I want to revisit the notion, now popular in my comments and emails, that mortgage cramdowns are good because they force banks to value the houses securing their mortgages at true market value.
This is very odd because, first of all, that's not really how mortgage accounting works--banks don't mark houses to market, and a very good thing, because their balance sheets would have been puffing up like blowfish for most of the decade. They very sensibly do not do this because in a rising market, they are unlikely to get their hands on a house in foreclosure to sell at a profit. So what they look at instead is the potential cash flow from the mortgage.
In a falling market, of course, they are much more likely to end up with the house, and the loss. But what matters is still not the absolute size of the change in the house's value; it's how that affects your future cash flow. We don't want to just write down every mortgage bond by how much the price of the underlying houses has fallen; we want to plug that change into our model, which will increase the losses we have to allow on each default.
But here's the thing: even if we get a more accurate picture of how much each default is going to cost us, we still don't know how many defaults we're going to have; that depends on a lot of other things, like whether the homeowner could ever afford the payments, whether they lose their job, and how willing they are to torpedo their credit rating in order to get out from under an overpriced mortgage.
Nonetheless, it wouldn't be a bad idea to get a better handle on the value of the houses securing these mortgages, forcing the bankers to increase the allowance for bad debts. But the other problem with this notion is that rewriting the bankruptcy code does not achieve that laudable goal. It writes down the value of only some houses--the ones where the owner is willing to declare bankruptcy fairly immediately. And it writes them down completely--new interest rate, new principal. We're not forcing banks to recognize the potential losses on these mortgages; we're forcing them to take the actual loss. Meanwhile, all the loans where the borrowers haven't declared bankruptcy remain on the books at their original value, representing a larger potential loss than our models currently allow.
Let's remember, too, that the possibility of a one-time-only cramdown of your underwater mortgage makes bankruptcy more attractive. That means we'll get more of them. Customers who might have surrendered the house in foreclosure will take them, but so, probably, will marginal borrowers who are simply struggling, who might have sent the wife back to work or gotten a second job. Suddenly, bankruptcy isn't just a way to get your monthly debt service down to a manageable level--it's a way to substantially improve the net asset position of the household, by tens or hundreds of thousands of dollars. People talk about feeling like they're idiots for not just mailing in the keys and walking away, but when you do that you end up with nowhere to live and a gigantic crater in your credit report. With cramdowns, you take a big ding on your credit report, but you get to keep a house, and any future appreciation, in exchange.
To sum up, the cramdown doesn't solve the problem of unknown risks lurking on the balance sheets. Meanwhile, it turns potential losses into real losses, and probably increases them, because Chapter 13 is now definitely a much more attractive option than foreclosure, and possibly a more more attractive option than continuing to make your payments. It forces us to recognize losses in the banking sector, yes--the losses you just created by government fiat.
Copyright © 2009 by The Atlantic Monthly Group. All rights reserved.
That's a weird argument for people to make and I'd actually be sort of interested in seeing the emails (I'm not seeing much in the commentary below that's coherent that tries to say banks should value by the market).
"you get to keep a house, and any future appreciation, in exchange."
Since you appear to be reading comments perhaps a third time mentioning it is a charm: What about a LIEN on the property to compensate for future appreciation until original principal is realized? 50/50 splits, increasing the principal over the next five to ten years as things improve, anything like this....
Because you can't slap a lien on "all future appreciation", and also, it's not in the bill.
If you allow a mortgage cram down you will see a flood of people who can make their payments but want to get their mortgage down to market level.
There is no requirement that a car payment has to be a hardship to do a cramdown, for instance. You just automatically do it if you can. Same with houses.
I think the effect of being able to cram a mortgage would be similar to what would happen if student loans were dischargeable... a flood of people filing (bankruptcy lawyers would be handing out fliers at graduations); and really the credit score isn't the real reason people don't declare bankruptcy. They don't do it because of social stigma and embarrassment. The damage to your credit is not as big a deal as people think. It's all mostly stigma.
And if there is a flood of bankruptcies, that will reduce the social stigma. Sure, its a bit embarrassing, but everyone is doing it and it saves me so much money!
