Another Happy Day for Banks: Cramdown Bill Fails

By James Kwak

President Obama, he of the 68% approval rating, asked Congress to allow bankruptcy judges to reduce the principal amounts of mortgages on primary residences (they can already modify almost all other loans in bankruptcy). The goal was to pressure mortgage lenders, or the investors who now own those mortgages, to modify the mortgages themselves to give homeowners a better option than foreclosure. Because, you know, we have a housing foreclosure crisis going on. But after passing the House, the measure got only 45 votes in the Senate, with zero Republican support and twelve Democrats defecting.

Banks campaigned against the measure by - get this - threatening that it would destabilize financial markets. The New York Times reported:

A letter signed by 12 industry organizations this week to senators warned that the legislation would “have the unintended consequence of further destabilizing the markets.”

Translation: banks are weak; weak banks are dangerous; therefore Congress should not do things that might be bad for banks.

According to the Washington Post:

[Senator Richard] Durbin negotiated with Bank of America, J.P. Morgan Chase and Wells Fargo for weeks, hoping their support would bridge the gap. Even after the proposal was weakened significantly, the financial services industry refused to sign on.

I know the main legitimate argument against bankruptcy cramdowns: it increases the riskiness of mortgages, and therefore mortgage rates would have to go up a little for everyone. (Which sounds fine with me.) But the way this issue played out had nothing to do with what would be best for the country as a whole; it had everything to do with what the banks wanted.

Instead of bankruptcy cramdowns, the Times reports that the banks got a reduction in the insurance premiums they will pay the FDIC for deposit insurance - which is like a group of car owners voting themselves lower premiums on their auto insurance. But because there is zero chance the government will let insured depositors lose money, any shortfall in the premiums paid by banks to the FDIC will be made up by the taxpayer.

Not that this should surprise anyone.

Comments

[mrmillergd:]

Let's stick with the processes we have rather than make new ones. Foreclosure is the best way for people to get out of houses they can't afford and for banks to write down inflated assets. In principle you hate to kick a family out of their home, but let's not kid ourselves - it's not like we don't have a glut of inventory and cheap rentals available in every market. And I highly doubt that foreclosures are resulting in a massive loss of the homeowner's equity.

May 01 11:08 AM

[Misha:]

The importance of government actions on the banks cannot be overestimated and the defeat of this bill may not be a cause to celebrate. Obama’s characterization of decanting Chrysler’s bond holders given yesterday may be an indication of things to come for banks. We may no longer see a very accommodating bank policy by the government in order to avoid a broader damage to the economy. If government’s plan works for Chrysler, we may see new approach to banks which does not involve saving current stock and bond holders as a consideration. As a first sign, watch the outcome of the current arguments by 6 or so banks to soften the stress test results. I am not sure the government will be persuaded.

Will there be a need for more government involvement? Who knows! Maybe not if the economy is truly recovering. I started to doubt that the moments CNBC started talking about Dow 10,000: Things are getting frothy. Note that most of bull arguments are based on the improvements in second derivatives, which is ridiculous on multiple levels. For starters, anyone who works with data knows that a derivative of a noisy data amplified noise. Second derivative is then simply useless. But if you insist on taking derivatives, take a look at the this graph (2.bp.blogspot.com/_FM7... lifted from Zero Hedge blog) that shows that for the first time since October 2008 more Americans believe that is now harder to find a job. Less jobs, more defaults of all kinds, more pain for banks, and more capital must be raised. The Government may no longer play a role of lender of last resort with minimal strings attached. I cannot blame them.

May 01 02:20 PM

[Al-USA:]

Thanks for the article.

Indeed, it should be no surprise to anyone who is aware of the American financial Oligarchy. The Oligarchy is proving itself incompatible with liberty, freedom, and democracy - not to mention capitalism.

Of course, all of the above been lacking for a while, in my opinion, but at least it is now in the open, so it can not, must not, continue for too long. Or, has the moment passed as when Caesar crossed the river Rubicon and the Republic ceased to exist? I hope not.

May 01 06:54 PM

[RichardfromHB:]

A similar cramdown proposal was floated last fall when the TARP funding was first being debated. Obama urged that the cramdown be unlinked so as to not delay the TARP emergency funding. In retrospect, the banks got all their trillions and can now sit back and pick off the bills that might give them any haircut. Ah the American way.

