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A defense of mortgage modification in bankruptcy.

Todd's Wall Street Journal op-ed makes many good points but it doesn't address the main argument for bankruptcy reform. The basic problem posed by the housing crisis is that millions of people find themselves with negative equity and rationally abandon their homes. Banks have trouble seizing, maintaining, and selling these houses, and bankers will tell you (anyway, they've told me) that the rule of thumb they use is that a foreclosed house will lose fifty percent of its value. I am unaware of any studies that prove that this figure is correct but the anecdotal evidence is powerful. In some communities, abandoned houses become havens for drug dealers and squatters who strip away wiring and whatever else might be valuable in the house. The derelict houses reduce the value of neighbors' houses, who then can be plunged into negative equity themselves, causing them to abandon their houses as well, leading to further degradation of the neighborhood, in a vicious spiral.

From a theoretical perspective, there are really two problems. First, bankers and mortgage holders are unable to negotiate contracts that provide for an automatic mortgage modification in the event that the value of the house falls below the debt. An optimal, complete contract would provide for such a debt adjustment, but it seems likely that bankers fear that any such provision could be too easily gamed, and so they prefer to renegotiate ex post if necessary or simply swallow the costs by having a policy of automatic foreclosure. Second, bankers and mortgage holders have no incentive to take into account the possible negative effects of mortgage default on neighbors.

As I have argued in earlier posts, the solution to such a problem in principle is mortgage modification. A banker does better by voluntarily reducing principal and interest than by foreclosing; however, big banks have traditionally refrained from renegotiating, perhaps because the transaction costs are high (smaller banks have traditionally agreed to renegotiate, by contrast). In the current climate, big banks are rethinking their earlier policy, but in any event it is hard to renegotiate with someone who has abandoned his house and disappeared.

If people can strip down their mortgages in Chapter 13, they will be less likely to abandon their houses, and this will have positive effects on their neighborhood. It is possible that such a rule could increase the cost of credit, as Todd argues, but the opposite effect is just as likely. On the one hand, banks might be reluctant to extend credit if they know that, in effect, repayment amounts will be reduced if housing prices decline, or banks will raise interest rates to cover this risk. On the other hand, if the result is a reduced incidence of foreclosure, then banks will do better rather than worse, and so interest rates should fall. If the right to modify the mortgage is limited to cases of financial crisis (which is not in the current bills), then the positive or negative effect on the cost of credit will be correspondingly smaller, minimizing a risk of disruption in the mortgage market.

We have learned from this crisis that every mortgage imposes potentially serious negative externalities on third parties. When someone defaults and abandons his house, he causes harm to others. The law currently does not punish that person or try to deter him from what is essentially a kind of pollution (like abandoning a car in the street); any attempt to do that would be impractical. So in a second-best world in which wrongdoers cannot be punished for the harm they cause others, restrictions on the contracts that bring about this state of affairs may well be justified. That is what bankruptcy law has always done; mortgage modification is a further development in bankruptcy law that would be justified in crisis (and possibly even normal) conditions.

Related Posts (on one page):

  1. Libertarian Stop Signs:
  2. A defense of mortgage modification in bankruptcy.
  3. Don't Let Judges Tear Up Mortgage Contracts:
Fraud Guy (mail):
What is the cost of allowing bankruptcy modifications? Dean Baker goes through a back of the envelope estimate in the following post.
Basically, not so much—the rates vary more than that some weeks in a stable economy. There is no need for doom and gloom.

And, anecdotally, a house that was appraised at $480K in 2006 was foreclosed on after not selling for over two years. It is now listed by the bank at $249K, or about $30K less than they were owed on it. My experience, having lived through that foreclosure.
2.13.2009 11:54am
Bill Snowden (mail):
In my dozen years experience in representing debtors in Chapter 7 cases I have seen Sears modify the contracts on a regular basis (not a mortgage, I know), typically offeering three options: pay the outstanding account balance in full (reaffirm), with little interuption in credit priviledges; pay a reduced (negotiated) amount which reflects the secured portion of the debt, if any, with a lowered credit limit; and complete surrender of all secured items, if any, and walk away from the contract. Any reaffirmation agreement receives the blessing of the Court and is enforceable thereafter.

Seems simple enough to do with a mortgage, without the need for a cramdown provision, IMHO.
2.13.2009 11:56am
bode:
I can't say it better than Tanta at Calculated Risk:

Just Say Yes To Cramdowns

I believe this line sums it up best:

"Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13."

It's important to read this type of analysis carefully. I think it's pretty clear that if you want special consideration from the law, you need to be something pretty special. Predatory lending that makes no sense (or prime grade A lending in the biggest bubble in the history of mankind explodes in a $3T blast) doesn't seem as deserving of special treatment. Time and time again it is shown that if you have skin in the game, you'll be more conservative. This is skin in the game. I don't care if they DON'T do it retroactively, but they do need to do it going forward. Going backwards, well, it's in the banks' best interest to just do it themselves, but they can lose that 100% of that money for all it matters now -- it's going forward that's important.
2.13.2009 11:57am
Dan Hamilton:
What part of these people made a deal and should stick by it don't you understand?

This "rationally abandon their homes" is a bunch of BS.

Just like anything else.

I buy a 52in HDTV on payments. Just because the price drops before I pay it off. You seem to believe that that I should go back to the store and demand that they lower the price.

In December Ford had a sale on their F150 Trucks. Half-off. If I had bought a truck before the sale should I have gone back into the dealership and demanded that they change the price. After all the new truck had lost half its value.

"rationally abandon their homes" If they can't meet the payments fine, but if they just don't want to the )(&)(*^@(#%)( people deserve anything that happens to them.

When you buy a house just like anything else the value will go up or down over time. The value of your home will not always go up. You know that when you bought the house. If you didn't you are to stupid to buy a house.

You bought it.
You were happy with the price or you would not have bought it.
Make the payments if possible.
If you cannot make the payments fine.
If just don't want to make the payments then you have no honor and any contract you sign is not worth the paper it is printed on.

To offer any support to those people who just don't want to make the payments is wrong.

Yes they can get away with it but NOBODY should ever believe what they are doing is right. Legal yes but right NEVER.
2.13.2009 12:08pm
Art Eclectic:
bode, I think the serious problems are as follows:

1) There is a lot of uncertainty about just how many loans were written to borrowers who cannot qualify for the same loan on an asset that is now 50% less than the original sale price. If those numbers become transparent, the whole enchilada could crumble since it is currently only being held up by the not knowing how big of a hit the banks are going to take. Right now, nobody really know how many borrowers with $400k loan and can't even qualify for a $200k loan in a cramdown.

2) The solvency card game depends on nobody knowing just how bad the banks lost at financial Las Vegas. This is why all attempts at transparency are being fought tooth and nail.
2.13.2009 12:13pm
ChrisIowa (mail):
Part of the problem now is that only one side is available to negotiate. Since mortgages have been packaged and sold and split and spread over all creation. Bankruptcy court can overcome that problem.

In return for including the mortgage in the bankruptcy, the court should be allowed to consider whether the bankrupt at his current income has any possibility of paying off a mortgage reflecting the current value of the house. If not, the bankrupt should be forced to move into accommodations more in line with current income.
2.13.2009 12:18pm
Ben P:

This "rationally abandon their homes" is a bunch of BS.

I buy a 52in HDTV on payments. Just because the price drops before I pay it off. You seem to believe that that I should go back to the store and demand that they lower the price.



Dan,

the part I think you're missing is that the law is just different with homes.

If you buy a TV on credit, you're personally obligating yourself to pay the amount you're borrowing for the TV. If you default, not only can the bank repossess the TV (Presuming a purchase money security interest) but they can come after you personally for the amount that you still owe. If the TV really halved in price you're still on the hook for a substantial part of that money. That's a deficiency judgment.

If you file bankruptcy, (Ch 7 for the purposes of the argument) they can still take the TV, but you've wiped out the personal debt. We've always had that in the law.

If you take out a mortgage the bank retains an interest in your house and you personally obligate yourself to pay the money you owe the bank. If you file bankruptcy the same result obtains, you lose the house, but you don't owe the money anymore.

However, a significant number of states in the country have structured their foreclosure laws in such a way that even without filing bankruptcy, if you surrender the house, you no longer owe any deficiency in the mortgage. That's already fact.

So if a borrower is underwater on their house in a non-recourse state, there's nothing presenting them from already just walking away and screwing the bank even if they actually can afford their payments. Sure, their credit takes a hit, but no worse than it would in a bankruptcy. Then we have all the negative externalities that come with vacant houses.

