposed to be sound banking policy that the government can go back and change the terms of contracts that were freely entered into, after the fact—and always in the borrower’s favor?

The move will cost the banking industry billions, for which the banks will get nothing in return. Oh, and will likely cost you some serious money too. Why? If the bill passes, mortgage lenders will inevitably raise interest rates and tighten terms, to pay for the higher credit costs and uncertainty the bill will undoubtedly cause to occur. Those higher mortgage rates will in turn put added pressure on home prices—which will exacerbate the housing crunch, not help end it. Wonderful.

I’ve been tempted to stick up for Pandit’s leadership at Citi (or at least give him the benefit of the doubt) since the major screwups at the company weren’t of his making. But his cave-in to the Democrats on cramdowns is his own doing. It’s a disgrace. From now on, Vik Pandit hasn’t just inherited the mistakes of others. Now he’s making his own, and the first one is outrageous.

Comments

[User 336252:]

And what happens to those of us who pay their mortgages on time? We're not getting any breaks for living within our means and paying our bills responsibly.

Of course banks do not want to foreclose on these loans. They don't want the house, they want the loan satisfied. To that end if the borrower is having a tough time making the loan work, I would not have a problem with the lender agreeing to smaller payments (either by reducing the interest rate or allowing the shortfall to be added to the principal). The loan amount should never be reduced. A mortgage is a secured loan -- by securing it with a tangible asset that in normal times will increase in value, this is how the interest rate is kept lower than that of a credit card.

Now, when the house is inevitably sold, and hopefully at a profit, does the bank get made whole? Or does the deadbeat keep the profit?

And I sincerely hope that any principal reduction on the mortgage is subject to federal income taxes. I think this was in place for short sales but I heard it was suspended.

Jan 13 04:47 AM

[mr_subprime:]

I'm here to tell you that the banks are not victims here.THEY ARE THE PURVEYORS OF FINANCIAL RUIN. The subprime borrowers who who were TAKEN ADVANTAGE OF are the victims. Yes, I said TAKEN ADVANTAGE OF. Look at the trust performance of, say, any 05 vintage securitized loan trust deal and you will see that the ARMs in these instruments are running 20% foreclosed, bankrupt, or REO. This was no accident! And until you people get your head out of your butts and see that the banks INTENDED to make bad loans so as to capitalize on the real estate, you will not understand. The lack of real UNDERWRITING and FRAUDULENT ORIGINATION PRACTICES are to blame. I know. I'm one of those "deadbeats". But I didn't buy a house to defraud the bank. I bought a house to raise my family in. Let's get a little truth into the marketplace!

Jan 13 10:39 AM

[Guero:]

Uh, first of all, according to John Lounsbury's very well-sourced article

seekingalpha.com/artic...

there will be more like 8.1 million foreclosures for the years 2009-2012.

But let's go ahead & use your non-sourced, highly suspect figure of 5 million for "the entire cycle" (whatever that means). You really think 5% of all of the existing housing stock in the US is not a high foreclosure rate?

I am suspect of government intervention in this crisis as well, although if I see a well-thought out plan with governement involvement I would not necessarily oppose it.

But let's not stick our heads in the sand & pretend that this is not an enormous problem that just might choke the elephant if it plays out through the "normal" foreclosure/resale process.

Jan 13 11:13 AM

[BuffalloBill:]

'Remember what go us into this mess, a lot of idiotic lenders who lent money to people who didn't deserve it'. Yeah, like WaMu, Lehman Brothers, Citicorp, BofA, and every other greedy Wall Street Banker. They want to keep their absurd bonuses (using the taxpayers money), and screw the homeowner who got pulled down in this downdraft because of the bankers. I say the cramdown law makes alot of sense. It finally gives power to the borrower to negotiate a reasonable interest rate with the banks. The banks pay almost 0% for fed funds but lend it out at 7-10% to subprime borrowers or 30% for credit cards. I'm a conservative, but I've lost all sympathy for these loan sharks who are destroying the American middle class for their own greedy self interests.

Jan 13 01:28 PM

[cadoggy:]

I don't understand why anyone would think that a cram-down is a good idea when there are multiple better options to go with.

First, people need to stop treating a home as if it's a child that you can not be humanely separated from. Moving out of your home and into another - more affordable - home, should be the first option.

Instead of paying to prevent foreclosures the government should pay for programs that give borrowers incentive to leave the property amicably. That way the bank doesn't have to blow as much money in a costly foreclosure and the borrower is assisted with moving costs and perhaps even deposits for their new rental home. As an added bonus borrowers who accept this plan could be given a moratorium on derogatory credit reporting (aka: no foreclosure on their credit report).

Lastly, cram-downs hurt everyone. They might help our problem today but they'll catch up to us with tighter lending and higher rates later.

