Greg Mankiw links to a plan to sidestep these issues:
we propose legislation that moves the reworking function from the paralyzed master servicers and transfers it to community-based, government-appointed trustees. These trustees would be given no information about which securities are derived from which mortgages, or how those securities would be affected by the reworking and foreclosure decisions they make. Instead of worrying about which securities might be harmed, the blind trustees would consider, loan by loan, whether a reworking would bring in more money than a foreclosure.
The government expense would be limited to paying for the trustees -- no small amount of money, but much cheaper than first paying off the security holders by buying out the loans, which would then have to be reworked anyway. Our plan would also be far more efficient than having judges attempt this role. The trustees would be hired from the ranks of community bankers, and thus have the expertise the judiciary lacks.
This wouldn't cost fragile banks any more money than they've already lost, and would cut through many of the coordination and information problems currently plaguing the market. On the other hand, it wouldn't do what a lot of people want, which is to help people with unaffordable mortgages stay in homes above their pay grade.
As someone who works regularly with community banker, let's just say that Mankiw has a lot more faith in their ability to assess credit and repayment ability than I do.
Community bankers I deal with have far more knowledge of the local markets and a company's ability to repay than some bank that has to follow orders from, say, far away Charlotte. They have also tended to demand more security, including personal guarantees, that puts the kibosh on really wild development schemes (until, that is, the local development council steps in with guarantees subsized by the taxpayers.) Community bankers do, of course, have their favored friends in the political and real estate community.
Some creditors would still be worse off in this situation and may have grounds to sue as a government taking.
For example, a mortgage stripped into IO and PO components. A restructuring might increase the total mortgage value by decreasing the principal and raising the interest rate. That helps the IO and hurts the PO even if the total money of the two were increased.
it wouldn't do what a lot of people want, which is to help people with unaffordable mortgages stay in homes above their pay grade.
I am openly hostile to this idea. More foreclosures and short sales means lower prices and more bargains for buyers. Given that a return to historical norms is long-term inevitable, we may as well make it quick. That this will be to my own personal benefit does not, I'm sure, play any role in my thinking.
Why don't servicers have the authority, as fiduciaries, to modify or sell off non-performing loans if they judge that this would serve the interests of investors better than foreclosure? I'd be surprised if they didn't have this authority, but if they don't, I'd think the investors would be willing to give it to them.
Any government role in this should be limited to offering to buy first mortgages (at, say, a 50% discount to the face value of the mortgage or the current value of the underlying property, whichever is lower) from willing parties. The holders of the mortgages could decide whether to modify the loans, foreclose on them, or sell them. That might limit the moral hazard of borrowers deciding to stop paying their loans in the hopes of getting a workout, since they'd face the risk of foreclosure. Mankiw's government-appointed trustees would face political pressure not to foreclose on homeowners, and that would increase moral hazard.
Rob Lyman,
The more expensive housing is, the more politicians can buy votes by offering to make it more affordable (via cheap credit, lower down payment requirements, etc.); same with education. Notice a pattern? Government distortions increase costs of living, and politicians run for government on promises not to remove those distortions, but to add new distortions that will supposedly ameliorate those high costs.
I'm no libertarian, but I'd think libertarians would be on to this by now.
The government sure can. That's the essence of a cram down. The bank loaned out $400,000 on a house now worth $200,000 there is no way they are getting that extra $200,000 back. The only thing to do is figure out how to get back as much money as possible. If the homeowner can only afford a $100,000 house then the home goes to forclosure and the bank gets as much as it can. If the homeowner can afford 200,000 or 250,000 then they adjust the mortgage.
The government will kick in enough to keep the banks solvent and keep a 50% upside stake in both the banks' stock and the homeowner's equity.
The only choice the banks have is to accept the government's offer or fail, be taken over by the FDIC, and the new executives will accept the offer.
You could also say that the government can't force you to testify against yourself. That is of course true. But, what the Government can do is offer you a plea bargain. Plead guilty and testify against your accomplices and we'll send you to country club jain for 2 years. Don't cooperate, and if we convict you, we'll send you to real jail for 20 years.
The banks will be, in essence, offered a plea bargain.
creech, I think we are only talking about residential (1 to 4 family) mortgages. There haven't been waves of defaults on the commercial side nor complaints about the inability of servicers to respond effectively.
DaveinHackensack, I think servicers do have the kind of authority you suggest, but (i) they are worried about being sued and (ii) they got the job by being the low bidder, so they have no incentive to work too hard. All this plan does is appoint someone new to do what the servicer should be doing and give them (i) stronger legal immunity and (ii) compensation appropriate to the task at hand, given an unforeseen level of defaults.
