Adam Levitin at Credit Slips has a big beef with a lot of the critics of the idea of mortgage cramdowns as an alternative to foreclosure. For the most part, they don’t know what they are talking about.
That charge may sound extreme. but Levitin makes a persuasive case. First, the only empirical work done on the question supports the cramdown case. Second, many of the charges made about cramdowns misconstrue (often badly) how the process works. Levitin charitably assumes these mischaracterizations result from ignorance, rather than a cynical effort to muddy the waters.
Levitin may unwittingly assume that readers have some familiarity with how the proposed mortgage procedures would work They are not being invented out of whole cloth; the same mechanisms have been used for some time in corporate bankruptcies. A key element of the “cramdown” that Levitin mentions merely in passing, is that that mortgage principal is written down to the value of the property (the rest of the mortgage balance is treated as unsecured debt and included along with the borrower’s other unsecured debts. And this makes sense. Push come to shove, if the borrower is upside down, the mortgage is worth no more than the value of the collateral. The bank is in fact going to get less than the market value of the property (it has foreclosure, carrying, maintenance, and selling costs).
From Credit Slips:
I’ve written extensively (see here, here, e.g.) on why permitting modification of mortgages in bankruptcy would generally not result in higher credit costs or less credit availability…. it’s worth repeating some of the key points and making some new ones.
(1) The key comparison is bankruptcy modification versus foreclosure. Opponents of bankruptcy modification often misframe the issue, whether deliberately or ignorantly. It is not a question of bankruptcy losses versus no losses, but bankruptcy losses versus foreclosure losses. If bankruptcy losses are less than foreclosure losses, the market will not price against bankruptcy modification. This is an empirical question, and to date, my work with Joshua Goodman is the only evidence on it. Opponents of bankruptcy modification have only been able to respond with plain-out concocted numbers (e.g., the Mortgage Bankers Association) or insistence on applying economic theory that looks at the wrong question.(2) Economic theory tells us that cramdown is unlikely to have much impact on mortgage credit costs going forward. The ability to cramdown a mortgage (reduce the secured debt to the value of the property) is essentially an option borrowers hold to protect themselves from negative equity. It is a costly option to exercise–it requires filing for bankruptcy, and that has serious costs and consequences. More importantly, though, cramdown is typically an out-of-the-money option. It is only in-the-money when (1) property values are falling enough that there’s negative equity and (2) likely to remain depressed in the long-term. Long-term declining residential property values have been the historical exception. What this means is going forward there really isn’t much for creditors to worry about with cramdown–homeowners can’t exercise an out-of-the-money option…..
(3) Arguments about bankruptcy court capacity and bankruptcy transaction costs are made by people who have no experience with the actual bankruptcy system. A serious misconception about bankruptcy modification is the belief that the bankruptcy judge would decide how to rewrite the mortgage. That’s not how bankruptcy works. The debtor (and debtor’s counsel) would propose a repayment plan that includes a mortgage modification. The judge either confirms or denies the plan, depending on whether it meets the necessary statutory requirements. This means that bankruptcy judges can actually handle significant consumer bankruptcy case volume. If you want proof that the bankruptcy courts can handle a huge surge in filings, look at what happened in the fall of 2005, before BAPCPA went effective. The courts survived that flood of filings. Today the bankruptcy courts are better prepared; there are more bankruptcy judges (thank you BAPCPA) than in fall 2005. Nor would there be tremendous time and money lost in valuation disputes. After there are a handful of cases decided in a district, all the attorneys know what the likely outcomes would be in future cases and settle on valuations consensually. Court capacity and excessive transaction cost arguments are made by people who have never stepped foot into bankruptcy court.
(4) There’s no other serious option on the table…..Bankruptcy modification is the only game in town, and to pretend otherwise is disingenuous cover for opposing it in the name of “studying all the options.”
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Yea – Bankruptcy cramdowns in Chapter 13 open up a huge area of fraud with respect to discovering “value” via court appraisals of property without actual sale. Similar legislation was considered during the Great Depression, but in committee Congress decided that allowing court modifications of mortgage terms in Chapter 13 would hurt the market for new mortgage originations by adding lender risk and such modifications were banned.
Biden and others are in favor of cramdowns. Giving the owner/debtor of a house a put option (to himself) at the current market “appraised” price liqudating the prior mortgage increases lender risk, such would increase mortgage rates and/or loan qualification requirements, bad idea.
Joe Pomykala
Joe, not a close reader are you?
Joe,
Appraisals are still used all the time for mortgages, despite the abuses in the last cycle, for insurance and estate purposes. And despite the fact that we can and do see fraud in all those arenas, they are still central.