If we allow them to file bankruptcy and judges to restructure their loans, we may allow some percentage to keep their homes and keep paying, but less. In some respects it's a win win, the bank gets to not get screwed if the borrower walks away, and the borrower gets to keep the house and we avoid the negative externalities.

The question above is whether or not this causes enough problems of it's own to make it not a good or not the most optimum solution.
2.13.2009 12:24pm
D Gonzalez (mail):
The other problem (and dirty secret, from what I can tell) is that a lot of these houses are not owner occupied. The incentive for walking away from your primary residence is vastly different from walking away from a speculative buy.

If it's an owner occupied, you actually have to get your stuff together, put it in a truck, move to another location you've previously secured to lay your head and unload the truck. There's a level of stickiness that erodes the argument for abandonment on a strictly operational basis (and sometimes on an emotional one as well).

Now, consider a house bought as an investment by a the owner above. His practical attachment to the house is less,he may not live in the area or even town where the house is located (less chance of public shame eroding the supporting argument for walking away) and no emotional attachment to the physical structure. So, more likely to walk away.

Say the bank offers a adjusted mortgage to the owner. He might take it to play the game out, but he's still in the property to rent or sell it. Absent one of those transactions, he almost certainly will default on the mortgage again at some point. There is no stickiness to his relationship to the house, other than his credit rating.

So, adjust/cram away. A lot of the foreclosures in my area (and honestly there are less in this Top 10 metro than any virtually any other) are non-owner occupied residences. Those are going to be foreclosures anyway. I'd love to see some stats on percentages of foreclosures to date on a owner occupied or not basis. I bet it's a lot higher than you'd imagine or that is being reported.
2.13.2009 12:25pm
senate wren:
Trouble is, mortgage modification rewards irresponsible borrowers and punishes thoughtful people. Joneses bought $400K house, Smiths bought $200K one. Now Joneses get their mortgage crammed down to $200K and they will be paying exactly as much as Smiths, but they are living in a better house.

How about we Whip (Up) Inflation Now instead? If wages and prices rise in perfect sync, paying off mortgages will become easier for everyone.
2.13.2009 12:26pm
Thorley Winston (mail) (www):




I agree with Dan Hamilton and Bill Snowden, I've always paid my bills in full and on time and have been saving up for the last ten years so that I can put a decent down payment on my first home. Now that the market is finally correcting itself and artificially inflated real estate prices are dropping to a more manageable level, I see no reason why irresponsible people should be bailed out with a "modification" of the mortgage that they voluntarily assumed -- particularly not when it means that those of us who act responsibly can get stuck with higher borrowing costs.
2.13.2009 12:26pm
Brad Ford:
Let's assume that a bank faces two choices on a loan:
1. Reduced the "balance" on a loan by 30% and reduce the interest rate to an amount below what they would normally charge a defaulted borrower; or
2. Foreclose on the loan and lose 50% of the amount of the loan value.

In most situations, the optimal solution for the bank would be Option Number 1. Unfortunately, the used of Collateralized Mortgage Obligations may mean the bank's role is limited to servicing the loan. Although the CMO owners may face the same math as outlined above, the large numbers of owners may make it impossible for anyone to "decide" to take the optimal outcome. In cases like this, judicial intervention may be appropriate to minimize the loss to the debt holders.
2.13.2009 12:45pm
Dan Weber (www):
This "rationally abandon their homes" is a bunch of BS.

Are you saying it doesn't happen? Because it does. They can and do walk away.

It seems we need things entirely different for owner-occupied and non-owner-occupied. If someone besides the supposed owner is living in the house, when the owner walks away, as a first step the current resident should continue living there with the same rent payments. (In many states, the renter cannot be kicked out of his lease due to problems of the owner, which strikes me as a good protection.)

I don't think non-owner-occupied loans are non-recourse in the states that have non-recourse. If you abandon your rental property, the bank can go after you other assets.

I have a vague support for cramdown for mortgages, as long as many conditions are met, and one of them is being owner-occupied.
2.13.2009 12:46pm
A. Zarkov (mail):
Banks should convert owners in foreclosure to renters with a non-transferable option to buy at some suitable strike price in 5 years. This means the owner won't get thrown into the street, and the property will continue to be maintained. The owner has a lot of incentive to stay under such an arrangement as he might get to be an owner again when the real estate market stabilizes. As long as the rent is fair, I think most people would take this deal. The bank now does not have to mark the mortgage to market. It doesn't have to repair the damage the angry owner does as he moves out. The neighborhood does better too.

Is this better than having the government buy up mortgages and pass the loss onto the taxpayer?
2.13.2009 12:48pm
Jon Roland (mail) (www):
It is all very well to oppose some proposal (perhaps not the same proposal proponents have in mind), but if libertarians are to have credibility in this debate we need to offer proposals that might work, even if they don't accord with our libertarian principles. They do, however, need to be constitutional.

First, it is not necessary to use existing bankruptcy procedures, which have well-known downsides that Todd discusses. It would be quite possible to create a new chapter of the Bankruptcy Code for expedited writedowns of only mortgages that would be able to provide relief for five million delinquent homeowners. It is also not clear that doing so would cause a rise of interest rates and down payments because of increased perceived risk. To recoup capital losses, perhaps, but the risk of default is less for a debtor who can afford the mortgage payments than for one who will lose the house, leaving it vacant and subject to vandalism, while he sleeps with his family in the car. (Assuming the car doesn't get repossessed with them inside it.)

What we have is a standard of living bubble. It is not just about houses or cars, but includes other consumption items. Easy credit has enabled too many people to buy too much they can't afford. The correction is to reduce consumption to a level that is affordable over the long term. But that still leaves the problem of what to do with all the goods that have already been produced. It makes more sense to let the buyers keep and use them than to wreck the surplus to reduce the supply. Price and production controls have been tried in agriculture and only succeeded in making a lot of people starve.

The argument that writedowns could later become windfalls doesn't really work. If prices start to ascend at more than the rate of inflation that is the sign of a new bubble that needs to be pricked.

The collapse of consumption will occur. The only question is whether there will be a catastrophic downward overshoot, or whether we can buffer the collapse for a easy landing. That makes a difference for a lot of things, not the least of which is the survival of our countries as constitutional republics.

What we libertarians can do is propose ways to detect and prick bubbles before they burst. It is not unlibertarian to let water out of dams before the dam bursts. Freedom to contract is all very well if the parties are rational and farsighted, and they don't organize themselves into systems that are too big or too well connected to fail, or that blindly all pursue the same business strategies, led by middle managers that serve their own interests at the expense of their shareholders.

Teams of auditors looking for compliance with rules written for the last bubble don't work. I have proposed using grand juries, to broadly investigate large organizations, both public and private, and report on anything they find that seems dangerous. There don't have to be criminal indictments. But they need not to be bound to some fixed standards that clever middle managers will inevitably find ways to evade. They should particularly target any sector where there is a runup of prices and apparent profits higher than inflation. If it's too good to be true it is probably a bubble waiting to be pricked.

We also need to propose ways to reduce the costs and risks of employment, especially of American workers. That means eliminating wage withholding and going to a purchase tax (not a sales tax or VAT) which could be on the purchase of labor, payable and reportable by the employer and not the wage earner. It should make no difference whether one is an "employee" or a "contractor" for tax purposes. Better yet, of course, would be to eliminate all taxes on labor.

We libertarians are reputed for being the ones with all the best ideas. Let's get more creative.
2.13.2009 12:50pm
commontheme (mail):

I am unaware of any studies that prove that this figure is correct but the anecdotal evidence is powerful.

Perhaps you should hold out for some studies.

I have been shopping for a house in the SF Bay Area for 6 months now and there is not really a significant difference between the price of homes sold after foreclosure and ones that are sold otherwise.

Yes, some of them are sold at 50-60% of their peak value, but so are other homes that have not been foreclosed upon.
2.13.2009 1:01pm
Dan Weber (www):
I have been shopping for a house in the SF Bay Area for 6 months now and there is not really a significant difference between the price of homes sold after foreclosure and ones that are sold otherwise.

That's not really what's being measured. The question is how much does the bank see from foreclosure after paying transfer fees, realtor's fees, taxes, maintenance, repair, and all the lawyer's fees for the actual foreclosure.
2.13.2009 1:23pm
gallileo:
Commontheme,

You shouldn't confuse "price to buy" with "amount the bank gets". They have to pay an agent, legal fees, and their own employees to manage the foreclosure.

Not to mention the foregone payments during the six months between the NOD and the final sale.