BTW, part of the problem for servicers right at this moment is that everyone is waiting to see what government programs/assistance might become available. Even Greg Mankiw or Megan McArdle would have trouble advising a borrower or a servicer as to the optimal course of action right now, given the uncertainty.
Why don't servicers have the authority, as fiduciaries, to modify or sell off non-performing loans if they judge that this would serve the interests of investors better than foreclosure?
Some might, others might not. It depends on exactly how the transaction was structured, and there are lots of people doing it different ways.
Cramdown happens every day in bankruptcy court. All it would take is a simple amendment to the bankruptcy code to allow this to happen with residential mortgages as well as commercial security interests.
Regulatory taking? What is the value taken? A deficiency claim against the borrower, after the foreclosure for value less than the debt, and when the debtor's unsecured claims are almost certain to be discharged in a bankruptcy?
The value taken is zero; there is no taking. Thbis is an absurd argument.
Megan:
Could you possibly work less hard on this issue? Do you even check Calculated Risk any more?
First, this proposal is about the fifth to come up that assumes the creation of an army of skilled loan officers in the next 180 days. As you would know if you read CR regularly, that ain't happening. Also, if you're going to claim any expertise in this issue, why not actually look into the powers of the servicers and the trusts? Is actual research beneath you?
Second, this "many Democrats" schtick is getting extremely old. Yes, there are loony proposals on the left. But look at even (formerly) respectable sites like Volokh and you'll find a parade of comments about the evils of the CRA, Fannie/Freddie, and govt regulation. There are plenty of Republican voices that seem to be calling for a return to the 1890s.
Third, the cram down issue is complex and worthy of far more serious consideration than you give it. First, that power only arises in bankruptcy, which is probably worth noting. Second, many other debts are subject to cramdown. I'd love to see the literature on the effect of the cramdown power on the availability and price of credit that is subject to cramdown. Third, if the judge is limited to cramming down the debt to the currently appraised value of the house (which is one of the proposals that's been kicking around) as opposed to the ability to pay, then how is the bank worse off?
One of the big problems in the California market is that many of these homeowners can't afford the house with a standard 30 year fixed even at today's prices. The second problem is there are still a lot of speculators that own multiple houses, but can't pay the mortgages on them. I'm sure banks would love to get people into fixed rate mortgages they could afford that is insured by the FHA, but the reality is that most of these people can't afford a house payment on a home at current market rates.
I assume all those people saddled with huge frackin' mortgages that will bleed them dry for the rest of their natural lives will have to actually default before they go before the trustees?
The problem will work itself out. Empty houses bring in no income and prices are low, so there is incentive to compromise for all parties. The only remaining thing that needs to happen is the government stepping back and saying "We're done with the bailouts, hope they helped, good luck!"
On the other hand, it wouldn't do what a lot of people want, which is to help people with unaffordable mortgages stay in homes above their pay grade.
Being someone who is in a home below my pay grade (about 1/8th of my household income goes to mortgage payments), I am actively opposed to this. I lived responsibly, yet the Feds want me to help with bailing out people who don't?
It's this type of behavior that encourages people to not grow up.
I'd be interested to know how they'd account for the network effects of multiple (potential) foreclosures in the same neighborhood.
Plead guilty and testify against your accomplices and we'll send you to country club jain for 2 years.
Is *that* what they call those hookers who prey on rich white men now? Country Club Jain? Pretty degrading, if I do say so myself.
I don't believe that the servicers have a fiduciary duty, they are just the servicers. Usually, there is a another entity that is the manager of the pool of mortgages, that acts as a fiduciary.
Another issue is that servicers have top priority claims against the mortgage pool and would be the first to benefit from the sale of the mortgages. These claims arise as the servicer will sometimes forward payments to the security holders before they have received them. In a non-performing pool, it is possible that they have extended themselves farther than they should have and thus have a first-priority claim against the mortgage pool.
I'm not sure how selling the non-performing loans helps the borrower, unless the purchaser is the government. What price is the government going to buy these assets at? This is one of the problems with the TARP. Many people will have a problem if they pay par as then you are rewarding the banks for making terrible loans.
I'm not sure i see the downside to letting the bankruptcy courts handle this, pending the needed changes in regulations. Those judges can handle it, and it would require the borrowers to declare bankruptcy.
Given that in foreclosure most lenders get back around 40-50 cents, any cramdown that is not at that level is desirable, i would think. Also, there is a vicious circle effect as more foreclosures in a given area beget lower property values, which hurts the banks even more as they own the real estate following a foreclosure.
I would like to ask a question about the cram down opportunities with respect to the large number of underwater mortgages. I suspect these present a much greater stability risk to the system than do the foreclosures,since there are far more of them and anything done for the foreclosure-prone is likely to trigger action by those who are under water but still paying.