May 02 12:13 AM

[dcb:]

Notice how Obama doesn't speak out about this issue while it was one on the principle issues of his platform. It is because he stands with the established interests. They make sure they control both parties, so they can't loose. We think there are diffferences between the two parties. our democracy is a sham and doesn't really exist.

May 02 10:36 AM

[John Lounsbury:]

mmillergd - - -

You said: "I highly doubt that foreclosures are resulting in a massive loss of the homeowner's equity."

I don't think that preservation of homeowner equity is the central issue. I view the mortgage foreclosure process as having been put on an unequal footing with other default legal processes. The bankruptcy court does not not have the same "arbitration" power for mortgage foreclosure procedings as with other debt defaults.

You assert: "Foreclosure is the best way for people to get out of houses they can't afford and for banks to write down inflated assets."

That is debatable. Foreclosure is an expensive process and the bank assumes a considerable loss in process and maintenance costs, as well as mark-down loss in the distressed resale out of foreclosure. A major problem is that banks often do not have the resources to develop work-out plans with mortgagees on their own. If this were part of the foreclosure court proceding, some homes might be kept off the foreclosure market and the banks would actually gain financially, even with the "cram down".

This is a complex issue and I do not want to argue that the defeated Senate bill was necessarily the best option. However, I do not believe that forcing every possible foreclosure is the best outcome for homeowners, for the housing market and, especially, for the banks.

May 02 01:25 PM

[mikebrah:]

John,

You said:
Foreclosure is an expensive process and the bank assumes a considerable loss in process and maintenance costs, as well as mark-down loss in the distressed resale out of foreclosure. A major problem is that banks often do not have the resources to develop work-out plans with mortgagees on their own. If this were part of the foreclosure court proceding, some homes might be kept off the foreclosure market and the banks would actually gain financially, even with the "cram down".

The cynic in me finds it hard to believe the banks are unaware of their own best interest. In fact, the last 12 months have been a real eye opener with respect to just how far and how blatantly they will pursue their own best interest at the expense of everyone, even other banks.

These are institutions that were never taught to "play nice with others." The big banks are in some type of sadistic Thunderdome scenario. I think they all know some of their brethren won't survive and the tension is mounting.

I think the Ken Lewis situation and the stress tests are highlighting this fact. A year ago Lewis would have never been on record dissenting from the Treasury. He is panicking, with fears he is being left to the wolves.

A similar situation with the stress tests. The favored banks are pushing forward while the weaker ones want a re-do.

BAC:Fredo as GS:Michael.

When times were good, they were all content with a peaceful prosperity. Now it's war and the ruthlessness is front and center. GS has gone to the mattresses!

MM

May 02 04:29 PM

[John Lounsbury:]

Mikebrah - - -

You wrote (previous comment): "The cynic in me finds it hard to believe the banks are unaware of their own best interest. In fact, the last 12 months have been a real eye opener with respect to just how far and how blatantly they will pursue their own best interest at the expense of everyone, even other banks.

These are institutions that were never taught to "play nice with others." The big banks are in some type of sadistic Thunderdome scenario. I think they all know some of their brethren won't survive and the tension is mounting."

You have some of the same perspectives that I have. My thought process goes a little farther. Some foreclosures occur for one of the following reasons:
1. No one takes responsibility for the mortgage. It has a servicer, but the ownership is buried in a mortgage backed security. With no one responsible, workouts that might be feasible are not initiated. The result is that the direct loss is increased by the factors I have mentioned in other discussions: foreclosure and maintenance costs, plus often a significant writedown for distressed sale out of foreclosure (significantly greater loss than would have been achieved in a renegotiated mortgage).
2. The bank ownership of the mortgage is identifiable, but the bank is overwhelmed with potential foreclosures and does not have the staff and procedures to efficiently identify which mortgages would be beneficial for them to pursue renegotiation. Only those renogotiations pursued by the mortgagee get their attention and others they could pursue to their (the bank's) benefit fall through the cracks.

I think there is great potential to avoid some foreclosures and put mortgagors in a better financial position if some procedures were added to the legal process. I don't know if the defeated bill was the best one for this process, but I think something would improve the situation. It was only recently (2005-6?) that cram down procedures were removed from the foreclosure laws. I think that was a mistake.

I hope this amplifies some of my thoughts on the "cram down" question.

May 03 08:02 PM