Add in a pissed-off occupant who at the very least hasn't repainted or kept up the lawn, and more likely is vandalizing the place, and 50% losses are easy to see.

G
2.13.2009 1:26pm
Dalie (mail):
It's simply not true that a lot of these homes are not owner-occupied. The Bankruptcy Code *already* allows for mortgage modifications for non-owner occupied houses. It is ONLY primary residences that are not allowed to be modified.

So your vacation home, your investment home, your fifth mansion, whatever, can already be modified. It is only if you live in your home (and likely it would be your ONLY piece of property) that you cannot modify your mortgage. That is what this bill would be changing.
2.13.2009 1:26pm
Connecticut Lawyer (mail):
Eric is leaving out the most powerful argument in favor of allowing bankruptcy judges to strip down mortgages.

Doing so will increase the cost of mortgage loans and so reduce the number of people getting mortgages. Given the vast oversupply of housing on the market, and the inarguable fact that far too many people have gotten mortgages with inadequate income and inadequate equity, that would be a good thing.

Why is it that the supporters of cram-down don't like to make this argument?
2.13.2009 1:28pm
Happyshooter:
The problem is that our law on foreclosures started in the 1930s, and was an effort to give the person losing their home one more season to raise crops or find another place to live. It also assumes at its core that the home owner is a good person in tough times, and the mortgage holder is evil and not giving them a break for their down year.

That is why it takes nine months to wrest control (possession) of a home in default. In the meantime, the house stands empty, or has been stripped, or the person losing the home smashes the walls open, plugs the basement drains, and smashes the upstairs fixtures turning the basement and first floor into a toxic muck.

The problem is that the law can't be fixed. Somehow Michigan's sense that evil jewish bankers are evil home stealers (thanks to Ford and his nasty little newspaper and schools) transmuted in our more enlightened times to evil bankers and lawyers. People here believe this like they believe in God and the union.

The law simply can't be improved, no matter how much money the banking lobby throws at the state house. Any rep who tries, even from the most GOP district, would be dragged out of office.
2.13.2009 1:29pm
George Smith:
How about this: you can get a mortgage if you have a 10% to 20% down payment and a solid employment and credit history that indicates that you can make the payments, and that the payments are not too big a chunk of your monthly income. Think Barney and Chris will stand for that? Bet not. Oh, wait, that's how we got here.
2.13.2009 1:30pm
gallileo:
On another note:

In principle, I hate cram-downs. I was very careful when I bought my house not to overextend myself, and therefore live in a relatively modest home compared to my income and those around me.

Be that as it may, if the Jones and Smiths next door default and go into foreclosure, and their house is unoccupied and unmaintained for several months, *my house* loses some serious value. Not to mention the increased crime from vandals and drug dealers who might move in.

So the externalities of the poor decisions by both the lender and the borrower make me want to ensure that both parties have sufficient skin in the game to make good decisions.

So if we have to tell the lender, "Hey, if you don't do sufficient due dilligence on this buyer, you are going to get just as hosed as she is.", then I have no problem with that.

That may, in fact, increase the cost of credit. But if it does, so what? The increased cost reflects the true cost of covering the risk they are taking. If we don't force them to cover that risk, then we have to, which hardly seems fair.

G
2.13.2009 1:31pm
Michelle Dulak Thomson (mail):
commontheme,

Where in the Bay Area? I ask because we just bought a house (in Novato, northern Marin County) in December, after a few months of looking up here. Bank-owned properties were definitely cheaper than roughly equivalent ones being sold by occupant-owners. I think the occupant-owners couldn't quite believe the actual state of the market.

A pattern we saw a lot in online listings: House bought in 2005 or 2006 at some ridiculous price; offered for sale in 2007 or 2008 at the same or higher; offer price falls month by month as reality seeps in. Then a "sale" at a much lower price than the previous trend's lowest ebb (this represents repossession by the bank); then the relisting of the property after a few weeks at something above the "sale" price but lower than the owner-occupant's last offer. At this point, they seem to move fairly quickly.

The house we ended up buying was a short sale rather than a foreclosure — that is, the seller owed more on the house than we paid for it, and the bank ate the difference.
2.13.2009 1:34pm
bode:
Hi Art,

That's why I'm not sure it matters what we do going backwards, only forward. It changes the nature of the game slightly, and I suspect would even pass muster of the people here: there's nothing really special about mortgage debt here. All kinds of other debt gets handled in bankruptcy. I don't want to change the rules of a game that exists, but going forward, I see huge potential upside to this and very little downside. I'm not sure I understand why BofA should be treated differently for mortgages than for credit cards, except the rules say they are different today. Tomorrow, they should be the same. You won't see such absurd lending going forward, that much I guarantee.
2.13.2009 1:38pm
Fraud Guy (mail):
commontheme,

remember, when it comes to appraisals, and current existing home sales--it is the lowest common denominator that sets the market price. If a foreclosed home is sold at a loss by a bank at a 50% drop, then competing homes on the market have a tough time increasing their price over that, because when they go to get a loan, the appraisal is based on other market sales.

Conn Lawyer,

See my note (first). The change in mortgage rates is nearly negligible.

Brad Ford,

Per Sheila Bair at FDIC, when they took over IndyMac and their mortgages (no link, article from December), the terms of their servicing agreements allow your option one if the bank sees that as the best way to preserve value. They don't need the agreement of all the CDO holders.

I wonder if there instead needs to be a regulation that allows banks to make these modifications, which would hold them harmless from the CDO holders as long as certain standards are met (save x% of home value, no more than certain % of lifetime value lost with new terms, or other suggestions). With such safe harbors, they may be more willing to modify the loans.
2.13.2009 1:40pm
Avatar (mail):
The real check would be what home foreclosure does to pricing on a home that's NOT in an overheated real estate market. Go to Houston, say, and take a look at their foreclosed home prices; see if they're down 50% from the original price. (Hint: no.) People aren't walking away from houses when the price drops two, three percent; it has to have lost a significant part of the original value before anyone even considers that.

Dan has about half a point. Yes, it's certainly dishonorable to take out a loan in order to purchase an asset and then renege on the terms of that loan when the price of the asset changes. The market does a pretty good job of capturing that untrustworthiness in your credit rating; if you walk away from your mortgage, your credit rating is shot, and good luck borrowing money at anything less than usurious rates for several years.

However, what's a good credit rating worth? There comes a point at which the additional burden of having a poor credit rating is outweighed (or even dwarfed) by the current burden of having to pay hundreds of thousands of dollars over market value for a home.

It's hard to feel much sympathy for the bank. Sure, the individual was taking a risk that the asset would decline in value - but so was the bank; it retained its interest in the asset for a reason, and that reason was a bet of its own: that the asset wouldn't decline in price, or indeed would go up, and so in the event of foreclosure the bank would be able to keep all the money that had been paid back AND an asset worth enough to cover the loan too. Surely the bank is familiar with the terms and risks of mortgages, since it enters into many more of them than the buyer does!

At least you'd think so. Recent experience says maybe not...
2.13.2009 1:41pm
Rich from Queens:
Anyone who thinks that they can solve the mortgage/modification problem without the bankruptcy court is just kidding themselves. There are just too many diverse interests and parties involved, and too many subjective decisions to be made. At least one commentator has suggested a "phantom bankruptcy" procedure, where the bankruptcy specialists can evaluate the "toxic" assets, negotiate terms and even "cram down" without the normal formal bankruptcy procedures. As I've previously commented, I believe there is also an analogous precedent in civil procedure and admiralty with "in rem" and "quasi in rem" procedures. An "in rem" bankruptcy might be structured so that just as the "ship" itself is the subject in admiralty jurisdiction, the mortgage itself (or the mortgaged property) is dealt with as a distinct entity in an "in rem" bankruptcy. The homeowner could be treated like a creditor as to its equity, like a "debtor in possession" as to occupancy, and possibly like a source of an "account receivable" on his note as to any part of any deficiency that is not forgiven (in "recourse" jurisdictions). Mortgages which have been securitized in a particular investment vehicle could be consolidated, and treated akin to a "class action" in such an "in rem" bankruptcy, without the investment vehicle itself being in bankruptcy. Indeed, the securitization itself might be seen as already treating mortgages as distinct entities in and of themselves. Such an "in rem" procedure would avoid needless procedural requirements of a normal bankruptcy, would facilitate truly fair modifications, and would save the homeowner, and the investment vehicle, (and actually, the non-secured credit-card debt and other creditors) from the stigma and adverse collateral credit effects of a bankruptcy and discharge while still achieving the intended re-adjustment results.
2.13.2009 1:41pm
Ak Mike (mail):
Posner is wrong about the externalities, at least as a significant factor. Experience in Alaska's housing depression of 1987-91 shows that this ever-widening circle of desolation does not occur. The local depression was more severe than anything that is likely to happen nationally now. Most of banks in the state failed. State and federal agencies, as well as the remaining banks, carried out massive numbers of foreclosures. HUD ran a 20 page supplement in the Anchorage newspaper every week of foreclosed homes for sale - that was only HUD's foreclosures, and in a city of less than 200,000 population. Condos, in particular, dropped to 15% of their former value; single family residences lost up to 60%.