I’m not sure I can see the difference in the ultimate loss on a cram down vs foreclosure, though there could be some issues on timing of the loss. It seems the only two choices for underwater/insolvent households will be bankruptcy, in which case there is a loss to the lender on cramdown, or they send ‘jingle mail’ to then lender and walk away. In theory, whether the judge crams down to “market value”, or the security is sold as REO at "market value after getting jingle mail, the loss SHOULD be the same. Granted, there is an argument a judge may cram down to too low a value. However there are costs to hold REO (maintenance, insurance, etc.) and I don't think banks necessarily do a better job of selling eg by definition REO does not involve a willing seller & there is a real reason that historically buying REO from banks was a good investment.
Also, as I understand in bankruptcy there is still a need for a repayment plan for, at least a portion, of the unsecured creditors in bankruptcy (the underwater/crammed down is unsecured) so you don't necessarily get off scot free. If this payment amount is greater than zero, the only people that will go to bankruptcy will be those who really want to keep that homes (say they want to keep their kids in local public school). If I don’t care about keeping the home since I can rent the house cheaper than owning, then I will send in the jingle mail to the lender since I don’t have to come up with a repayment plan and my credit is equally bad in either case.
Granted some may abuse bankruptcy, but that isn't a new risk. But, given the need to develop a repayment plan in bankruptcy, I think the number of people that will subject themselves to that, vs sending in jingle mail, is not necessary that large a population. People that borrowed 12x their income and getting crammed down to 9x aren't going to be helped in this.
Everybody would know exactly what everything was worth if it wasn't for the bailouts! Hold onto your bad paper, or sell it on the open market for what you can get for it, whatever suits you best. But now people can and will wait, for years, to see what they can unload it on the government for!
If you allow a mortgage cram down you will see a flood of people who can make their payments but want to get their mortgage down to market level.
That's why they must go before a judge and plead their case. Judge takes a look at their finances and sees that they can make the loan payments so he doesn't cramdown the loan.
To explain what banks aren't marking to market, it's the mortgage backed securities they hold. Cramdowns will force them to mark the securities to market, since it will be harder to be in denial just how much they'll receive in payments. The sooner the banks get their books in order so investors start trusting them again the better.
I think there's a tragedy of the commons argument in favor of some type of cramdown. For an individual mortgage in default, foreclosure might be the best option for the bank. Because the bank has decided on foreclosure, the homeowner decides it's not even worth the effort to make partial mortgage payments. As a result foreclosure goes forward full steam ahead.
With a lot of foreclosures at once, though, all the banks loose because instead of recovering a large portion of the lost mortgage in auction they get nothing. Meanwhile the collapsing home prices make all the other loans they are holding more risky. With cramdowns, though, you get fewer foreclosures which means the ones that do go to foreclosure don't contribute as much to falling house prices and allow the banks to recover more of their loss than they would otherwise have.
The trick is to make cramdown available as an option but not so easy that the millions of homeowners who are making their payments without cramdown jump at the opportunity. I think having to file for bankruptcy is a good way to limit cramdowns to cases where the homeowner wants to keep the house, will make a good faith effort to make payments but just needs to make a lower payment. You can have a lein option so that a cramdowned home cannot be sold at a profit in the future without paying off the original mortgage.
Step back a bit. I think everyone is in agreement that real estate has been vastly overvalued and that it needs to return to somewhere where it was in the mid- to late-90's. What's that, a drop of anywhere from twenty to seventy percent?
So. Someone has to eat the difference. And I think we are all agreed on that as well. The question is, who? It seems for a variety of reasons that it should be the lenders. But let's say it's the homeowners. What happens then? Well, there's a wave a foreclosures where the property reverts back to . . . somebody, but I think it is safe to say that these properties will somehow find themselves back in the hands of the various banks.
Who, by some strange coincidence, also appear to be getting some rather hefty bailouts with not much in the way of concomitant concessions(sorry.) So the upshot seems to be - what Megan is advocating - is that the banks get to have their cake and eat it too.
Myself, I think that cramdowns are a good solution, and that zombie banks should be 'nationalized' for some value of nationalization. But if worst comes to worst, I'll forgo the cramdowns if banks are then subject to heavy-handed federal oversight and, somewhat reluctantly, vice versa. But there is no way can anyone argue that banks getting their properties back, being bailed out, and not being nationalized is anything but a very, very good deal for the institutions responsible for this mess in the first place.