But you’d reject it for cramdowns. I see. Then if I follow your logic, we must reject it in all those other areas too.
I don’t buy it.
And Richard is right, you clearly didn’t read the article, just reacted in a knee-jerk manner to the premise.
Why is the mortgage balance added to unsecured debts? In a corporate bankruptcy it would be written off. The bank would never get it back if foreclosure was the chosen alternative.
It’s hard to believe anybody can trot out the “will make credit harder to obtain” argument with a straight face at this point. Oh horror of horrors, we won’t be able to build another bubble?!
polit2k,
No, the procedures for corporate and personal BK would be symmetrical, In both cases, you bifurcate secured and unsecured debt, treat mortgage debt as Levitin outlined. You take any remaining assets that could be used to pay down the unsecured debt, There used to be priorities among unsecured debt for corps (unpaid employee comp was once first, that is no longer the case, not sure what the priorities are among unsecured creditors except as provided contractually, as in degree of subordination among debt instruments).
Readers please correct me if I am wrong or have oversimplified, but my impression was ex the IRS and the mortgage per above, that other secured creditors could seize the pledged assets, any remaining assets would be pro-rated across unsecured debt (debtors are allowed to keep a certain amount of personal property). So if you had $5 K in the bank and $50L of unsecured debt, your creditors would get ten cents on the dollar.
Hi Yves,
Thanks for the clarification. Makes sense. I was incorrectly thinking of an “arrangement” rather than a fully crystalised bankruptcy. Tim C.
Cram It To Me!
First, we already do know that numerous Federal Agencies were corrupted by Politicians. Fannie, Freddie for starters.
Secondly, we do know that all Federal Judges are politically appointed and they in turn make all appointments of other officials at Federal Courts.
Thirdly, we already know that Barney Frank, powerful and influential politician already interfered directly with TARP $$$$$.
Fourthly, here is a quote from the article:
“The judge either confirms or denies the plan, depending on whether it meets the necessary statutory requirements. This means that bankruptcy judges can actually handle significant consumer bankruptcy case volume. If you want proof that the bankruptcy courts can handle a huge surge in filings, look at what happened in the fall of 2005, before BAPCPA went effective.” So, the Judge can either cram or not cram and they can to it in volume!
Fifth, so putting all of the above together, we now will have Federal Judges in even more important positions to grant favors to politicians either for constituents or, in volume fashion, to clients of Lobbyists. It is by political influence that one advances in the Federal Judiciary.
So, sixth, unless the probity of Federal Judges can be guaranteed, this will institute another localized political influence and patronage scheme. As infamous politician, Tip O’Neil once revealed: “All politics are local.” and so, too, is all political corruption.
Lastly, didn’t a few Senators have sweetheart deals on their mortgages with Countrywide? Well, it does not take a gigantic leap to believe that Cramdowns will be a certain area of interest for politicians.
I can even imagine criminals moving their mortgages into a position where they can take advantage of a cramdown. Properties may even be bought and then manipulated for such a purpose. The criminal mind knows no limits to its inventiveness, after all, that’s what has taken us to where we are today.
Cramdowns, More Of The Same Is Better
I do believe that cramdowns will negatively impact costs of borrowing for this simple reason.
The banks can use it as an excuse to charge more.
I think that they will have to modify their risk models when they look at borrowers.
That said, my real gripe with cramdowns is that it allow a house which was probably bought for more than it was worth, to remain off the market and thus not provide sufficient impetus to carry out, what I beleive is an essential market correction. As I have posted here, there is evidence that prices may have to return to pre-boom levels, as they have in past boom/bust cycles. See that chart I have posted here –
http://thelastgoodidea.blogspot.com/2009/01/this-didnt-take-long.html
Furthermore, costs of owning and renting are still just about as far apart as they have ever been. Home price growth over the last deacde is still vastly out pacing personal income growth. Even with the last 2+ years of correction, home prices are still way ahead of their 20 year cycle. Like it or not, without corrections to bring these metrics back into line with their historic and expected norms.
Anything which interferes with with markets attaining the parity I just detailed, can only serve to prolong and perhaps increase the severity of the slump.
There are four kinds of persons in housing right now:
1) those who are underwater and could not afford the house their in even at the lower value.
2) those who are underwater and could afford the house at the lower value.
3) those who are not underwater and making mortgage payments on time.
4) those not in the market and looking for a new home.
A combination of several actions and programs geared towards each separate group need to happen in order to stabilize housing and the economy. Without cramdowns and restructuring mortgages it can not happen.