Yet the neighborhoods remained intact and did not deteriorate. We bought at that time a house that had been foreclosed on and remained vacant for a year; but our street was fine. There were very few or no houses in the city that were broken into and stripped.

Prices declined, a lot of people (such as my family) were able for the first time to afford to buy a home, and the state rapidly recovered.

Many of the comments in favor of strip downs are written as though banks have to be forced to do what's good for them. Surely if they are really benefiting from renegotiating the mortgage, they will do that? And notwithstanding the rigidities imposed by securitization, if the securitized funds will be destroyed or more badly damaged by refusing to authorize renegotiation, they will rethink that policy?

And don't we all agree that people all still need to live somewhere, and so all the foreclosures will not result in empty homes, particularly if there are a lot of foreclosures?

Also:

(1) although in theory in some states you cannot pursue a defaulting homeowner for the mortgage deficiency and you can a defaulting TV owner, in practice people who cannot afford to keep up the payments on a TV are not worth suing for the deficiency and the remedy for the finance company is usually annoying phone calls and repossession. It is a lot more serious to lose your home than your TV.
(2) Defaulting owners of rental property are not protected by anti-deficiency, and usually have assets that are worth being sued for.
2.13.2009 1:42pm
Anderson (mail):
Trouble is, mortgage modification rewards irresponsible borrowers

Right. And disallowing modification rewards irresponsible lenders. So what's your point, exactly?
2.13.2009 1:45pm
gab:
George Smith said:


How about this: you can get a mortgage if you have a 10% to 20% down payment and a solid employment and credit history that indicates that you can make the payments, and that the payments are not too big a chunk of your monthly income. Think Barney and Chris will stand for that? Bet not. Oh, wait, that's how we got here


Let's not forget Wells, and Wachovia, and New Century Financial, and Bear Stearns, and so on and so on...
2.13.2009 1:49pm
Thales (mail) (www):
"Increas[ing] the cost of credit" may not be a bad result in many cases. Cheap loans for bad credits was part of the problem to begin with. We obviously want solid credits to be able to borrow at reasonably appropriate rates, but it's not necessarily a bad thing to push a lot of marginal future homeowners to rationally consider the alternative of renting, which notwithstanding industry propaganda, is not "throwing money away." I have excellent credit and a high income, but have decided that retirement of law school debt and building a large savings cushion, for examples, are higher priorities to me than the "can't lose" investment of a home in a primo Chicago neighborhood. I haven't noticed my friends that bought near the height of the bubble making fun of me for renting in some time . . .
2.13.2009 1:56pm
Thomas_Holsinger:
My experience in Stanislaus County, as a trial court research attorney, has been that there were a lot of first-time buyers of homes who would never have qualified for any sort of home loan prior to the bubble. This is coming up in collections cases.

It looks very much like people were lured into buying a home, for the very first time, with the intent of flipping them rather than keeping them. And there were some, what proportion being obviously unknown but there were some, otherwise unqualified first-time home buyers who bought homes with significant cash-outs on the loans and splurged the cash-out. My impression is that these types simply had no thought for tomorrow, rather than intending fraud. They were promised free money and took it.
2.13.2009 1:57pm
pete (mail) (www):

The real check would be what home foreclosure does to pricing on a home that's NOT in an overheated real estate market. Go to Houston, say, and take a look at their foreclosed home prices; see if they're down 50% from the original price. (Hint: no.) People aren't walking away from houses when the price drops two, three percent; it has to have lost a significant part of the original value before anyone even considers that.


That is a good question. I live in San Antonio which was not an overheated market and to my knowledge there have not been many foreclosures here in the older parts of town, but there are a decent number of foreclosures in some of the newer developments. These homes go for around 125-200K, but from the descriptions of the people I know who live in the neighborhoods, some of them were crammed full of people before they were foreclosed. The forclosed homes are not selling fast, but i am not sure how much the prices have dropped.

And as a side I have no clue on how to solve the mortgage problem, but no matter what solution (if any) gets passed I will probably not be happy with it.
2.13.2009 1:59pm
David M. Nieporent (www):
Right. And disallowing modification rewards irresponsible lenders. So what's your point, exactly?
"Allowing lenders a chance to recoup what they lent" is a rather odd definition of "reward."


So your vacation home, your investment home, your fifth mansion, whatever, can already be modified. It is only if you live in your home (and likely it would be your ONLY piece of property) that you cannot modify your mortgage. That is what this bill would be changing.
And for that very reason, ceteris paribus mortgage rates are higher for all those other properties than for your owner-occupied home.
2.13.2009 2:07pm
Ak Mike (mail):
Anderson - irresponsible lending is self-punishing - a look around should persuade you of that. Is being forced to foreclose (if you refuse to renegotiate) on a diminished-value house a "reward"?
2.13.2009 2:08pm
George Smith:
If we could keep the discussin to residential single family home mortgage lending. Congress essentially forced Fannie and Freddie to buy crap sandwich mortgages, so lots of mortgage lenders made the loans that Congress wanted made, and F&F bought them and sold MBS on the secondary market. Dodd and Frank blocked any attempt to reign in F&F, and the unwise loans to marginal borrowers just kept on comin'. Everyone who bought the MBS (backed by the government, they thought) wound up with non-performing assets when the ARMs reset to market and the borrowers couldn't keep up the payments. Many other institutions made bad loans in non-residential areas, and the ones that did deserve their fate, but the residential mortgage mess had its genesis in Washington. I've been (and still am) in the real estate lending business for 25 years. My mortgage broker friends call this the Dodd/Frank recession.
2.13.2009 2:08pm
Dan Weber (www):
Many of the comments in favor of strip downs are written as though banks have to be forced to do what's good for them. Surely if they are really benefiting from renegotiating the mortgage, they will do that?

There are distinct tranches. Some of them are better off with a foreclosure. Some of them are better off with a renegotiated payment. (Go watch a start-up where the VC's have preferred stock and note whose money gets risked. In theory they are all "shareholders." In practice some shareholders are more equal than others.)

And don't we all agree that people all still need to live somewhere, and so all the foreclosures will not result in empty homes, particularly if there are a lot of foreclosures?

Well, one thing is that we had too much supply, which leads to depressed prices. So we will have empty housing, but the question is where the empty units are.

If we want home values to legitimately increase, make it illegal to build new houses and invite a million immigrants from India to move in. Ha ha, can you imagine if I recommended that?
2.13.2009 2:32pm
Ak Mike (mail):
Dan Weber - I don't think we have too much supply; I think we have had overpriced supply. I bet there are a lot of people around who would be happy to live in those homes if they could afford it. Like you said, it leads to depressed (=reduced) prices. Good for buyers, bad for sellers. Kind of like the big-screen TV market.

The favored tranches shouldn't care about renegotiating - they won't be affected. The higher-risk tranches should be willing to renegotiate their slice rather than lose it entirely - and even, if necessary, pay a bit to the favored tranches to let them do it.
2.13.2009 2:41pm
David Drake:
Jon Roland said:


We libertarians are reputed for being the ones with all the best ideas. Let's get more creative.


How about let the parties to the contract work it out voluntarily and, if they can't, then let the lender enforce the contract as written?

Those who say that foreclosures are causing the decline in home prices have it backwards: the decline in home prices are causing many buyers (e.g. speculative investors and those with ARMS) to walk away from their homes because they cannot find the "bigger fool" to buy the place from them.

To discourage this next time, simply stick the people involved with the consequences of their bargain.
2.13.2009 2:43pm
Anderson (mail):
irresponsible lending is self-punishing

Whereas having to file bankruptcy is a stroll in the park.

All the smug "well I pay *my* bills" arguments above, are really arguments that work just as well for abolishing bankruptcy, period. The fact is, we have a bankruptcy system, and there is no particularly good reason to exempt mortgages from its jurisdiction.

