The Senate Voted Wisely on 'Cram Down' Bill

On April 30th, the Senate defeated the “cram down” bill that would have allowed bankruptcy judges to adjust mortgages so as to allow those people going through bankruptcy to keep their homes. The defeat came as some Democrats sided with the bill’s opposition, mirroring a general weariness from within the banking community towards this piece of legislation.

The media balked at this defeat with claims that echoed the bill’s sponsor, Richard Durbin (D-Illinois), that the banks essentially controlled Congress and that Senators needed to vote along with the needs of the American people rather than according to the desires of the banking and mortgage lobbies. The accusation from Durbin, and from the media following the defeat, was that these senators (particularly the 12 Democrats who voted against the bill) were essentially bought out. The media portrayed the Senate as under bank control.

We would suggest an alternative interpretation of the Senate’s vote and the defeat of the “cram down” bill: it was a good decision on a piece of unwise legislation. The reason, of course, was that the banks opposed this bill was because with the decision kept in their hands, they would decide in such a way as to minimize their losses. In the hands of a bankruptcy judge, there is no guarantee whatsoever that bank losses would be minimized -- bank losses are not the point of this legislation. And as we face an economic climate wherein financial institutions are in need of taxpayer bailout, exactly where do we think they will turn to recoup their losses when the bankruptcy judge decides in the best interest of the borrower and not the bank?

In the end, those people who may have fallen onto hard times and who find themselves in bankruptcy court will become a burden to the tax payer who may never have taken a mortgage, who may have decided to rent instead of buy because the rates seemed to good too be true, or who is now only barely managing to stay, themselves, out of bankruptcy court. For anyone facing bankruptcy, the situation is, of course, bad, but what is bad for banks, because they are on the government dole, is bad for everyone in the country. We’re the ones who have to bail them out.

Disclosure: No positions.

Comments

[R. Grace Ro...:]

The Cramdown failure will help the banks recover sooner I agree, but it will be done at the expense of every American Taxpayer who has already purchased a home, and at the expense of every one that will buy a home in the future. Take a look at what I have discovered as a 10 year real estate and bankruptcy attorney:

The banks are not even thinking about programs to save homeowners from foreclosure. They have a bigger fish to fry. I would bet a new plan of action is being put into place to recover from this mess. Think about it for a moment. Banks need to attract investors to recover. Investors want to see results; portfolios that are doing well. How will those portfolios be built? I'm guessing, but have you noticed at the foreclosure auctions, banks are starting to accept bids FROM OTHER BANKS (their friends) that are 50% less than the face value of the notes? What a brilliant idea. The bank selling at foreclosure gets to take a 50% write-off for the loss. The bank buying the property ends up with a property for 30% off fair market value. When the buying bank goes to sell at fair market, they show a profit to investors. Now the bank looks like its on the right track for its new investors. All the banks come out smelling like roses after this whole mortgage fiasco.

I have a client who will remain nameless for client confidentiality purposes. But he is representative of what I have observed in the past week. He has a $400,000 mortgage on his house. He asked the bank to reduce his mortgage to $300K and that he would pay 6% interest on the modified loan. My client's house is worth about $280K. The bank said no.

Unfortunately he was too far behind to do a Chapter 13 and catch up on the arrearages. But might I point out to you that those arrearages would never have existed BUT FOR his lender telling him that they would not consider a loan modification unless he was 3 months behind on his mortgage! My client was left with no alternative but to let the house be foreclosed upon.

When the house went to foreclosure, EMC sold the house to US BANK for about $150,000.00. This means that EMC will now book a $250K Loss on this investment. HOWEVER, US BANK will spend another $15 to $20K on eviction/relocation fees and may be another $15K to clean up the property and resell it at $280K. US BANK will be able to show a clean return on its investment of nearly 30% return. . . numbers investors will find attractive. It will then be business as usual for US BANK.

EMC will look bad to its investors, but those investors will have moved on to banks like US BANK. EMC perhaps will simply disappear as the fall guy for a mortgage industry who suffered chronic and severe anemia!

Let me point out something however. The banks will not be successful in this endeavor unless they actually have properties going to foreclosure sale; a LOT of properties going to foreclosure. The banks won't achieve the foreclosure numbers it needs to make this policy work with a broad policy of encouraging loan modification. It seems transparent that this is why recently so many of my colleagues and their clients are failing to achieve en masse positive modification results.

Let's get real. The financial incentives offered by Obama's plan amount to throwing a kid a penny and asking him to go clean out all the cow pies in a 30 acre cow pasture. I wouldn't count on seeing the banks voluntarily provide fair and reasonable loan modifications in the future.

Without the stick of a cram down the banks have already moved on to their bigger fish to fry! Your average homeowner in America will be merely the kindling to fuel that fire!

May 10 11:21 AM

[Roberto Ant...:]

I strongly disagree with Odysseas Papdimitriou that the failure to pass mortgage cram-down was and is a benefit to banks and other mortgage lenders.

The purpose of the U.S. bankruptcy provisions is to give everyone a "fresh start." By forcing debtors to continue to pay mortgage payments where the loan is "underwater," the opponents of cram-down make it virtually certain that debtors will allow their mortgage obligations to go into foreclosure, and walk away from their homes in a Chapter 7 bankruptcy.

Consider the result for the mortgage lenders. If $400K, for example, was the mortgage loan amount, and if the home is now worth $300K, a foreclosure means that the lender has taken an immediate $100K loss, the same as in a cram-down. No, more than that because there are many costs in unloading a foreclosed home, such as property maintenance, repair, clean-up, selling costs, taxes, et al. Factoring in all these costs, it is likely and probable that the lender will be able to recover only $200K by the time the property is re-sold.