For group 1 – the government needs to through a new office buy the mortgages from existing buyers at current written down values. The write down would then be handled as a tax credit which would count as an asset that one could borrow from the NY Fed at a reasonable rate. The new federal agency would then convert these units into a rent to own program. As an affordable housing developer, I can tell you that this would be cheaper than paying $5m in fees that get wasted every time a building goes up. So now you have one set of homes not coming to the market for sale which is a good thing since a lot of these homes are clustered together.
For #2 – the banks should do write down the mortgages to existing home values, again take a tax credit, use the tax credit as an asset to borrow from the NY Fed. This group of people would not be out selling their homes and again would avoid a ton of homes hitting the market. This is much cheaper than selling REO properties and the money the lenders keep at the end of the procedure.
#3 and #4 – new mortgages need to be nationalized with a strict set of guidelines (much like Fannie’s procedures now) with a maximum mortgage of $1,000,000 (this should match the maximum deductible allowed by the tax code). The amount of mortgage would be dependent on the down payment made. So for a $1m mortgage maybe you need 30% down for a $400 non and have that on a sliding scale. The federal reserve could control the rate and use this as a tool for monetary policy. This would allow people in category #3 to refinance and those in #4 to buy homes. This would put money into the economy.
I know this plan is not perfect and not all mortgages are in banks but you could see as the environment betters how the government could start selling off their mortgage assets to investors and how the market would kick start alive again after some time with a private mortgage market thriving again. I still think that this is a lot better than TARP or the $1-$2 trillion they are going to spend.
For me personally, I bought a home at a distressed price where I made money the day I bought it. I put 40% down and have about 50% equity based on the appraisal. I had a higher conforming loan at $749k plus $100k line of credit. Because they lowered the conforming limits again. I can now not refinance unless I want $200k floating (which I dont). If my mortgage went down to 5% from 6.25% then that is money that I could use to consume or save so every month someone, either my bank or a retailer would get $700 a month from me. Sounds better than bridges to nowhere.
Appraisals are close to useless. Every mortgage in 2005 and 2006 had an appraisal supporting it. At least at those times, one party wasn’t using the useless appraisal against the other as a club. Everything in the pro-cramdown post makes total sense. But since I’ve spent my life seeing appraisals on the commercial real estate side that made zero sense, I can’t support a policy that makes sense if it has to rely on an appraisal to carry it out.
“The ability to cramdown a mortgage is essentially an option borrowers hold to protect themselves from negative equity.”
I guess, in a way, that perceived protection would quicken a recovery in the housing market, but probably infinitesimally so.
Interesting idea. And the objection sems to be withholding of credit…one assumes that it means witholdng or increase in costs to the “good” borrowers.
Mind you this is where you have to allow competition to kick in and that borrowers at some point can shop their mtgs to lower offers when the mtgs open or are renewed. Companies with lower loan losses would have the advantage.
One benefit is the symmetry to the commercial process, which seems to work, but it also accepts reality. The oejections on the cosumer side then flip to moral argumens, incentives and hazard.
However, in the current system the risk is all on the borrower, their reputational and financial risk.
This shares the risk a little more back to the apparently more “savv player” the lender…who lends money for property all day, the borrower only borrows once in awhile.
It isnt about giving a gift to anyone, but is anyone really better off following the current system. Under this porposal the bank hasnt given up it lien on the property, it maintains some form of payment, focing a loss on what it did lend, which is less than otherwise. It helps support price by preventing mass liquidations….but IF it does cause lenders to ration their capital in terms of tihter lending standards on down payments and income verification….well, isnt this what we wanted.
IF the government wants to engage in specific programs targeted at individuals to enable them to qualify OR provide seperae insurance where the risk is CLEARLY AND EXPLICITLY the governments (meaning it would need spending authorit from Congress) then this works as well.
I would rather make it clear that lenders take losses for bad decisions. Not that this seems to stop some, I still think the airline industry, as an example, is still able to obtain “dumb” capital for some unknown reason leading to chronic overcapacity.
We need to be sure that the mg industry doesnt keep falling into the same trap.
Richard Smith @4:40 am asks/states, “Joe, not a close reader are you?”
A good question, Richard. So good, I must then ask you, since you are such a close reader and all—Did you even read the referenced articles in the post—you know, the ones that actually back up the author’s assertion about all the “empirical evidence” that supports the cram down case?
For that matter, when Yves writes—“First, the only empirical work done on the question supports the cramdown case.” Yves—did you even look at this empirical work? [And while we are at it—how on earth do you know that Levitin and Goodwin have conducted the “only empirical work” done on the subject?]
What a complete joke.
Since the referenced article with all this great empirical evidence is in a pdf format, I can’t cut and paste, but go to page 16—and there he lists all this evidence in all its damning glory.
Please read it Richard and Yves….and then tell me how this could possibly pass for empirical evidence.