What the "libertarians" are really defending is the power of the banking lobby to write its mortgage exception into the law in the first place. Which I guess makes as much sense as any other libertarian tenet. Torture is okay; modifying mortgages in bankruptcy, not so much. Got it!
2.13.2009 2:54pm
NTB24601:
As this discussion continues, its worth remembering that Professor Posner's argument doesn't depend on any sympathy for debtors. His argument is that mortgage modification in bankruptcy appears to produce a more profitable result for everyone: creditors, debtors and society at large.
2.13.2009 3:04pm
Bob from Ohio (mail):

Torture is okay; modifying mortgages in bankruptcy, not so much. Got it!


Sarcasto, clean-up on Aisle 2!
2.13.2009 3:06pm
PersonFromPorlock:
One point about the "if the court writes down mortgages then mortgage interest rates will rise" argument: if the lenders are punished for lending irresponsibly they will become cautious: the result should be lower interest rates on subsequent mortgages because that caution reduces the risk factor. There will, of course, be fewer mortgages written.

Note to Dan Hamilton: what part of "the lenders and real estate sellers shouldn't take advantage of their customers' ignorance" don't you understand? Holding the typical mortgagee responsible for the terms of his mortgage is like holding a patient responsible for the treatment his doctor prescribes.
2.13.2009 3:08pm
Dan Weber (www):
One point about the "if the court writes down mortgages then mortgage interest rates will rise" argument: if the lenders are punished for lending irresponsibly they will become cautious: the result should be lower interest rates on subsequent mortgages because that caution reduces the risk factor.

Objection: assumes facts not in evidence.

(I think that banks should be subject to cramdowns, at least going forward, and that they will compensate by requiring significant down payments. Which is good. But I also realize that it could lead to redlining.)

Holding the typical mortgagee responsible for the terms of his mortgage is like holding a patient responsible for the treatment his doctor prescribes.

If you cannot read the pages at closing, you shouldn't own a house.

You know why there are so many pages? Why no lender has ever tried going with a 3-page mortgage documentation and marketed the ever-living daylights out of their simple process?

It's because it's not allowed. Because having 4 different pieces of paper all telling you "your payment could go up" were insufficient and government demanded a 5th to say "yes, I really understand my payments could go up."

So we add more and more pages, and now people cry that there are too many pages. Reading is hard! Why can't they just put this on TV?
2.13.2009 3:22pm
Boblipton:
For me the real sticking point has been the securitization of loans. The way those securities are generally written, you can pay the loan off or you can repossess the property, but there is no way to modify the loan, and the bank that negotiated the loan no longer holds the mortgage. Instead, it is split into a million little pieces and distributed among many securities. How are you going to get sign-offs on those?

The only method that makes any sense is for the original bank -- who, one supposes, is still collecting a management fee on the entire operation, to eat the clippings from the haircut. And how are you going to explain to a shareholder's meeting "We took a writedown on assets we don't own"?

Bob
2.13.2009 3:27pm
Andrew J. Lazarus (mail):
"Allowing lenders a chance to recoup what they lent" is a rather odd definition of "reward."
It makes sense to me. Risk of non-payment is part of the business of lending. Government action that reduces this risk (after the loan broker has thrown a bash with his up-front fees) is a reward.
2.13.2009 3:39pm
Elliot123 (mail):
Is there any reason for capital to flow to mortgages now? Why bother? It's quite rational to abandon the mortgage market now.
2.13.2009 3:40pm
Ak Mike (mail):
Anderson -
When people get in bad financial trouble, they go through bankruptcy. It's a big pain for a brief period, has some effects on their credit rating for a few years, then it's behind them. If you borrow irresponsibly, the result is getting to enjoy the stuff that you bought with the loan for a while, then having it taken away.

When a bank gets in bad financial trouble (if, admittedly, it isn't bailed out) it is closed and is gone forever. If you lend irresponsibly, the result is the end of the institution. If you view that as a reward, then the current system rewards lenders.

NTB - I agree that you have described Prof. Posner's argument. However, it's mistaken. The effects on society at large of allowing bankruptcy judges to readjust mortgages will be bad: making it harder for deserving borrowers to buy houses, removing predictability from lending, and tremendously increasing the number of bankruptcies with effects that will hit all areas of the economy.

The effects on lenders will be even worse, taking away from them the decision whether to foreclose or renegotiate, and greatly increasing the cost of enforcing mortgages. The borrowers will be winners, true, but one out of three is not enough.
2.13.2009 3:41pm
Xanthippas (mail) (www):

Doing so will increase the cost of mortgage loans and so reduce the number of people getting mortgages. Given the vast oversupply of housing on the market, and the inarguable fact that far too many people have gotten mortgages with inadequate income and inadequate equity, that would be a good thing.


I was thinking the same thing as I read that. Why the assumption that it's a bad thing that it's harder to get a mortgage and thus buy a house? Obviously people want to fill empty houses, and build new ones, but easy credit is what got us into trouble in the first place. Surely you can argue about the impact that this might have on the cost of mortgages, but if there is an impact, that seems like a good thing to me given the bubble bursting that we're witnessing.
2.13.2009 3:45pm
NickM (mail) (www):
The reason banks take such a hit on selling foreclosed properties is because they have to sell them within a year. Change the regulations to allow them to lease out the properties, and the negative externalities from vacant houses diminish, the valuations based on comparable house sales don't take the hit, and lots of people who can't afford to own those houses will rent them.

Nick
2.13.2009 3:48pm
Happyshooter:
The reason banks take such a hit on selling foreclosed properties is because they have to sell them within a year. Change the regulations to allow them to lease out the properties, and the negative externalities from vacant houses diminish, the valuations based on comparable house sales don't take the hit, and lots of people who can't afford to own those houses will rent them.

Nick, good idea on paper. Bad idea in real life. Renters of houses tend to be folks who can't live in an apartment because they are poor and 1) their family is too large; or 2)they are too scummy.

Either way, drinking beer and blasting noise follows like night follows day, and crime will take off in the neighborhood. Soon, the block is ruined.

If folks don't have their life savings tied up in the house and the block, they ruin it for short term pleasure.
2.13.2009 3:53pm
Brad Ford:
Commontheme: commontheme (mail):
I have been shopping for a house in the SF Bay Area for 6 months now and there is not really a significant difference between the price of homes sold after foreclosure and ones that are sold:

Although much of the press focuses on people who could not afford their original homes, many "responsible" buyers are being punished by the forclosure of their neighbor's home. The more foreclosures in the area, the lower the value of all the homes will be.
2.13.2009 4:07pm
NTB24601:
Elliot123: Is there any reason for capital to flow to mortgages now? Why bother? It's quite rational to abandon the mortgage market now.

If the housing market has corrected itself, then shouldn't the mortgage business return to being a relatively safe and profitable use of capital?

Ak Mike: NTB - I agree that you have described Prof. Posner's argument. However, it's mistaken. The effects on society at large of allowing bankruptcy judges to readjust mortgages will be bad: making it harder for deserving borrowers to buy houses, removing predictability from lending, and tremendously increasing the number of bankruptcies with effects that will hit all areas of the economy.

Some of the comments seemed to be careening into a debate about the equities of forgiving debt, which could cause the thread to devolve into partisan wrangling. As a reader, I find those comments less interesting than debate on the argument that Professor Posner presented (that cramdown benefits all concerned).

Your comment about Alaska's housing depression of 1987-91 was one of the most interesting in this thread for me. I wonder, though, how applicable the Alaskan experience is to the rest of the nation. Alaska strikes me as having some fairly unique characteristics.

NickM: Change the regulations to allow them to lease out the properties, and the negative externalities from vacant houses diminish, the valuations based on comparable house sales don't take the hit, and lots of people who can't afford to own those houses will rent them.

Wouldn't that be problematic in states that allow deficiency judgments? If the lender is going to retain the property, then you'll need some mechanism to calculate the amount of the deficiency. During times of financial crisis, accurately appraising the property without a sale may prove difficult.

Also, lenders may not embrace moving into the property management business.
2.13.2009 4:15pm
Ak Mike (mail):
NTB - thanks for your thoughtful response. Alaska does of course have unique characteristics, but in general I would expect its uniqueness to tend to more severe rather then less severe systemic effects of mass foreclosure.

The economy is thin and therefore less resilient than lower-48 economies. The contraction occurred at a time that was not so bad in the rest of the nation, so it wasn't hard for people to simply abandon their homes and leave the state. Viewing the nation as a whole, the number of occupied dwelling units cannot decline that much, because people who abandon their underwater property need a new place to move to. By contrast, when people walked out on their Alaska homes in 1989, they would leave the state and no one would be moving in to replace them.