How in the world is this the best, or even a sane option? I'll hold off on the usual "Well, if you're a libertarian . . ." until the usual brain dead responses get made.
This is exactly right, imho. And why I think that for this to really work, Obama would have to appoint some sort of 'Cramdown Czar'(Why not? We seem to have so many Little Fathers already.)
Yes, the stipulation needs to be made that certain groups of people don't get this option. If you're living in the house as a homeowner, and you actually have a chance at servicing a reasonable payment schedule, sure, investigate the possibility of a cramdown. If your property was purchased with the intent of flipping it, that is, as a speculative venture, well, no, you don't get a chance to get out from under. You were acting as a businessman taking a business risk. The same for people who are carrying impossible levels of debt, or whose mortgage, even under a reset, would consume forty or fifty or more percent of their take-home paycheck. I feel bad for some of this latter group, as so many of them would seem to be people who are the most vulnerable to predatory lending, but I really don't have a good solution to deal with this particular problem.
What never seems enter the discussion is the difference between a legitimate mortgage and what banks started pumping out over the last decade.
0% down with cash out, optional payments, stated income and ARM's that adjust to extortianate rates were not legitimate mortgage terms, they were methods of making property into gambling chips. If a financial institution entered into or bought such a contract they've lost their bet and it's time to pay up. If a financial institution issued securities or insurance based on those contracts they've lost and it's time to pay up. Same goes for the homeowners who got the contracts. The fact that Alan Greenspan was touting for ARMs, SDOs and CDOs makes the federal government complicit in the fraudulent contracts. If you have a legitimate mortgage you should have to honor it or lose it, but if you're a party to the fraud the government (court) has every right to determine a proper dispersion of the losses between the parties to the fraudulent agreement.
"predatory lending"
"If a financial institution entered into or bought such a contract they've lost their bet and it's time to pay up."
Obvious leftist bias - "blame the business".
A more rational way of viewing this would be
"predatory borrowing" and
"If a home-buyer entered into such a contract they've lost their bet and it's time to pay up."
And before somebody accuses me of being pro-banks - I don't like banks or bankers and avoid doing business with them as much as I can. Partly because they are so heavily regulated by governments.
"If a financial institution entered into or bought such a contract they've lost their bet and it's time to pay up. If a financial institution issued securities or insurance based on those contracts they've lost and it's time to pay up. Same goes for the homeowners who got the contracts."
Well, OK, Fine - it's time for everyone to pay up. But this doesn't advance a solution. If you bought a house and can't pay, you get foreclosed on. The bank gave you a COLLATERALIZED loan - if you don't pay, the collateral gets sold to satisfy your debt.
With a mortgage cramdown, the borrower says that he/she can't pay and therefore, the ammount they owe should be reduced - that's lunacy. So we're saying that you shouldn't satisfy the agreement that you've already made. Buying a home is not the same as buying an option on a home.
But the real trouble with mortgage cramdowns is its affect on AAA mortgage securities. Cramdown legislation has the potential of making "money-good" mortgage bonds downgradeable to "junk" due to quirks in their structures. A AAA bond that takes a $2 hit because of this legislation would be downgraded to CCC or lower because it took a "principal loss". This could lead to banks & other fin'l institutions not being adequately capitalized (read: more massive bailouts and/or less lending).
But the real problem from my point of view is: what incentive does a bank have to lend if it knows that a judge can tell you: "Well actually, even though you thought you were getting back $400,000, you're really only getting back $300,000 -- And you're going to like it!" Or alternatively, rather than loan 80% of the value of a house, maybe they'll only loan 60% ande make you come up with the other 40%.
Cramdown sounds great for politicians trying to drum up votes from the little guy but it makes no logical sense. No one forced these people to buy houses. Imagine for a moment that these people paid cash for their house and a few years later they realize that their house went down in value - should they be able to go back to the seller and ask for a refund? That's in effect what they are doing to their lender. But somehow this is different and this should be OK?
Foreclosures are a real problem but messing with contract law is not the best way to go about solving the matter.