Because the author says so?
For crying out loud—he didn’t even publish the evidence yet—it’s “forthcoming”!!
Recently, I conducted a rigorous study about people who like to get all gratuitous with the following words:
Empirical.
Entropy.
Hegemon.
Meme.
Cognitive.
Fascist.
Here’s what I found:
For the most part–they haven’t got a freaking clue. Empirically I found this out. I did. I really did. And it was really, really, really enlightening.
Thank you, Dan Duncan, for the ad hominam. Your sarcasm is most helpful.
A quick Google search of the author would also turn up his SSRN page. A working copy of his empirical research can be found here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1087816
Thanks for posting this, Yves. I’m glad you did.
As a bankruptcy attorney, I can tell you that this concern over fraudulent appraisals is overblown. I require my clients to obtain appraisals for all types of property (vehicles, second homes, personal property) currently eligible for cramdown and most of the time the appraisals come in well above the true market value of the property given the current conditions.
Additionally, the banks will ALWAYS fight an appraisal they believe to be below market value. They are professionals. They won’t simply roll over and die if cramdowns are extended to primary homes.
In most areas of the country property values are still on the decline. If a homeowner in Chapter 13 owes $300K on a home that is worth $150K, they would have the option under the new law to cramdown the mortgage to $150K and the lender would have the ability to recover a portion of the $150K unsecured claim from the homeowner’s income over the next five years. The lender would likely receive a new note for $150K and at least $15K-$25K in plan payments (assuming plan payments of $300-$500 where the lender is going to receive most of the payment as the largest unsecured creditor) over the next five years.
If that same home went to foreclosure after it was surrendered in Chapter 13 by the homeowner (which is the case at this time without the new law), it usually takes the lender 1-2 years to take possession and sell the property. This is because it takes several months for the property to be released from the bankruptcy court and then 6-18 months to proceed through the circuit court to foreclosure. The lenders are recovering far less under the existing system than they would under the proposed system. This has to do with the number of missed payments, the loss in value due to the time it takes to recover the property and the costs associated with the eventual sale (rehabilitating the property, paying back taxes, insurance, sales commissions, etc.)
Those arguing against the extension of cramdowns to primary homes need to do more research on how Chapter 13 really works before simply stating that cramdowns will cost the banks more in the long run. The current cycle of foreclosure and liquidation will ultimately cost the banks much more than simply allowing cramdowns.
“We explain the lack of market sensitivity to strip-down risk by reference to two sets of consumer bankruptcy data, one from 2001 and one from 2007, both of which suggests that lenders’ losses in strip-down would be extremely limited both in scope and magnitude and often total less than those they would incur in foreclosure.” http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1087816
From what I’ve read, didn’t those years have unsusually low defaults?
But the situation I would be concerned about is this: Someone has a 300K loan – it gets crammed down to 200K. A few years go by and the person can only sell for 150k. (see Doctor Housing Bubble blog for examples of greater than 50% losses)
And say that some other workout happens to help the borrower – fine with me. I am not as concerned with the bank’s loesses as with the person who, despite the cram down, is still over-paying for housing. As well as every home buyer who is over paying because housing prices have not truly reached the historical relationship between income and house prices.
We got into this mess by giving howmeownership a cachet it doesn’t deserve. People should pay for housing what it is worth – not the amount that minimizes losses to banks.
If I understand the argument correctly, cramdowns aren’t supposed to affect the cost of credit because cramdown losses would on average be less than foreclosure losses.
But if a cramdown is better for the bank than a foreclosure (and surely it is better for the borrower), why aren’t banks already writing down the value? Why does a judge need to be involved at all? It seems like if a judge has to force a cramdown on the bank, that is prima facie evidence that the bank would rather have foreclosed, because they already have that option. And it isn’t too far a leap to conclude that the cost of credit will go up if cramdowns become common.
Anon @ 11:26
I would guess the reason the banks so not like cramdowns is because it would force them to recognize losses sooner than in the foreclosure case – this seems like a good thing for clearing out the system
The main reason the banks aren’t writing down values of underwater houses is that to do so is to admit bankruptcy. Average losses on mortgages will far exceed a typical bank’s 10% equity, so once they recognize the loss they are wiped out. So they’re trying to put it off as long as possible, hoping for a miracle.
Writedowns will save money compared to foreclosure, but the money saved will go to the taxpayer when we end up owning or bailing the banks, as we inevitably will at this point. The banks have no interest in saving the taxpayer money.
“Nouriel Roubini and Elisa Parisi-Capone of RGE Monitor release new estimates for expected loan losses and writedowns on U.S. originated securitizations:
• Loan losses on a total of $12.37 trillion unsecuritized loans are expected to reach $1.6 trillion. Of these, U.S. banks and brokers are expected to incur $1.1 trillion.