Despite all this, including the failure of most of the banks, the neighborhoods did not deteriorate, and those who stayed put saw their house values recover in about five years.

On your question to NickM: I think his point was that a foreclosure could be followed by renting out the house. In that case the deficiency would be calculated by subtracting the winning foreclosure bid (typically, an offset bid by the lender) from the mortgage balance. Rent received after foreclosure is irrelevant for deficiency calculation.
2.13.2009 4:57pm
wooga:
I bought my house on 100% financing in 2005 precisely because I knew that if the market crashed, I could always turn the keys in and walk away with just a credit hit. The bank knew that too. We both gambled on the market staying strong - or (as I expected) at least only dropping a little bit (under 10%).

The risk of me walking away from the home was factored into my loan in the first place. If the law could keep me trapped, I would have gotten a better loan! Think about that. So far all of you people who say:

What part of these people made a deal and should stick by it don't you understand?

This "rationally abandon their homes" is a bunch of BS.

I say suck it. I bargained for the "walk away" option as a form of insurance, and I have every right to use that option without the indignant scorn of Dan. I am sticking to my deal - specifically the part which says the loan is only secured by the property.
2.13.2009 5:23pm
Steve H (mail):

All the smug "well I pay *my* bills" arguments above, are really arguments that work just as well for abolishing bankruptcy, period. The fact is, we have a bankruptcy system, and there is no particularly good reason to exempt mortgages from its jurisdiction.


I'm glad someone finally made this point. Yes, it is frustrating to think about how I made the responsible choice and stayed in a more affordable house, paid a bunch off early, and am in no danger of being upside down. Maybe I'd have been better off getting in over my head and waiting for the bankruptcy court to save me.

But that argument applies to just about every bankruptcy situation, as the whole point of personal bankruptcy is to give debtors -- even blatantly irresponsible ones -- a fresh start.

This particular suggested modification of the bankruptcy code does not create any new exceptions to any general bankruptcy principles. It simply would *remove* a special exception for mortgate debt.

So it seems to me that comments about the general unfairness of bankruptcy are not that persuasive (in this particular context). Rather, if you oppose the proposed modification, it would be helpful if you could explain why mortgage lenders should be entitled to keep their special exception from the general cramdown provisions of the Bankruptcy Code.
2.13.2009 5:36pm
George Smith:
If you remove the special exception for mortgage debt, you have to remove the debtor's homestead exemption. The house is either in play or its not.
2.13.2009 5:48pm
George Smith:
Guess Wooga's not an innocent victim of a predatory lender.
2.13.2009 5:55pm
wooga:
No, George Smith, I was not a victim. I bought a small condo as my first home, and made sure that my mortgage payments could be covered by my income alone (so I had a financial buffer created by my wife's income). I can afford my loan now. I have not made a late payment on anything in over 8 years.

The issue is that it is economically wasteful for me to do so. I bought a $360k condo, and it is now worth less than $180k. It's easy for people to pontificate about how bad I am when they aren't the ones looking at $180,000 in excess debt.
2.13.2009 6:15pm
ohwilleke:
One way to eliminate gamesmanship in Chapter 13 mortgage modifications would be to allow a cramdown for purposes of the payments due under a mortgage, but to allow the bank to retain a non-resource lien on the property in the full amount of the loan.

Thus, if the house were subsequently sold or taken by power of eminent domain for an amount in excess of the cramdown value, the excess proceeds would first be paid to the bank until its non-recourse claim was satisfied, and only the paid to the benefit of the property owner.

With such a rule, a Chapter 13 debtor wouldn't be able to cramdown a mortgage at the bottom of a real estate bust, and then make a great profit a few years later, either because the appraisal used in the cramdown was inaccurate, or because the real estate prices swiftly rose after hitting bottom.

The average mortgage is refinanced or paid upon a sale of the property after ten years, and mortgages that are entirely paid off in payments by the original borrower typically come after thirty years. But, a typical foreclosure takes place two or three years into the loan. The likelihood that housing values significantly drop in a way that requires a cramdown after a couple of years during a bubble collapse, is greater than the likelihood that housing values will fall and stay at that level for another seven or eight years or more.
2.13.2009 6:23pm
Elliot123 (mail):
"If the housing market has corrected itself, then shouldn't the mortgage business return to being a relatively safe and profitable use of capital?"

I see no reason to think the market has corrected itself. It is not being allowed to do that. If it correted itself, it would be a dramatic and brutal correction, but government is trying to keep the market from taking its natural course. Nobody knows what government will do. Our legislators don't even know what they are voting for. This makes it rational for capital to abandon the mortgge market.
2.13.2009 6:40pm
Jon Roland (mail) (www):
Much of the securitization problem could have been avoided if, when a foreclosure or collection action is challenged, the claimant is required by the court, if the debtor demands it, the original signed note, and all co-owners are required to appear as parties. Mere affidavits of ownership fail the best evidence rule, and should not be allowed. I can remember a time when that rule prevailed.

I can also recall when we sold houses on a contract for sale, under which the buyer was essentially renting and building up a credit that served as the down payment. That also allowed him to build a credit rating for the payments he made on the contract, and thus qualify for a loan (with a savings &loan in those days -- remember those?). If he couldn't qualify for a loan, we financed it ourselves, for a while continuing the contract, and further down the way, by granting a deed. In most cases we had financed the house ourselves, paying the S&L a lower payment than the contract payment. Qualifying for a new loan was usually with that same S&L.

It worked for us. We never dreamed of securitizing.
2.13.2009 7:23pm
wooga:
Elliot123 is right,

Many of the riskier people who bought at the peak in 05-06 will have their mortgages reset higher at the 3 or 5 year mark. They are the fuel for further foreclosures. When people face the jump in payments over the course of 2009 through 2011, they will invariably choose to walk away from their homes (returning to the rental sector), causing more foreclosures and driving prices further downward.

This will be the worst in places like Vegas, Phoenix, and San Diego (where I live) where over 50% of homeowners are already upside down in their mortgage. Non-recourse laws only make it easier to walk away.

The market should go further down. Most of the remedies are aimed at simply stringing out payments for people who already can't afford their home. That is simply delaying the inevitable. Until the market actually hits bottom, investors are not going to get back into the real estate market, and we will not see values climb. Of course, once values start to rise again, it will get people like me a reason to hold on to an upside down home.
2.13.2009 7:27pm
Dr. T (mail) (www):
...banks might be reluctant to extend credit if they know that, in effect, repayment amounts will be reduced if housing prices decline, or banks will raise interest rates to cover this risk...
Neither of those would be needed if banks required borrowers to pay 20% down at the start of the mortgage. I never understood this change to 5% or less down payments. I'm amazed that bankers believed that house prices would rise continuously: did they never study this in their economics courses?
2.13.2009 8:07pm
FE:
I assume the reference to externalities in the last sentence of Prof. Posner's post is used to justify interference with the free market. If so, it proves too much -- any form of government regulation could be justified that way. True, every mortgage creates externalities. People who overpaid for their houses caused negative externalities to me, a renter, by driving up property values to the point where I could not afford to buy a house. Does this mean that that the government should have put limits on home appreciation, or forced homeowners to pay into a fund for the benefit of renters, in the name of addressing externalities during the boom? No. I didn't ask the government to intervene to keep prices from going up. But I don't want the government to intervene to keep prices from going down, either.
2.13.2009 8:08pm
Elliot123 (mail):
"I never understood this change to 5% or less down payments."

Government used CRA to pressure banks to lower credit standards so more minorities could qualify.
2.13.2009 9:54pm
Chem_geek:
I fully support so-called cramdowns...in fact, the language itself is propagandistic.

The fact of the matter is, the banks have been gleefully screwing the people for years, and buying $13,000 wastebaskets with their ill-gotten gains.

Do you recall the Late Fee Bonanza the banks revelled in after September 11th, when the U.S. mail came to a halt due to the air traffic shutdown? Contracts of adhesion, universal default, the bought-and-paid-for rewrite of the Bankruptcy Code, usurious rates...all these chickens are now coming home to roost.

Sauce for the goose, is sauce for the gander. The more the bankers squeal over this, the more I think it's a good idea.
2.14.2009 1:42am
Vermando (mail) (www):
I hope that Dan Hamilton's neighbors move out and leave him living in a neighborhood of abandoned homes occupied by vagrants and drug dealers.

Either that, or I hope that he and others read the actual post to see that feigning moral outrage about self-responsibility doesn't really address the issue.