Jan 13 02:30 PM

[k9s-4-k8:]

Who are we bailing out here? People who contracted unfavorable terms given their household income and/or people who just hate the fact they bought at the top of the real estate market. Why would they accept these terms?
1) They had never qualified for a home loan before because they either don't have enough income or capital for a down payment and didn't want to miss their once chance to ride the real estate bull.
2) They were buying a second home for investment purposes and likewise hadn't ever qualified for that second home before adjustable rate sub-prime loans became aggressively marketed and they didn't want to miss the chance of leveraging up on that 'can't lose' real estate bull.
3) They qualified fairly but because they bought in 2005, 2006 they are now underwater. They can afford to make payments but see the benefits of walking away and taking a short term bad credit mark on their credit report over accepting a reversal of fortune on paper.
Were all of these people conned? Doubtful. Many likely reasoned that they could always sell later at a higher price if rates got too high.
At what cost to the mortgage market are these cram down terms being adopted?
Absolutely, everyone will pay. People looking to buy homes will face much higher interest rates in any given interest rate environment so as to offset the expense of possible governmental intervention in the future as well.
People already in homes will pay through much slower real estate appreciation going forward. States and municipalities that have grown increasingly dependent on real estate appreciation for property tax revenues.
Who will benefit? Apartment owners.

Jan 13 03:21 PM

[PlentyOStocks:]

This is just a continuation of the same thing that created this mess.
First the government pressures banks to lend to unhealthy borrowers.
Now that they cannot pay, the government is pressuring banks to take a write-off while allowing the same unhealty borrower to keep the house.

How does this stabilize the banking sector? It does the opposite. It will only increase bank losses and make capital shrink further.

The banks are not the only lenders. This will cause private investor mortgage pools to disappear.

Does it make anyone feel comfortable buying a house, knowing that the government is artificially holding up prices?

Do you feel comfortable that the government now indirectly has a lien on every mortgaged residential property in the country; and more directly through Fannie/Freddie. In the future the green police will stop by and tell you that you need to plant and maintain more trees or lose your house.

Jan 13 04:51 PM

[code monkey:]

My father is on the board of a bank and his bank is unscathed by this issue. It's not the borrowers. It's poor bank management. You're bank is never forced to make a loan. There is a bunch of hoopla about loans to minorities. My Dad just chuckles....Cuz it's bunk! They only use the race card in this issue because, sadly the dumb wing of the Republican party get's all hot and bothered by race...This all comes down to a bunch of morally reprehensible people running our financial industry...These punks need a spank and its coming in the form of government regulation. They should feel lucky they aren't in jail.

Jan 13 05:02 PM

[oldlures1:]

Tom, I agree with you. The underlying basis is, as you said, that "A loan, recall, is a contract, willingly entered into between a lender and a borrower." Sure, some folks were taken advantage of, as has been the case for decades (and not just in banking), but they are the exception; few and far between, not the norm.
It is disheartening and disappointing (though not surprising) that many of the comments reflect/support a lack of culpability on the part of the borrower/homeowner. Sadly, it is the prevelance of such mentality, I believe, that exacerbates many of the issues facing us today and undermines progress going forward.
Keep it up - I like the way you think!

Jan 13 05:30 PM

[bigmoney:]

I'm a renter, living way below my means, but now I wish I had levered up a few mil in real-estate and enjoyed a plush bailout. Heads I win, tails you lose.

Jan 13 06:17 PM

[User 336779:]

If tHE LOANS WERE FRAUD AS HAS BEEN PROVEN,THEN THEY BECOME ILLLEGAL TENDER AND NEED TO BE VOIDED AND REWORKED BY A JUDGE IF THE BANKS OR SERVICERS ARE NOT COOPERATING...SIGNED i WOULD RATHER FORECLOSE ,IT'S LESS OF A RIP OFF!!!

Jan 13 06:42 PM

[joof:]

The bank will take a loss . It may mitigate the loss more effectivley by electing cramdown over a foreclosure

Jan 13 07:03 PM

[joof:]

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 13 07:03 PM

[Dave W:]

Forget the Cram Down. Foprget who did what to create the problem. Concentrate on the solution.

Modify all loans issued since January 01, 2000, into 20 year, Zero interest loans. The resulting principal only payments will: 1. lower the house payment and rapidly reduce the mortgage balance for the underwater homeowner. 2. provide capital to the lender to lend at today's rates and underwriting guidelines. 3. stabilize the housing market and stop foreclosures and short sales. 4. put all homeowners and investors in a positive equity position within 5 to 7 years, not 15 to 20. 5. increase tax revenue to State and Federal governments without increasing taxes. 6. provide a monthly economic stimulus to the household from the reduced house payment, without government intervention, bailout or increase in taxes. Much better than a one time check.

Not my idea but the proposition of The American People's Fix, check them out at americanpeoplesfix.com. An alliance of homeowners and investors with a viable solution to the housing market meltdown.

Jan 13 07:31 PM

[Billy Ocean:]

Disolve Citi and give the mortgages to the home-owners.

I have no sympathy for Citi, the majority of their sub-prime mortgages were predatory on their face. They've already received tens of billions in tax payer dollars and let's not forget, Citi has already made a hefty return of parts of these loans.

18% on a 300k mortage fr 3 years is over 100k for each mortgage.

Let Citi die and give us our damn TARP money back, they don't deserve it.