/rant
I suspect in the cases of a large number of mortgages now, probably increasing proportional to the interest rates charged, that it has become practically impossible for the creditors to prove that the debtor owes them the money. Given that mortgages have been bought, sold, bundled, resold, etc, XYZ either cannot prove, or cannot afford to prove, that A owes them a certain sum. So the debt is effectively unsecured. Allowing cramdowns must necessarily expose that situation. This is not the case for a homeowner who financed with, say, a small town S&L that kept the mortgage and can easily prove what it is owed. I know a property manager who has resorted to stopping payments on some houses just to see who will emerge from the cloud in which these contracts exist to squawk.
We need a solution to foreclosed homes standing empty all over the country, many now owned by a system rather than an entity. People should be living in them. I don't think allowing cramdowns in Federal legislation would be about punishing bankers further, since the markets have already effectively done that job. It would preserve many families in their homes, merely be requiring creditors to exert their claims.
Why not?
Sure, there might be some individual cases where this lien is inapplicable. And so they can't get the cramdowns.
(To be specific, a lien which gives the lien holder access to M% of the appreciated value over the next N years.)
It seems quite simple:
Insofar as cramdowns successfully substitute for foreclosures, everybody is better off, since a cramdown is equivalent to foreclosing+reselling, but with less pain, trouble, and lost resources for everyone involved.
Two scenarios for non-success:
1) Lots of people jump on the BK + cramdown bandwagon, who wouldn't otherwise be foreclosed on.
2) Lots of people who get a BK + cramdown end up being foreclosed on anyhow.
1) - No idea how willing people are to accept BK and if this would get past the BK judge. Why should we think that the crater in your credit record represented by BK is attractive to people?
2) - No major loss to the bank here. Maybe they even got a few extra months of payments.
It seems like a win-win to me, if the chaos of foreclosure can be successfully avoided in a substantial number of cases.
But the real problem from my point of view is: what incentive does a bank have to lend if it knows that a judge can tell you: "Well actually, even though you thought you were getting back $400,000, you're really only getting back $300,000 -- And you're going to like it!" Or alternatively, rather than loan 80% of the value of a house, maybe they'll only loan 60% ande make you come up with the other 40%.
Alternatively, it could dissuade bankers from underwriting a mortgage that was risky because the underlying asset value and borrower finance, regardless of the payout to the bank, loan originator, et. al. being sufficient to override their cupidity and/or pander to their greed, was insufficient to actually cover the risks of the loan.
It takes many to tango, but the music to dance was being supplied by the bankers and their MBS.
I made a comment on the earlier thread that I should have realized would be seen as supporting cramdowns. My actual point was that mortgagers and mortgagees who entered into ARMs collateralized at full or greater than full market value of the property at the time of sale weren't just taking a risk, they were making a high stakes gamble which they have already lost. The difference between the parties is the "homeowner" has no investment to lose. So if a judge were to cramdown he'd have to guess at a value and would probably err to the high side. The bank takes a loss now that is likely less than what it's going to take anyway, the neighborhood avoids an empty and deteriorating property, the financial system has an asset that can be presumed to have some predictable value rather than an unknown liabilty, and those institutions that hold to much in that market fail. Oh, and some folks don't have to figure out where to move to. All the government actions so far have encouraged institutions to delay identifying their losses so they can appear sound enough to get a handout or possibly sell them to the country for much more than the underlying worth.
But the real problem from my point of view is: what incentive does a bank have to lend if it knows that a judge can tell you: "Well actually, even though you thought you were getting back $400,000, you're really only getting back $300,000 -- And you're going to like it!" Or alternatively, rather than loan 80% of the value of a house, maybe they'll only loan 60% ande make you come up with the other 40%.
Yes but the situation is more like this:
You thought you were getting back $400,000. If you foreclose now maybe you'll get back $150,000 in a year or so after all the costs and auctions and the house sitting on the market for months is done. If you don't foreclose you may get nothing because the homeowner may just stop paying. Clearly the option is foreclose.
Now what if you and other banks hold off foreclosing some (not all) of these loans. Then they may get back $250,000. This is a better option but to obtain it it isn't just a matter of taking a hit on one particular mortgage but getting a lot of your competitors to do the same....and at this point many of the bankers who have to make this call are worried about their jobs, bashed every day as the cause of the financial collapse and being worked to death....all because they've been too loose.
Because you can't slap a lien on "all future appreciation"
Why would that be necessary? The lien would simply be the amount of the cramdown. If the person tried to sell the house after getting a cramdown, the mortgage holder would have the right to exercise the lien to recoup their loss.