Not that I necessarily support the professor's proposal - I have no idea what should be done. Bad choices all around, and no easy way to distribute the costs.
2.14.2009 3:06am
roystgnr:
The law currently does not punish that person or try to deter him from what is essentially a kind of pollution (like abandoning a car in the street); any attempt to do that would be impractical.

Ummm... why? You've got an easy way to punish him: take his *house* away and sell it to the highest bidder. He has no chance of getting away: you know where his house is. So why is there any resistance to punishing people or banks who abandoned a house when they should have sold it to someone who can maintain it?

Wait, I know why there's some resistance: abandoning houses reduces their supply, which props up insane housing prices elsewhere; auctioning houses increases their supply, which might help that bubble finish popping; that's enough to explain why banks and politicians might dislike the idea. But why would it by found so obviously objectionable by a law professor?
2.14.2009 11:14am
Jim Hu:
Am I missing something? The comments here seem to be focused on whether its a good idea for mortgages to be renegotiated in some instances. Presumably there are often circumstances where this is the best of a bad set of options. But isn't the argument about whether bankruptcy judges should be empowered to force the parties into a particular renegotiation?

Since this is a law blog and IANAL, I'd be interested in whether the law profs think this would be a taking.
2.14.2009 1:27pm
markm (mail):
Anderson:

What the "libertarians" are really defending is the power of the banking lobby to write its mortgage exception into the [bankruptcy] law in the first place.


What you call a "mortgage exception" is just the difference between secured and unsecured loans. A secured loan puts the creditor first in line for the value of the asset named as security. For a business, that might be the unsold inventory. For a consumer, it's the house, car, sofa, etc., if they were purchased on a secured loan (or if you put an asset you already owned up as security, such as a home equity loan). So a secured creditor (those with security assets named in the loans they make) gets paid first, up to the value of the named assets. Unsecured creditors (credit cards, unpaid bills) get a share of whatever is left. If the security asset is worth less than the loan, the secured creditor gets in line with the unsecured creditors for the rest of his money.

It's how the world works. A loan backed by my paychecks and a durable asset is less risky and carries lower interest than a loan backed just by my paychecks. A mortgage is just a long-term secured loan with real estate as the security, and originally they were treated identically under the law. Bankers wish that had stayed the same. The real "mortgage exception" is various laws in various states that treat mortgage holders worse than other secured lenders - non-recourse laws, waiting periods for foreclosure, laws allowing the former owner to pay up and reclaim the house within a certain time, even after then bank has sold it. (About 20 years ago when I bought a foreclosed house in Michigan, the bank had to give us disclosure paperwork indicating that for something like a year, if the former owner paid off his loan in cash, we'd be on the street, although we'd have our money back. It's pretty unlikely for someone who couldn't keep up payments to come up with such a lump sum, but not always impossible (the lottery, rich relatives dying), and I think we got a few thousand off the price because of it.)

This cram-down proposal, if applied across the board, will further disadvantage mortgage lenders. They'll demand more security (20% down, even more if the market looks like it might be in a bubble), better credit ratings, and higher interest rates. Then Congress will hear from constituents that can't qualify for mortgages and will once again hammer the bankers to lower their standards, and the cycle starts over again...

That said, a rational banker will often accept a cramdown because the lender loses less money that way. When one or two claimants to the house show up at the foreclosure hearing, they can negotiate such terms with the debtor; if they don't, it's probably because a cramdown is a really bad idea. (E.g., borrower didn't just get caught once in an unexpected situation, but appears to be irresponsible enough that a re-negotiated loan will just mean another foreclosure later.) The problem appears to be mainly with mortgages that were sold and insured in many slices, making it impractical to get everyone with a stake in the house together for negotiations. In that case, I would accept court-ordered cramdowns - and if it retards the securitization of mortgages in the future, maybe that's a feature, not a bug.

Second, we do need policies that protect renters of foreclosed property. I suspect that this really means that we need to end policies that somehow make it more advisable for a bank to kick the tenants out and leave the place empty for months than to collect rent on it until it's sold. Why would the bank want to lose money this way, unless rental regulations are so onerous that they prefer to empty the place at the first opportunity?
2.14.2009 1:44pm
markm (mail):
Ak Mike:

NTB - thanks for your thoughtful response. Alaska does of course have unique characteristics, but in general I would expect its uniqueness to tend to more severe rather then less severe systemic effects of mass foreclosure.

I wonder if there's another sociological difference, namely much less urban poverty? (I know AK has plenty of rural poor, but do they crowd into the cities as happens in the rest of the country?) Much of the deteriorating neighborhood stuff I hear about - people stripping pipes out of the walls to sell them as scrap metal, etc. - sounds a whole lot like there were neighbors from the slums to start with.
2.14.2009 1:58pm
Tom Perkins (mail):

Government used CRA to pressure banks to lower credit standards so more minorities could qualify.


That observation is not complete without mentioning that lenders could then no longer justify applying traditional qualifications to non-minority borrowers.

That's a real government multiplier.

Yours, TDP, ml, msl, * pfpp
2.14.2009 4:51pm
Aleks:
Re: Renters of houses tend to be folks who can't live in an apartment because they are poor and 1) their family is too large; or 2)they are too scummy.

That's so far off base! Poor people are much more likely to rent an apartment than a house (apartment rent is overall cheaper because aprtaments, on the average, are smaller than houses). House renters tend to be people with decent income who may not be want to be tied down by buying (if, for example, they can foresee a possibility of needing to move), and yes, they will often have children and perhaps pets, and these do better in houses than apratments. Also, some people like to have some outdoor space of the sort not available in apartments. I've rented four different houses, in Ohio, Florida and now Baltimore, over the last ten years. I have a very good income, but do not want to tie myself down to a property since I may need to move for work (it's happened three time in that period). I don't have kids but do have cats, and gardening is a hobby. Oh, and I am not "scummy" and I do my (rather moderate) drinking at a nightclub not at home.
2.14.2009 5:01pm
Elliot123 (mail):
"That observation is not complete without mentioning that lenders could then no longer justify applying traditional qualifications to non-minority borrowers."

Correct. Government pushed to lower standards across the board to the level monorities could handle. Standards fell for everyone. We would have been much better off to simply have had affirmative action lending so lower standards only applied to minorities.

It will be very interesting to see if we get a complete replay of this if the mortgage market begins to recover. Suppose we get back to a situation where one gets a loan only with stable employment, good credit, and a down payment. Suppose a higher percentage of whites and Asians qualify than blacks?
2.14.2009 8:47pm
Chem_Geek:
Capital doesn't "flow" as some people assert above. No, capital is money, the admission fee paid by bankers and financiers and cheats and liars (but I repeat myself) into the Great Game of Screwing People.

So, as long as the aforementioned liars &cheats think that they will not be able to screw over the people, they will not capitalize the mortgage market.
2.14.2009 9:24pm
Elliot123 (mail):
Capital is directed towards different investments by people with money. When people do that, we say capital flows into an area. I guess we could say it' a figure of speech, but it works.

Note that pension plans were heavy investors in mortgages. Their capital flowed into the mortgage market when they bought Fannie Mae bonds and other mortgage instruments. People who deposit their savings in a savings &loan also are investing in mortgaes. Their capital flows into the mortgage market. Are they also liars and cheats? Are they also liars and cheats?

Who is not a liar and cheat?
2.14.2009 9:32pm
K. Dackson (mail):
And what of the people who have taken their responsibilities seriously?

I have considered just abandoning my house and simply leaving the country, allowing other people to pick up the pieces. Including the cars, other credit, utilities, cable cell phones, and all the rest. Would I really do it? Probably not.

But if I am expected to contribute to the bailout of the deadbeats (through a higher tax burden, and higher costs for everything that the coming inflation is sure to bring), what is the disincentive to become a deabeat?

This is what special rules for the irresponsible make people who take their committments seriously consider.
2.15.2009 6:29pm
Elliot123 (mail):
"But if I am expected to contribute to the bailout of the deadbeats (through a higher tax burden, and higher costs for everything that the coming inflation is sure to bring), what is the disincentive to become a deabeat?"

This happened in Alaska in 1986/1987 when oil prices crashed along with housing. People just turned over their keys. I paid $100,000 for a house in 1981. In 1986 comparables sold for $34,000. I sold for $100,000 in 1991.

Nobody really cares about the irresponsible folks. Much of what is being done is to keep the inflated house values of the larger block of responsible people from crashing.
2.15.2009 9:33pm
Bruce Hayden (mail):
I think that markm has some of the best analysis here.