• Mark-to-market writedowns based on derivatives prices and cash bond indices on a further $10.84 trillion in securities reached about $2 trillion ($1.92 trillion.) About 40% of these securities (and losses) are held abroad according to flow-of-funds data. U.S. banks and broker dealers are assumed to incur a share of 30-35%, or $600-700 billion in securities writedowns.
• Total loan losses and securities writedowns on U.S. originated assets are expected to reach about $3.6 trillion. The U.S. banking sector is exposed to half of this figure, or $1.8 trillion (i.e. $1.1 trillion loan losses + $700bn writedowns.)
• FDIC-insured banks’ capitalization is $1.3 trillion as of Q3 2008; investment banks had $110bn in equity capital as of Q3 2008. Past recapitalization via TARP 1 funds of $230bn and private capital of $200bn still leaves the U.S. banking system borderline insolvent if our loss estimates materialize.”
If Professor Roubini is correct and I fear he is, why don’t any of the accounting firms listen to him? What about starting with the accounting firms and perhaps, one of the worst offenders KPMG. Why does anyone even care what KPMG has to say? Why does anyone want to work at KPMG? KPMG audits a disproportionate percentage of financials yet totally missed the banking collapse. Exactly what is KPMG expert at and why would anyone listen to them after all their failed audits of failed institutions? Many as early as 2005 predicted the financial meltdown and the unsustainable lending pattern of the financials including Dr. Roubini of the Stern School of economics, why didn’t KPMG listen. If I were a partner or employee at KPMG I would be extremely concerned about all the pending lawsuits and potential criminal liability of KPMG. You know for a fact that Tim Flynn the CEO and Joe Loonan the head lawyer will not stand behind the partners as evidenced by the tax partners KPMG threw under the bus when the DOJ came a calling. In fact, Flynn, completely reneged on the former O’Kelley’s promise to support the tax partners (after he got brain cancer) and lied to the tax partners by pulling the carpet out from under the them by hiring Bennett and Holmes to not only lie about the tax partners to the DOJ but deny them legal fees for defense at the DOJ’s request. Loonan, Holmes and Flynn, totally screwed the tax partners and an email exists wherein Loonan specifically states that in the KPMG tax settlement with the DOJ he has no idea if any of the facts are correct but KPMG better sign or the DOJ will put them out of business and ends the email by saying: “freedom is just another word for nothing left to lose”. The point of course is those that run KPMG have no honor, are lying scum and if you are employed by KPMG and something bad happens, KPMG will do everything it can to ensure it survives at your expense. Of course something bad has happened, the banking collapse was a no brainer, predicted by many and most of the KPMG audits of the financials are riddled with fraud. The lawsuits and criminal investigations are coming, no doubt. All KPMG partners and employees should be very concerned as KPMG has no problem throwing them under the bus for a life of ass raping if it will save KPMG a nickel. Why any clients would accept advice or rely on KPMG for anything shows a total lack of due diligence and perhaps, negligence by those clients choosing to use KPMG. Of course, the last sentence does not apply to those clients that are actually consensually engaging in fraud with KPMG. The firm of KPMG has no honor or expertise in any matter just self interested thieves like Flynn, Holmes and Loonan attempting to make as much money as possible for themselves before the firm implodes. Many emails exist concerning KPMG’s malevolence and will be disseminated over time. Thoreau has a great quote, “no one can associate themselves with the U.S. Government without disgrace”, the same applies to KPMG, no one can associate themselves with KPMG without disgrace.
Thoreau, may this is one for you:
I think someone mentioned that if the lender (bank) were to forego the unsecured balance a tax credit might be forthcoming. How does this work? Can such losses be carried backwards as well as forwards? Are there time limits and if so what is the start time? Technical stuff, I realise but I’m wondering if there might be an inexpensive way to incentivise lenders to chose cramdowns.
Why would you go into a Court room and asked the Judge to break one contract and enforce another one? Because the banks need to adjust their balance sheets because they lobbied Congress to set it up that way?
Carry out the original contract whether it leads to a write off or not? You gonna do a bailout on a bad risk to begin with? WTF?
I’d rather see the failed homeowner walk and cross the street to rent than be saddled with some balloon payment to cover the banks’ asses.
Credit clears in five years or so and maybe the IRS extracts a penalty or maybe it’s waived.
polit2k, losses can go back 2 years and forward 20, and in fact, Paulson a few months ago illegally changed the tax law something congress is only supposed to be able to do by allowing banks to recognize all the losses of acquired insolvent banks.