According to marketwatch yesterday:
" Lawmakers included a provision that would require a borrower that sells his or her home within one year of having a mortgage modified to provide 80% of the appreciation to the lender.
The bill has a similar provision that would give lenders 60% of any appreciation of a home sold in the second year after the mortgage is modified by bankruptcy judges. "
http://www.marketwatch.com/news/story/court-mortgage-modification-bill-passes-house/story.aspx?guid={BB747EF3-D3BF-4A8F-AA44-60896B90F246}&tool=1&dist=bigcharts&
So it appears that one of Megan's objections is being taken care off in the legislation.
Hate to be a pest, but now can Megan comment on the effect of the LIEN-like provision?
I'm expecting it will have little impact on her argument since she resisted acknowledging this simple obvious win/(mostly)win provision.
I just can't see myself thinking it's okay if my neighbor and I both got $500k/6%/30yr mortgages and he gets a court ordered cramdown to a $350k/5%/30yr mortgage. Especially if he doesn't sell and 10 years from now he's got lower mortgage payments and more equity in his home than I do because he went into bankruptcy and I didn't. He would paying less principal and less interest (even if the interest rate isn't lowered in a cramdown, the interest would be on lower principal) with each payment. If his financial situation as improved enough, he could pay extra principal each month so that his total payment is the same as mine, but he'd payoff his mortgage earlier.
Hate to be a pest, but now can Megan comment on the effect of the LIEN-like provision?
I'm expecting it will have little impact on her argument since she resisted acknowledging this simple obvious win/(mostly)win provision.
I don't think it's an obvious win/win if:
- the borrower does not sell within the 2 year window mentioned
- the home is eventually foreclosed anyway
-the borrower sells within the 2 year period but the amount he keeps is more than the bank would have made if they foreclosed and held the house for that same period before selling
Also back to the neighbor factor:
my neighbor and I both got $500k/6%/30yr mortgages and he gets a court ordered cramdown to a $350k/5%/30yr mortgage.
In a year, if my neighbor sells for $425k he splits the "appreciation" with the bank. If I sell for $425k...
The change in the law is meant to encourage lenders to negotiate workouts preemptively so that borrowers can avoid BK. If lenders know that they can be crammed down, they should be more motivated to get off of their capital-hoarding backsides and cut a deal in lieu of dealing with the court system.
In large part, this is an indirect way of dealing with the servicer-agency problem inherent to mortgage backed securities. Traditionally, the relationship between lender and borrower was straightforward, but the MBS market has created borrowers consisting of multiple parties who have conflicting incentives that often run counter to each other. These conflicts promote foreclosures even when the valuations should dictate otherwise, because foreclosure is often the easiest way for the servicers to comply with their servicing agreements.
The real-world value of the average homeowner has been compromised by this game of financial chicken. By allowing lenders to hide from their problems and pursue legal actions when they make little sense, the little guy who isn't in foreclosure is being harmed. The borrower getting the cramdown is an accidental beneficiary of the process. The real winners are those who benefit from putting a floor on real estate values, a group that is ironically dominated by the very banks and securities holders that are invested in mortgages.
The real winners are those who benefit from putting a floor on real estate values
Why are we so eager to prop up inflated real estate values? I'm still waiting for them to drop to within reason so I can get a place.
I don't have any strong opinion on cramdown, but everything seems to come back to reinflating the housing bubble, which is not a good thing.
Why are we so eager to prop up inflated real estate values? I'm still waiting for them to drop to within reason so I can get a place.
They're trying to prevent a collapse of the banking system and the consumer economy. A cyclical correction is one thing; a deflationary death spiral is something else entirely.
In the long run, you would also be better off if the market bottoms out. If the banks fail, there wouldn't be anyone to provide you with a mortgage, anyway...
If the banks fail, there wouldn't be anyone to provide you with a mortgage, anyway...
I have a big wad of cash from the sale of my last house. If nobody can give mortgages, the only people buying will be me and the goldbugs. That's what I call a buyer's market!
"They're trying to prevent a collapse of the banking system and the consumer economy. A cyclical correction is one thing; a deflationary death spiral is something else entirely."