What he points out, that most above seem to have skipped over, is that if secured loans get crammed down, then the value of securing a loan decreases / the value of the collateral drops. If there is little difference between secured and unsecured loans, they will be priced accordingly.

Sure, in the short run, it might be to the advantage of the loan holders to allow cram down. But in the long run, mortgage rates are going to increase, in relation to other lending, since the risk of holding them has increased.

I think that maybe the better approach would be to ALLOW lenders and borrowers to agree to a reduction in principle, but not to force it on the lenders.
2.16.2009 12:06am
Bruce Hayden (mail):
One question that I have had concerns whether the government could offer cram downs of mortgage loans without incurring liability for the amount crammed down. They would essentially be abrogating the contract between the lenders and borrowers, and taking the amount crammed down from the lenders and giving it to the borrowers, without offering compensation. In other words, why wouldn't there be a Takings issue here?
2.16.2009 12:10am
Aleks:
Re: In other words, why wouldn't there be a Takings issue here?

Read the Constitution on this. The Takings clause refers to takings without due process of law. A proceding in a federal bankruptcy court certainly qualifies as due process. Creditors are, after all, able to lodge objections and plead their case, although in most personal bankruptcies they usually take a pass and let the judge sort it out. Moreover, all bankruptcies involves a loss of assets to the lender and the abrogation of the lending contract, yet the Constitution specifically enumerates bankruptcy law as one of the powers of Congress.
2.16.2009 9:38am
Aleks:
Re: Standards fell for everyone.

Yes they did. But this had little or nothing to do with minorioty lending. Note that the government's main lending mortgage program to low income borrower, the FHA, did not lower its standards one iota. If CRA lending had been the driver of this mess, you'd expect the FHA would have been leading the pack. Moreover the reduction in lending standards was worldwide, also occuring in other countries with homogenous populations and no affirmative action issues. What drove it was a belief in the mortgage industry that securitizaion was a magical elixir than could transform even the shakiest mortgage into a safe investment product-- and the fact that the business lending the money could imemdiately sell its mortgages to Wall Street and would not be in the line of fire if the mortgage failed --assuming the failure happened out in the future; there was usually a six month repurchase clause in these contracts and toward the end of the bubble mortgage companies began making too many loans that failed on first payment; hence the collapse of New Century and others due to a tidal wave of repurchases forced on them. Government's culpability in this disaster was the failure to properly regulate markets. But government did not force anyone to lower their standards. That was done quite voluntarily by people whose business model was instant profit over long-term stability.
2.16.2009 9:47am
Dan Weber (www):
What he points out, that most above seem to have skipped over, is that if secured loans get crammed down, then the value of securing a loan decreases / the value of the collateral drops.

If the bank has a $200,000 mortgage on a $80,000 house, it only has $80,000 of secured debt. It might have $120,000 of unsecured debt. (Or maybe not, if this is a non-recourse state.) Good luck trying to collect $120,000 during bankruptcy.

I'm a responsible homeowner, and my house has even gone up by 10% in the past few years since I bought it. But I think cramdowns can be proper, as they'll help the market find the correct value more quickly, but with less waste and distress than foreclosures. If that means it becomes difficult to buy a house without 20% down, well, good. We might have avoided the housing bubble if we had stuck with a 20% down culture.
2.16.2009 1:39pm
Elliot123 (mail):
"What drove it was a belief in the mortgage industry that securitizaion was a magical elixir than could transform even the shakiest mortgage into a safe investment product... "

Many things happened that were necessary, but not sufficient, to cause the mortgage problem. I agree the securitization was necessary, but it was not necessary and sufficient. Neither was the lowering of credit standards using CRA necessary and sufficient. These things all built on each other to provide an aggregate that was necessary and sufficient.

If we invoke ceteris paribus, we can show how each action that was taken did not cause the crisis. But, that's the hook. CP didn't prevail.

"If CRA lending had been the driver of this mess, you'd expect the FHA would have been leading the pack."

I doubt there is any single driver of the mess, and looking for it is counterproductive. We face a great danger here given the human tendency to simplify explanations. This is compounded by the equally strong tendency to deflect blame. Ten minutes ago I heard my congressman on the radio saying the mortgage crisis was caused by the Bush tax cuts.

"But government did not force anyone to lower their standards."

In 1995 Clinton and Rubin used the aggresive enforcement of existing banking regulations to threaten punishment for non compliance with their new interpretation of 1977 CRA. True, the banks weren't forced by legislation, but they were threatened with retaliation by regulators if they didn't. Again, a necessary condition, but not a sufficient condition. Not THE driver, but one of the many drivers.

Lots of people and practices deserve credit for the mess. Let's be sure to give everyone their fair share of the glory.
2.16.2009 1:42pm
ohwilleke:
First, "I see no reason to think the market has corrected itself."

I do:

1. Housing prices have fallen at unprecedented rates nationally and fallen most precipitiously in markets that had the most severe bubbles, like Las Vegas. Some of the earliest hit markets have seen prices stabilize.

2. The subprime mortgage market for all intents and purposes no longer exists (it is on the order of 99% smaller), and the Alt-A mortgage market has been virtually eliminated (it is on the order of 95% smaller). The vast majority of the top one hundred subprime lending companies are no longer in business.

3. New offerings of mortgage backed securities have come to a virtual halt. Every single free standing investment bank in the United States (these institutions largely financed the housing bubble) is no longer a free standing investment bank; Lehman Brothers, the most exposed of the lot, went bankrupt.

4. Mortgage originators and private mortgage insurance companies have tightened their underwriting standards in terms of down payments, documentation and creditworthiness, with stricter standards applying in markets most at risk of further price decline. Washington Mutual, the bank which had among the most lax mortgage underwriting standards, no longer exists.

5. New housing starts are at record lows, as are architectural firm billings. Construction company bankruptcies are numerous.

6. Foreclosures in some markets have hit a peak and started to decline again.

Second, keep in mind that cramdown is the norm, rather than the exception in bankruptcy law. You can still cramdown a loan on a vacation home, for example. Loans on primary residences and loans on "new" cars are pretty much the only exceptions to the cramdown rule, and the rule for new car loans dates only to 2005. Cramdowns are routine in Chapter 11 business bankruptcies.

When someone keeps a car and a house in a bankruptcy, despite not being permitted to cram down, essentially what is happening is that the debtor is affirming an unsecured debt that would have been discharged in bankruptcy if the property were surrendered, while other unsecured creditors get stiffed. Basically, this happens because a home or car is worth more to its current owner who often has a non-transferrable sentimental attachment to the property, than it is to the creditor whose interest is only financial. The contradicts that general principle applicable in a bankruptcy reorganization that creditors should receive no more than they would have received in a complete liquidation. The same general principle explains why there are exemptions in bankruptcy for items like wedding rings and family photos.

Third, the evidence strongly disproves the CRA as a meaningful factor. Loans that went bad came disproportionately from non-bank lenders not governed by the CRA. The timing of the enactment and enforcement of the CRA doesn't square with the timing of the bad loans either. CRA enforcement was weakening at precisely the time period when bad loan originations were picking up. Indeed, a more plausible interpretation of the data is that declining CRA enforcement caused banks to retreat from lending in poor minority communities, which increased the rate of poorly underwritten non-bank, mortgage backed security funded lending, which in turn caused the subprime collapse which caused the financial crisis.

Also, with respect to another canard, FHA exposure and involvement in the subprime collapse was at levels much lower than that of the private market, and comparable FHA loans have gone bad at considerably lower rates than non-FHA loans.
2.16.2009 6:10pm
Elliot123 (mail):

Housing prices have indeed fallen, but there is no evidence they have stopped.

Sub prime mortgages have stopped. They were not a downward pressureo prices, but were an upward pressure.

MBS have stopped. That doesn't support prices. It removes mortgage funding from the market.

Standards have tightened. That reduces the number of buyers which is not an upward pressure.

Housing starts are at a low. That is an upward presure.

Foreclosures in some markets have peaked. That doesn't indicate the market has corrected. It indicates it is in the process.

The CRA influenced an across the board drop in credit requirements. This applied to minority purchases as well as all others. It wasn't an affirmative action program.

When I speak of a market correction, I refer to a change in prices, nothing more. We should probably distinguish between the process of market correction and the bottom of that correction. I agree the market is in the process, but there is no reason to think it has finished. "Corrected" usually means it has finished.

The market has reformed in many areas, and you mention some, but that's not what is typically meant by a correction.
2.16.2009 9:03pm

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