Jan 13 09:59 PM

[nino:]

THIS IS A HORROR SHOW. I do home loans and lend hard money. As of today, I do not do hard money loans at any price. To say that a judge has a right to arbitrarily change my loan terms is soviet style doctrine. I will lend out Bank money for as long as it will last which will not be long if this law passes. We are all toast if this passes.

Jan 14 01:26 AM

[jaguire89:]

Incredible!. People wake up. Your home is devalueing for one simple reason there is no end in sight. Nothing has worked yet. Folks Dept. of HUD has for decades tracked real estate values. Our homes were and are over priced. These judges will use commen sense and sources. I guarantee that the appraisors selected to assist these judges with reassessing values will be far more helpful and accurate with there figures. Then the pressures the same appraisors would have gotten from the original banks who put together.these original loans. THIS WILL PUSH BANKS TO RENEGOTIATE QUICKER OR BE FORCED TO LOSE MORE PER LOAN. End in sight then!!!!!!

Jan 14 02:15 AM

[Mark in SF:]

Ah... so cram downs, which are the norm for commercial property owners under bankruptcy, should not be for the common folk.

No, no, no.... somebody had got to be the debt slave.

Jan 14 02:48 AM

[Mark in SF:]

This article is absurd. If someone someone has made a legitimate claim to bankruptcy, they will be walking away on the property anyway, leaving the bank with the collateral worth what their crammed down loan asset would have been worth.

In other words: The bank will take the hit in bankruptcy, or take the hit when they foreclose. What's the difference?

Jan 14 02:54 AM

[Mark in SF:]

nino: " I do home loans and lend hard money. As of today, I do not do hard money loans at any price. "

Hey nino: I suggest you do not lend more money than a property is worth, if the only collateral is that property.

DUH!

Jan 14 02:58 AM

[Yoski:]

You left something out. The judge can only reduce the loan amount ABOVE the appraisal which would be treated as unsecured debt. Of course that all depends on who does the appraisal. Let's assume for a second that the appraisal reflects true market value (I know, big assumption) then it is in the banks interest to have the principal reduced and keep the borrower paying a reduced rate. The alternative is foreclosure where the banks is pretty much guaranteed to recover less than true market value. The difference for the banks is made up by the tax payer through various bailout packages.

Jan 14 05:40 AM

[Duude:]

The difference between a cramdown and foreclosure is upholding contract law and leaving the decision-making with the banking institution who holds the contract or throwing contract law out the window which undoubtedly carries huge new carrying costs for all future contracts which affects real estate appreciation/depreciat... for as far as the eye can see. Its the banks and homeowners that need to come to terms. Banks know they have to contend with foreclosure and they don't desire to become property owners. But the decision has to be left with them, or the real estate market will die.

Jan 14 10:12 AM

[monday1929:]

You fail to mention the unceasing criminal activities of Citi, Robert Rubin etc. Do you think they care about their shareholders?

Jan 14 11:28 AM

[DavidHu:]

I think there is a middle path here. Dont allow a writedown of the original principle, but do allow judges to disallow high rates and excessive fees; plus allow a rightdown of balances that accrued from high fees and rates. Some adjustable mortgages start out with a teaser rate of 1% but baloon to 15% or more after 2 years. There is no way these loans could ever be paid back. they were designed to either be refied or foreclosed. And many servicers will pile on 1000s of dollars in fees and penalties for a single missed payment.

Jan 14 01:22 PM

[jefff:]

It's funny how you point out how the "sanctity of the contract" is so important to you when it comes to homeowner mortgages, while neglecting that fact that Citi needed taxpayer (i.e. working class American) money in order to survive, because of its lack of ability to meet its own financial contracts. You fail to point out how the 2005 bankruptcy law changes have ultimately contributed to Citi's, and other banks current woes. You think "contract sanctity" should apply to individuals, but have no problem whatsoever with corporations getting money from taxpayers when they are unable to fulfill their own financial contracts.

Personally, I don't care about your bank, I don't care about your corporation, I don't care about your investments. Your sheer greed and contempt of working class Americans is palpable. The greed of you and your ilk is what has gotten us to this financial precipice in the first place.
When are you going to realize that our society cannot function as it has when wages have stagnated, and housing prices have been driven to heights beyond all reason, and all other cost of living aspects have dramatically risen.

Our society has lost its way. We routinely refer to people as "consumers". Health care has been turned into the "health care industry". Every aspect of our lives has been turned into some corporations' opportunity to exploit us for profit.

I do not, and will not subscribe to your selfish, privileged and greedy view of society as nothing but an opportunity to enrich yourself.

P.S. Your taxes should be raised dramatically

Jan 14 01:33 PM

[RichardfromHB:]

Only one other commenter had it right. This is not an issue about sanctity of contract. Corporations and high asset individuals have had the ability to ask a bankruptcy judge to modify their loan agreements for many years. Current law allows cram downs for mortgages on vacation properties, but not for those on first residences. Applying the same rules to first homes is NOT socialism, just an end to hypocricy. It also wouldn't be the end of the world as we know it since banks still wrote loans for yachts and vacation homes until the greedy guys broke the system.

Jan 29 01:33 PM