If a mortgage is held in a Mortgage-backed security and that mortgage's principal gets reduced via bankruptcy cram down, those losses are spread out to all classes within the deal meaning not only the lowly rated BBB tranche (the "first loss" piece) takes a hit, but so does the AAA tranche as well. Even if it's only 50 cents of a loss, or a couple hundred bucks, the AAA bonds which might otherwise be just fine get downgraded to below investment grade forcing all parties that hold them to mark them to market, take write-downs to their capital and (drum roll please) either raise capital or get more bailouts from uncle sam. SO while it's nice to crow about saving the financial system, the unintended consequences of Mortgage cram-down could do just the opposite of saving it. Banks would not lend knowing that their contracts could be voided by bankruptcy judges. It's a slippery slope when the rule of law is just thrown aside for political expediency. There are plenty of ways to keep people in their homes without cram-downs.
Getting away from that - it's shocking see such complete and utter disregard for contracts & contract law. SO even though a homeowner agreed to pay $400k to a bank, now that they can't they're entitled to have their principal amount reduced? And I noticed that no one answered my question - if i paid $400k in cash for a house, and now my house is only worth $300k, am i *entitled* to go to the person who sold me the house and ask for the difference? How is asking a judge for your money back any different.
The unintended consequences for going down this path are immense, but people don't seem to understand the avalanche of downgrades that could follow from this if it becomes widespread. The only saving grace is that there aren't that many chapter 13 bankruptcy judges so the speed with which these things could be done would be pretty slow.
SO while it's nice to crow about saving the financial system, the unintended consequences of Mortgage cram-down could do just the opposite of saving it.
We already know that the end result of allowing lenders to obfuscate with their bogus balance sheets is to ensure that investors lose trust in the stock market and play elsewhere. Bad balance sheets need to be fixed, but they cannot be fixed without identifying them.
You aren't fooling investors at all, you're just spooking them. I don't want an American Nikkei, and neither should the poor schmuck whose 401k has been torpedoed, thanks in part to this bank-led fiasco.
Banks would not lend knowing that their contracts could be voided by bankruptcy judges.
Sure, banks are going to stop lending money and convert themselves into coffeehouses because of the big mean government. Tellers will be retrained as barristas, and ATM's will be converted into espresso machines. The horror, the horror...
Banks are in the business of selling money, and they will continue to do so. The proportion of borrowers who file bankruptcy is low enough that it means little or nothing in the aggregate.
The greater risk to the industry comes from bad lending practices that are driven by greed far
more than they are by bankruptcy law. They happily offered 0% credit card offers even though those were unsecured. Let's stop with the alarmist rhetoric and deal with real world scenarios, shall we?
Getting away from that - it's shocking see such complete and utter disregard for contracts & contract law.
I do hope that you expressed this same degree of outrage when the MBA lobbied to change the bankruptcy rules at the expense of existing credit card holders.
it wouldn't be a bad idea to get a better handle on the value of the houses securing these mortgages, forcing the bankers to increase the allowance for bad debts
You're probably right about this, but you understand what happens when a bunch of banks, many trading well under book (whatever that is), need to raise capital at once, right?
I'm wondering if there's a way to have our cramdown and eat it too.
1. In the case where the cramdown becomes a lien, the AAA mortgage holder gets paid if the homeowner sells the house for a price equal to the original mortgage or more. So make it a full lien then lasting the life of the mortgage. If the homeowner rides out 30 years at the reduced rate only then does the AAA holder suffer. Yes he suffers but he's going to suffer a lot, a real lot, in a foreclosure where the house sells for a lot less than what is owed.
2. Say the mortgage holder rides out the 30 years making all the reduced payments on time. Perhaps then the lien could be activated and the holder would continue to make payments to cure the piece that was 'crammed down'. Basically, then, cram down doesn't really become a way to get your mortgage cut. It simply becomes a way to stay in your house if you are willing and able to make reasonable mortgage payments on it.
3. Since this comes with a bankruptcy, ruined credit and you have to pay the thing off anyway it a cramdown is not very appealing for a homeowner to seek out unless he is very committed and very able to make a reasonable mortgage payment. In this economy even AAA holders have to take what they can get. Ideally cramdown should be an extreme measure that stops the major bleeding. If that can be accomplished then banks would benefit.