I am under the impression that most of the mortgage backed securities were actually issued by trusts that purchased the mortgages and then sliced up the risks. Now most of the trusts are probably paper creatures of banks, to be sure, but they are ostensibly independent entities.
I am further under the impression that there are no clear models that accurately project the long term payment streams for the mortgage components in the individual trusts,since there is very little public information available on the payment performance on individual mortgages that allow one to build predictive models across a group of trusts.
It would then seem very difficult for the government to come in and impair the payment streams to the trusts without having to answer for the future liability of the trust to its debt holders. It may well be the case that the government can try to argue that it is doing nothing more than reducing the outstanding mortgage to some percentage of the actual sale price of comparable houses and that it is not destroying any real value that can be realized. But how can it make that argument in the absence of a generalized mortgage payment model that is acceptably predictive of the long term payment stream?
After all, the trusts are only interested in the payment stream and how it will allow responsibilities to the debt holders to be met. I would think the trusts would immediately step in to sue if any effort at a cram down were attempted in the absence of any predictive evidence that there was no long term future for the trust.
Much is said about the master servicers and the originating banks, many of whom do have some bounce back responsibilities to the trusts. But there is very little discussion of the various trust structures that are out there and which are more able than others to work through the problems being presented.
Of course, it would be best for all concerned if we had a program or programs that eliminated,through occupancy or demolition, of the enormous overhang of vacant houses, which is still well above historic levels in both the newly-built and used-housing market. Prices cannot stabilize until the vacant house pool is reduced to or below historic levels. A target of 'well below historic levels' is really what we need.
"I'm not sure how selling the non-performing loans helps the borrower, unless the purchaser is the government."
It helps the borrower if the purchaser then attempts to modify the loan. That's what some private sector entrepreneurs are already doing, e.g., Robert Lee, of Foreclosuretrackers.com in Southern California. Here's how he explained it to the O.C. Register a few months ago.:
In that example, he's buying the mortgage from a bank, but the same workout process would make sense for a buyer buying a non-performing mortgage from the servicer (or other entity) that acts as the fiduciary for the investors in a security derived from mortgages.
When I hear terms like "community-based" and "government-appointed" I cringe
I have spent considerable time looking at mortgages and I'd say that - in California at least - about HALF of troubled mortgages are to:
-investors who did not live in the house
-straw buyers in Frauds
- buyers in Home Builder frauds (true victims)
-cash-out refis by 75-85 year olds who gave the money to their kids
- liars who drastically overstated their ability to pay (service) the mortgage because they hoped to either flip or refi
Should such people have their debt crammed down? put on a drastically "liberal" payment plan?
I would rather the investor in the mortgages take the hit on foreclosures. The market in the worst parts of CA is actually starting to move again since the houses are discounted so deeply. (Not really even discounted, but sold at a reasonable price. These "$850,000" houses really should sell at $350K, that's all they are worth and pretending it ain't so will not help. solve the problem
This plan is worthless. I would say it raises more questions that it answers, but really it doesn't even try to answer any of the obvious questions raised months ago.
Here's a quote from the plan:
"The rules governing the trustees must ensure that only homeowners in true financial distress qualify to have their mortgages reworked, so that homeowners do not see the program as a free ride to a cheaper mortgage."
There you go. The trustees will do this while mounted on unicorns, no doubt.
Sorry, there was a typo in my post. When i said
"I'm not sure how selling the non-performing loans helps the borrower, unless the purchaser is the government."
It should read "... helps the lender ...". Basically, the lender can take a hit by selling the loan or refinancing it at a lower principal amount. Likely these are fairly close in value to the lender and if we want to support the banks, it would likely be best not to let someone else come in to make the vig, as in the example you provided.
The reason i said it really only helps the lender is if the gov't comes in it is because they are the only ones who will pay up and take the hit on the refinancing. Then of course, all of us taxpayers take the hit on buying a mortgage at par that should be 50c.
The other problem with cram-downs is that it will lead to higher mortgage rates in the future. Lenders will need to charge higher rates to compensate them for the risk of getting future mortgages crammed down.
"Likely these are fairly close in value to the lender and if we want to support the banks, it would likely be best not to let someone else come in to make the vig, as in the example you provided."
The lenders, or the investors who currently own the mortgages, ought to have the right to sell the loans, modify them, or foreclose on them as they see fit. In the example I provided, the entrepreneur is buying the mortgages from willing sellers. Sometimes it's quicker and easier to sell loans and let someone else try to make a vig by modifying them than it is to try to yourself.
Here are some graphs that depict an illustrated history of stock market bottoms, and comparisons to where we are today.
How is this not also a taking?
Do you really think that putting community bankers in charge of loans is the way to get banks to reduce, for example, principal? Or is that the same as putting the fox in charge of the henhouse?