I think the focus on comparing lender losses in cramdown vs. modification scenarios is misplaced. My personal experience is that lenders oppose cramdowns because modified mortgages frequently redefault, whereas once the lender forecloses and sells the property it is done with it.Cramdowns and modified mortgages are perceived as ongoing problems, while foreclosure and REO is a permanent solution.
Kevin,
To what extent is the hit from the remaining unsecured balance the probable cause of later default, do you think? If all or most was foregone by the lender bank would this change the lender’s view of the risk of repeat default significantly, do you think?
From what I hear Paulson’s protege has experience in tax matters too. Maybe he could be encouraged to consider a new variation, namely that only losses from voluntary forgiveness of all or part of cramdown balances can be rolled backwards (forwards seems a bit academic these days). Might this make lenders go for cramdowns more willingly? To be fair I guess losses from foreclosures could be rolled forward.
anon said “It’s hard to believe anybody can trot out the “will make credit harder to obtain” argument with a straight face at this point.”
cram-downs via bk process will make it more difficult or costly to obtain a mortgage. for an example, look at the financing terms for a non-primary residence. rates and downpayments are usually much higher than primary residence. the question to be posed is are higher mortgage costs a good outcome. given the stress because of lax underwriting, it will be a net benefit to society if mortgages are harder to obtain. this would greatly limit the next bubble.
While I have no panacea to the problem I do hate the idea of write downs. I have suggested that time might be the best thing for the US government to purchase for, unless one believes the housing downturn to be ‘forever’ then, at some point, it will make sense to own the underwater homes again.
A recent survey of the FDIC loan modification program at INDYMAC shows that, for those choosing to accept the FDIC deal, the average outstanding mortgage was about $275,000 and the payment modification about $425/month. With US median home prices less than California we might expect a national mortgage modification to be about a third less per person.
To me, as a industry outsider, this would seem to indicate a refi at current interest rates along with, perhaps, a ‘bridge loan’ might enable most distressed homeowners to make payments on their home at the original purchase price for a long enough time, say 5 years, to ‘save’ the situation.
Assuming even a modest level of inflation and rising income over the next 5 years what seems insurmountable today isn’t in 2014 assuming housing prices do not keep falling.
Offering $25,000 in bridge financing to distressed homeowners to finance their ‘deficit’ years would cost far less than cramdowns, foreclosures, etc. Each one of the predicted 2 million plus
foreclosures could be offered such a plan and it would only cost around $50 billion. Further, halting the flow of foreclosures and defaults would do more to stabilize homeprices and bank balance sheets than just about any other course of action.
The ‘bridge loans’ would be interest free for the first five years or so and then could be secured by any future equity gains in the homes. To increase participation in such a program a stick might also be wielded since many of the underwater homeowners might prefer to just walk away. That stick might be an examination of their original loan application to determine if they falsified their income!
the real issue here doesn’t have to do with the losses on those loans who were doomed to foreclosure to begin with. the market value is what it is. the issue seems to be the powerful incentive this would give to borrowers.
we also shouldn’t forget that property values can increase too (and they will when the market stabilizes). when this happens, will lenders be able to participate in the gain? or does it seem like good contract law to place lenders in the position that they lose in any case? i read that contract as follows: the bank agrees to pay me today’s value so i can buy the house, i agree to pay back the full value, unless the value declines in which case i won’t – so too bad for the bank. and if the value increases, good for me. it’s a win-win (for the borrower – values increase, borrower wins; values decrease, borrower wins).
banks: price that risk in!
Cram Downs are necessary for another reason.
Many mortgages are traunched whereby there are a myriad of owners in a myriad of products …
Only through a cram down can effective value be obtained whereby different derivatives of the mortgage get real pricing reducing toxicity in the system.
Cramdown gives the homeowner two simultaneously exercisable options, both a put option (written by the lender) to sell the principal residence to the lender at the strike price current principle balanced owed, and a call option (written by the lender) to buy the house at the strike price of current appraised “market” price (found by court discovery, debtor and creditor battle their hired gun appraisers). The options have unlimited duration and never expire. The homeowner owns two options and the mortgage lender is writer, they are implicit covenants added to the mortgage contract, but since the options have value, they must be paid for by the borrower to the lender ex ante at origination via less favorable mortgage terms such as higher interest rates or more stringent loan qualification requirements. Now the real question is how much different this is than straight foreclosure on a nonrecourse loan.
More the key is what happens to the interest rate on new forced mortgage loan over the stripped down principle. The new interest rate is set by the court, could be a few points higher than the prime rate or treasuries of a similar duration. Thus if Congress allows modification of liens in Chapter 13, homeowners will flock to file not only to have principle lowered, but moreover to use it as a way to refinance mortgages at lower court set interest rates. Some of the new filers maybe would not alternatively gone to foreclosure. Cramdown no doubt increases lender risk. This would be reflected in higher mortgage rates hurting the already battered real estate market.