4. Yes this is disrespectful to the rule of contracts. We are not, however, in a normal environment and if holders of these mortgages want to play by the letter of the rules then the TARP money can be returned to Treasury and we can start the stimulus package by hiring bankruptcy lawyers to untangle the Wall Street wreckage.
My concern is more with the gov't putting people in a situation where if they go into bankruptcy and get a cramdown they could easily come out ahead of someone who bought a property for the same price than with any issue of fairness between banks and borrowers who can't afford their mortgages, but I'll address these points anyways
1. In the case where the cramdown becomes a lien, the AAA mortgage holder gets paid if the homeowner sells the house for a price equal to the original mortgage or more. So make it a full lien then lasting the life of the mortgage. If the homeowner rides out 30 years at the reduced rate only then does the AAA holder suffer. Yes he suffers but he's going to suffer a lot, a real lot, in a foreclosure where the house sells for a lot less than what is owed.
The lender suffers with each reduced payment since less principal is being payed back and less interest on the principal owed is payed. There is also no guarantee that a lender will suffer less with a cramdown than if the house is foreclosed. It depends on the amount of the cramdown (principal and interest), the location of the house and a host of other factors.
2. Say the mortgage holder rides out the 30 years making all the reduced payments on time. Perhaps then the lien could be activated and the holder would continue to make payments to cure the piece that was 'crammed down'. Basically, then, cram down doesn't really become a way to get your mortgage cut. It simply becomes a way to stay in your house if you are willing and able to make reasonable mortgage payments on it.
This would basically be extending the length of the mortgage. I don't think you really want to add the complexity of activating a lien (admittedly, this is outside of my realm of expertise) if you can serve the same purpose by changing a 30 yr mortgage to a 40 yr mortgage. Typically if you borrow money for longer periods of time you should expect to pay a higher interest rate. You are also probably getting into a situation where people are going into their retirement years still owing substantial amounts on their mortgages.
3. Since this comes with a bankruptcy, ruined credit and you have to pay the thing off anyway it a cramdown is not very appealing for a homeowner to seek out unless he is very committed and very able to make a reasonable mortgage payment. In this economy even AAA holders have to take what they can get. Ideally cramdown should be an extreme measure that stops the major bleeding. If that can be accomplished then banks would benefit.
There is a big difference between taking what you can get and taking what the gov't says you have to take.
4. Yes this is disrespectful to the rule of contracts. We are not, however, in a normal environment and if holders of these mortgages want to play by the letter of the rules then the TARP money can be returned to Treasury and we can start the stimulus package by hiring bankruptcy lawyers to untangle the Wall Street wreckage.
So this would just be for the current economic situation we are in now? Bankruptcy court forced cramdowns would end after we get through the recession and then the process would sunset?
Wow - You have GOT to be kidding RW...
What does a persons 401k, an American Nikkei, or bad balance sheets have to do with obfuscating and making a mockery of contract law? Did I miss the memo where the country stopped caring about property rights?
If you don't have money, you can't buy a house. if you borrow money to buy a house...**YOU** aren't really the one buying the house... the Bank is buying the house and you are then paying the bank back because they lent you the money to buy the house. It's not *your* house my friend.
Perhaps you don't understand this RW, but a mortgage is a *collateralized* loan. If you don't pay the loan, the collateral is liquidated to satisfy the loan.
It's funny to hear you scoff at the notion that banks won't offer the same terms with or without cram downs. Lets do a really simple example. If I lend $80k on a home worth 100k and then years later it's only worth $60k and i (the bank) have the $20k principal reduced (crammed down by a BK judge), the next time I lend $, wouldn't I only lend the $60k and make the borrower plunk down $40k (again to purchase a house worth $100k) so they have more "skin in the game". Basically what you've just done is tightened up lending standards even further than they already are. This makes the cost of ownership that much more expensive for the rest of society and makes housing turnover fall even further.
[on a side note, what does a person's 401k have to do with anything? A person is just as able to invest their hard-earned cash in US Treasury Bonds as they are speculative Emerging Market Stocks. Both go up and down in value. If you don't like that, put it in a FDIC insured CD. People choose for themselves what to invest in and the profits *AND LOSSES* are theirs alone. I certainly hope your indignation was the same when the market was returning 20%+ per year in the late 90s!]