There is no way to solve the housing crisis if the crisis is defined as "banks are foreclosing on defaulters." That's how the system is designed to function and it won't function if you attempt to change that aspect of it.
Banks simply won't lend mortgage money if they are going to be prevented from using foreclosure as a stick. Attempting to solve the "foreclosure crisis" merely creates a "credit crisis."
The crisis is actually not foreclosure ... its value. The underlying value of our homes has been allowed to be deteriorated. It is simply a matter of the law of supply and demand.
If you build more houses than the market can support, home values drop. And yet, it has occurred to nobody that the solution is to regulate the number of homes, a solution which has the benefit of costing the taxpayers nothing.
By the same token, if you allow illegal aliens to borrow money from our banks, then you are just an idiot, since those illegal aliens can be rounded up and deported at the drop of a kosher Iowa chicken.
When the demand of buyers is suddenly deported, the value of homes drops. So, illegals shouldn't be allowed to borrow in this country to prevent their demand from skewing the market.
If we temporarily ban the construction of new homes, and lend only to citizens, home prices will rise, home equity will return, spending will jump, creating millions of jobs. It is the least-cost solution to the taxpayer.
What exactly is wrong with having people who over-borrowed losing their home? They borrowed the money and now they can't pay it back. These people should lose their home and move in with their relatives or rent something they can afford. Home ownership isn't a right (at least not yet).
What exactly is wrong with banks that made bad loans going bust? These banks should all go out of business -- why should the taxpayers have to put good money after bad to keep bankers who have demonstrated their bad judgement in business?
None of the solutions mentioned on this page are a true cram down. The real cram down happens on the courthouse steps when properties are "marked to market" in a public auction and an arm's length fair market value is set. If you "own" the home, you can go make your best offer at the auction -- of course if you have the money to bid, you should be paying your mortgage.
Any other solution continues the fraudulent Ponzi scheme -- the people who played by the rules, worked hard and saved should not have to subsidize the bad actors. Doesn't removing this kind of moral hazard encourage more of this bad behavior in the future?
This happens every day in bankruptcy court. I am there 2-5 times a week - and the bankruptcy judges, chapter 7 and chapter 13 trustee's are not dupes. They will sniff out hidden assets, scrutinize budgets, review tax returns and statements of current income. The self-employed have to provide bank statements and other proofs of income. Futhermore, creditors get noticed for everything - and they have a vested interest in making sure the trustee knows about "undisclosed" income, assets or other important facts that may have been inadvertently or purposefully not listed. So why not use this? Because then the bureaucracy of the lenders would have to not just shift blame around. Hey, of course we are liquid - we have $XXX billion of loans! Yeah - might as well have a vault full of Zimbabwian money - that'll be worth.....nothing.
So the borrowers stop paying - spend money on loan modifications that go no-where- and the properties are foreclosed and get tossed on the pile of other repo's homes. And bargain hunters? Chill - the bank has no interest in "giving" away these assets - that would involve making a decision - which is anthetical to a bureaucracy.
Concerned Citizen,
You wrote: "What exactly is wrong with banks that made bad loans going bust?"
Here is what is wrong with it: The government FORCED those banks to make those loans. Left to their own devices, no sane person would lend money for example to an illegal immigrant. Why? Because that immigrant can be deported at any time.
Yet. Our government requires that banks lend to illegal aliens. Banks are legally prevented from refusing to extend credit based on citizenship.
So, the government forces banks to lend irresponsibly. When they do that, they shouldn't be allowed to "go bust" when the bill comes due.
Our Democrat-controlled government is the problem.
Syndicated mortgages (most of them) have been chopped into little pieces. There is no "bank" that holds the loan, and that would therefore take the haircut. Which piece owner gets to be the lucky winner, or do they each take an equal share? How do you compute equal when one bought the interest rate risk and one owns the default risk?
And what if there's a second or a third? Who takes the hit then?
I think you mean, "stay in homes that USED to be above their pay grades."
"Concerned Citizen,
You wrote: "What exactly is wrong with banks that made bad loans going bust?"
Here is what is wrong with it: The government FORCED those banks to make those loans. Left to their own devices, no sane person would lend money for example to an illegal immigrant. Why? Because that immigrant can be deported at any time.
Yet. Our government requires that banks lend to illegal aliens. Banks are legally prevented from refusing to extend credit based on citizenship.
So, the government forces banks to lend irresponsibly. When they do that, they shouldn't be allowed to "go bust" when the bill comes due.
Our Democrat-controlled government is the problem."
Thea above is ABSURD. A bank is not allowed to make race-based discriminatory lending decisions. However, all bakns can, should, and will, make lending decisions based upon thier belief regarding: (1) the borrower's ability to repay, and (2) the value of the underlying collateral.