Section 75s of 1934, Frazier-Lemke Amendment, knee jerk legislation, with similar cramdown provisions for farm property, was ruled by the US Supreme Court in Louisville Bank v. Radford (1935) as unconstitutional Fifth Amendment violation taking of private (lender) property for public use (to rehabilitate farmers) without compensation.
Congress is about to make the same mistake as it did in 1934 by adding cramdown to the stimulus bill which likely will be passed in a few weeks. They really should have committee hearings, testimony, and debate; but will likely instead behave like idiots similar to the way they passed the bailout bill in September. In 1938 when Congress put the anti-cramdown lien modification ban into Chapter XIII under the Chandler Act, it was being a bit smarter not wanting to further depress an already depressed real estate market.
Using South Florida as an example one can say land cost is off 50-60% and rapidly snowballing
with huge amounts of foreclosures and pre-forclosures rooting into the system. My guess is withing a year or two a 1.5 mil lot circa 2005 is worth 400k-500k, it’s very ugly here.
Now for the bad news…all the folks in construction, finance, services, auto and yacht and
real estate sales, restaurants, hotels, commercial real estate, etc etc. These earners that
brought home 200k-500k are now making 50k- bad news for housing. People cannot afford the
levels of debt so much further asset contraction is in order.
Realistically, I see no end game other than further collapse of housing prices. Let the homeowner
walk and let the bank do a write off with some government support. If someone wishes to stay
in a home and has any income, than let the bank adjust the mortgage down to current values.
Why must someone jump through all the bankruptcy hoops..why distress the owner to that level.
The downside is homes will be much cheaper in two years…to many foreclosures in the system.
It’s very depressing to see 10 years worth of homeowners being thrown out on the street.
The best thing is to expedite the process and get to the new base…the banks are far to
slow in the short sales and foreclosures, dragging this mess out. Remember, South Florida is
closing in on four years of this collapse- Spring of 2005 was the peak.
One last thought..some effort should be made to address property taxes and insurance costs.
These burdens are significant and add to the downside pressure. Home Ownership has lost it luster IMO, they have successfully killed the golden goose.
IIRC, cram-downs on primary residential mortgages were the customary practice, until Congress changed the law around 1978. But even after that change, judges interpreted the law to continue to allow cram-downs, until a SCOTUS ruling in the early 1990’s nullified that interpretation. Hence, it’s not just that such a change in the law would render the practice analogous to business bankruptcy practice, but, in fact, would restore traditional bankruptcy practices, and hence would seem entirely practicable. However, cram-downs would be just a small piece of the puzzle of resolving the housing/foreclosure crisis. Some broader legislation allowing a mass-administrative process would be in order, not in order to prop up housing prices, nor shield irresponsible spend-thrifts, but for the larger macro-economic purposes of preventing housing price declines from severely over-shooting, preventing the massive social externalities of foreclosures and dereliction of housing stocks, and re-balancing and stabilizing both financial debt and housing markets by reducing their accumulation of fictitious “values” to get calculable transactions flowing again, though at non-bubble rates of flow. Anon. at 8:11 AM is partly on the right track, though fixing the housing mess is not mutually exclusive to fixing the broader financial system mess, fixing the trade deficit mess, or providing fiscal stimulus/public investment both to tide over the down-turn and to assist in the search for new avenues for real productive investment to re-balance and revive the currently severely distorted economy.
Haven’t read all.
But, is it true that mortgage debt in the US is non-recourse?
Does that not make cramdown just another effort to maintain inflated property values.
If you don’t have to pay don’t pay.
Live in the proprerty for another twelve months while the Government ditthers.
So what if you can’t get credit later.
You won’t be able to anyway.
Cramdown seems to me to be a method designed only to put an unrealistic value on a property for the purpose of inflating balance sheets.
Any homeowner who accepts it is an idiot.
After twelev months of non payment they can use the money to rent (any of the many vacant properties).
Maybe I don’t understand cramdown.
What a load of rubbish. He conveniently sidesteps the issue of unintended consequences.
If my neighbor gets his $500k mortgage “crammed down” to $300k, and I’m still paying on a $500k mortgage on the same street, you better bet I, and millions like me, will immediately stop payments on my mortgage, go into instantaneous foreclosure, live rent free for 6-12 months, and then expect my own cram down.
Nothing has convinced me that housing is anything but a dead asset for the next 5-10 years.