So what have the banks and other mortgage lenders gained by fighting "cram-down?" The end result is that they are far WORSE off than if the bankruptcy laws allowed cram-down of primary mortgages.

The reason why cram-down failed in the Senate is because there are mean people there who are willing to extend billions to Wall Street and the banks, but who want to punish the little home owner for failing to be able to make mortgage payments in times of economic melt-down.

May 10 11:38 AM

[fixed incom...:]

completely agree with the author.
When a borrower does not pay their mortgage, the only true recourse a lender has is foreclosure. The cramdown would force lenders to negotiate modification at a borrower's request, giving borrowers additional negotiating leverage, which they do not deserve. Lenders perform 100% on their side of the contract when the loan closes and funds. Borrowers need to hold up their end or face the consequence of losing their house. Cramdowns would give borrowers a free lunch and require lenders to still maintain the contractual relationship, even though it is clear the borrower is unwilling or unable to perform. Fool me once shame on you fool me twice shame on me.

May 10 11:51 AM

[captainccs:]

Cram-down would have made contracts worthless and unenforceable. Why draw up a contract if the government can throw it in the trash can?

I know, I know, no one needs to be responsible for his actions anymore. The nanny-government will take care of you cradle to grave at taxpayer's expense. But you are the taxpayer. Catch-22!

May 10 12:19 PM

[russ:]

The continuation of the current law (the defeat of the 'cramdown) means banks are treated as 'special' and get to avoid any participation-responsi... in the bankruptcy proceedings. It's nice to be 'special'. If a person is filing bankruptcy there is no shame or aversion to walk away from a house and let the bank eat the forcloosure. Banks are not always smart which is why many hawked poorly structured loans, did improper documenatation and quickly collected their fees. Be careful what you ask for.

May 11 08:24 AM

[Gregman2:]

The reason for the legislation in the first place is because the banks have been way too slow to do write downs and modifications. This legislation was an attempt to force the banks to get off their butts and
get moving. We're all tired of the banks slowing this recovery because of their unwillingness to take write downs and losses in a timely manner--the banks are driving us into a deeper recession.

May 11 11:47 AM

[Odysseas Pa...:]

As a taxpayer that need to pay for the bailouts do you want to maximize the losses for the banks or minimize them? I think we all agree that we want to minimize them. Thus, who do you think will do a better job in minimizing the banks losses. The bank itself (even with all its shortcomings and inefficiencies) or a bankruptcy judge?

May 11 01:29 PM

[Ding Hoc:]

The way to solve the problem is to require financial competency as a condition of high school graduation. The bogey man is not the lending institutions, it's our acquiescence to ignorance. Turning contract law on its head is not the answer.

May 11 04:58 PM

[RealityChec...:]

Sen. Dick Durbin (D-Ill.) introduced legislation in the Senate Thursday which would allow homeowners in bankruptcy to renegotiate -- or cramdown -- mortgages with banks. His corresponding amendment to the House-passed bankruptcy reform bill is scheduled to be voted on at 2:30. (Read the whole thing.)

[UPDATE: It fell 15 votes short of the 60 needed to end a filibuster. Here are the 'no' votes and the amount of money they've taken from the financial industry.]

The measure is widely expected to fail, as crucial Democratic senators, whose votes are needed to overcome a filibuster, have publicly declared their opposition.

Democratic Sens. Ben Nelson (Neb.), Mary Landrieu (La.) and Jon Tester have indicated they plan to vote against the amendment. Sen. Evan Bayh (D-Ind.), who supported the bill last time around, expressed reluctance to back it this time. The banking industry has lobbied relentlessly against the reform.

On Monday night, Durbin concluded that the banks "frankly own the place."

The place came (relatively) cheap.

The banking and real estate industry has funneled roughly $2,000,000 into Landrieu's campaign coffers over her 12-year career, according to data from the Center for Responsive Politics. Bayh has taken in about $3.5 million. The financial sector is Nelson's biggest backer; he's taken $1.4 million from banks and real estate interests and another $1.2 million from insurance firms. Tester has fielded roughly half a million in his two years in office.

That's about nine million dollars -- far, far less than one percent of the amount taxpayers have spent to bail out the financial industry.

The opponents of the bill all say that industry influence is not the reason they'll vote against the measure. Rather, they claim genuine policy disagreements: concerns it could raise interest rates or increase defaults, for instance.

But Durbin's amendment is very narrowly tailored and would only allow mortgages signed before Jan. 1 to be modified -- meaning that interest rates on future loans should be unaffected.

We'll be watching the roll call and will post the rest of the no votes along with their take from the financial industry.

Durbin's office has also calculated, relying on data from the Center for Responsible Lending and Moody's, how many homes his bill would save and how much home equity it would preserve by preventing foreclosures, which damage entire neighborhoods.

Landrieu's Louisiana could see 12,651 homes and $500 million of equity preserved. Tester's Montana: 2,815 and $40 million. Nelson's Nebraska: 3,763 and $140 million. Bayh's Indiana: 27,960 homes and $590 million.

Across the United States, the measure was estimated to prevent 1.69 million foreclosures and preserve $300 billion in home equity.

Since the above was published; another 800,000 foreclosures have occurred in the first quarter of 2009 and more are sure to come as a result of 3.6 million "pay option loans" that will readjust over the next few years.

If you think those Senators voted against "cram downs" in an attempt to preserve homeowners who dutifully pay their mortgages; then I guess you still believe their were (and probably still are) WMD's in Iraq.

May 31 04:39 PM