Its time people start taking responsibility for their own choices - no one forced you to invest in stocks, just like no one forced you to take out that teaser ARM with no money down.
If you don't pay the loan, the collateral is liquidated to satisfy the loan.
Thanks for the lesson, but I came into this discussion understanding what secured debt is.
My respect is for the economy. As part of that, I have absolutely no desire to allow banks to pull down the economic system just because they are reluctant to deal with their balance sheet problems.
Since I, as a taxpayer, am literally paying to prop them up, I am demanding some quid pro quo in return. TARP money should come with strings attached, and one of the biggest strings should involve resolving bad debt.
There is enough undercollateralized secured debt in this system that the problem has become a systemic one. Since your allegiance to contract law won't fix that, some of the rest of us who pay your fees have other ideas that go beyond the limits of right-wing legal theory. We've already had enough damage from bad theory, it's time that we moved on and got real.
Basically what you've just done is tightened up lending standards even further than they already are.
Of course I have. It was never wise to promote excessive LTV's. But in the short run, the banks are going to have to experience what happens when they create so much systemic risk. It's going to hurt, but they've earned it.
what does a person's 401k have to do with anything?
Everyone's portfolio values have declined because the bank stocks have collapsed. The bank stocks collapsed because of dishonest balance sheets. So those liar banks are literally costing people their retirement money. The banks are nailing the common person six ways to Sunday, but the right is too busy trying to punish the little guy to do the math.
Its time people start taking responsibility for their own choices...
...except when those people are bankers, apparently. "Accountability" is a code word for passing the buck onto the little guy, while the institution benefits from the little guy's largess.
You want the taxpayer to sacrifice his tax money AND his property value AND his retirement account just to support your commitment to current bankruptcy law? No thanks, we can do a lot better than that.
Actually . . . I didn't think it worth addressing because the point is so obvious and because the Usual Suspects just won't let go of a talking point once they've seized upon it, but: Isn't bankruptcy all about 'breaking contracts'? Don't judges already interfere all the time with 'contracts'? Sorry for yet more tic marks, but it seems like terminology of all sorts is becoming increasingly flexible in its application to rhetoric.
Are you saying that the generic refusal to renegotiate is a direct result of this problem? I will admit to seeing bad faith everywhere these days, primarily because there is so much of that going around. But I honestly don't understand why lenders - or at any rate, the persons holding the mortgage - would prefer to foreclose on a property. My own suspicion is 'Potter's not selling, he's buying', that there's a certain element who sees this meltdown as a business opportunity. Why renegotiate when you can end up with the properties, a bailout, and no significant oversight? Iow, the whole ball of wax?
I honestly don't understand why lenders - or at any rate, the persons holding the mortgage - would prefer to foreclose on a property.
In respect to loan servicing agreements, foreclosure is often the easiest process for the servicer to justify contractually. The lender's investors are not a unified block with aligned interests, given the differing positions of their tranches.
The servicer ultimately doesn't want to get sued, plus the special servicer often gets to charge large fees for a foreclosure. Between the legal downside and the financial upside gained from the fees, foreclosure may be the special servicer's best alternative, even if it isn't the most logical business choice for the other parties.
Isn't bankruptcy all about 'breaking contracts'?
Yes. This is one of the weirder objections to cramdown.
I honestly don't understand why lenders - or at any rate, the persons holding the mortgage - would prefer to foreclose on a property.
Because there isn't one lender, there are a bunch of holders of securities, each of whom is entitled to a tiny part of the mortgage's cash flow. Now, if the MBS were structured correctly and you felt like wasting a lot of money, you could imagine holding a big shareholder meeting and having a vote on whether to approve a workout, foreclose, or whatever. But in all probability the only possibility allowed by the prospectus/debenture/CDS contract is foreclosure, and the moment the issuer or servicer steps outside the four corners of the agreement, say hello to a securities fraud lawsuit even if doing so is better for the vast majority of shareholders.
Other commenters here have noted the basic reason for keeping people in their houses whenever possible: abandoned houses attract scrappers and other scavengers, which leads to increasing social entropy, which drives down prices even further in a descending spiral. Thus, foreclosures create the very hazard (massive devaluation in multiple properties) that mortgage securitization aimed to counteract.