Levitin is missing one small thing that will raise borrowing costs. Servicers would traditionally handle this but they are hesitant to because they are bound by contract to maximize cash flows to investors. Otherwise they may be at risk of litigation.
If a bankruptcy judge does the modification instead the losses are allocated on a pro rata basis across all tranches. This is buried in the prospectus of many prime jumbo and alt-a securitizations. This would likely cause even senior tranches to suffer downgrades. Since many banks and insurance companies own those tranches they will be forced into more writedowns and have to raise more capital. This will make it harder for people to access credit and will raise borrowing costs.
Anon of 9:03 PM,
You seem to miss the little complication that you have to declare bankruptcy to get the cramdown. Have you ever done that or had anyone close to you do that? It is not a cakewalk. It is an unpleasant and humiliating process. Try telling your kids what to say about why you are moving, for instance.
Abbot,
Whether the mortgage is non-recourse is a matter of state law AND whether it was a refi. Refis are NEVER non-recourse. only purchase money mortgages are, and then not in all states.
Since more than half the subprime mortgages were cash-out refis, that suggests an even larger % were plain old refis. Tanta used to remind readers that a lot of subprime borrowers were former prime who by bad luck or bad planning had to refi as subprime.
Anon of 9:22,
As a matter of fact, I did go through bankruptcy a few years ago as a result of a frivolous lawsuit. You’re right, it’s not pleasant, but it was NOT humiliating. It was actually a wake up call.
I do understand that you have to declare BK to get the cram down. No, this doesn’t destroy your credit for than a few months. Banks are more than willing to sign you up for credit cards to help you re-establish credit. My FICO score is back to where it was before my BK (mid-700’s) today.
I think you are missing the unintended consequences of being a debt slave once you accept a cram-down. I agree with Anon of 8:25pm. Anyone who agrees to a cram down (and a recourse loan along with it) and doesn’t walk, is an idiot.
You can already ‘cram down’ loans in bankruptcy–I know, because I’ve done it myself just recently.
You can already detach a second or third, etc note on a property if you can prove (usually by appraisal) that the value of the property is worth less than the loan. This is done in an adversarial motion. It happens everyday.
What congress is contemplating is to allow 1st mortgages to be subject to the same concept–allowing a portion of the mortgage to be shaved off as it is not secured anyway by the entire debt.
Banks and their lobbies bit themselves on this one–they wanted secured debt to be a high priority and unsecured debt could languish. Now, loans are being unsecured by cratering home values and banks are having to eat it.
“…Agency MBS are still not ‘explicitly’ guaranteed rather ‘effectively’ guaranteed while the firms are in conservatorship. This presents a problem especially with the new cramdown legislation on tap. Large Agency MBS holders better hope that .gov takes a firmer stance because if not, this market could see some considerable widening in short order. Remember, present backing is only $100 billion per GSE. Funny, but if they do stand up and back the entire $4.5 trillion GSE MBS enchilada and the cramdown legislation comes through, .gov (taxpayer) will be cramming themselves. Just think the Treasury yield action if .gov decides to ‘explicitly’ back trillions in Agency MBS…”
http://mrmortgage.ml-implode.com/
Joe,
It’s really a game of chicken between a goofy lender and a goofy borrower. The borrower has already been granted a quite different option from the one you mention – walkaway, aka jingle mail. The option was underpriced, because of the assumption that house prices only ever went up.
With the recent decline of house prices, that option threatens to be well in the money. What’s more, with house prices at these levels, recovery rates in foreclosure lead to a much bigger hit for lenders than a cramdown would.
That sounds like a basis for renegotiation to me, and in anything but single-family owner-occupied property mortgage loans, it would be.
What, pray, is special about those particular loans?
Just wait for the Option-ARM to recast in numbers (due in 2010 and 2011).
…Ah well – cramdown will be a pretty minor debating point if job losses pile up fast enough in the coming months.
Polit2k,
I think eliminating the unsecured piece would help in some cases, but the larger issue is the borrower usually exhausts their financial resources before the modification or bankruptcy, and any subsequent financial hiccup (job loss, illness, etc.) creates a new default. I’ve written more about that in a post here
http://residentialpropertyanalytics.blogspot.com/2008/12/re-defaults-why-workouts-usually-dont.html
It is obvious that for the past few years people have thought that giving credit was a get quick rich way. In the future with increasing interest rates, getting and paying credit is going to be quite hard.
The most common mortgage modifications are listed below:
lowering the mortgage interest rate
reducing the mortgage principal balance
fixing adjustable interest rates within the mortgage
increasing the loan term throughout the mortgage
forgiveness of payment defaults and fees
or any combination of the above
Check out this public service site: http://mortgagemodificationinfo.org