Taxpayer Cram-Down

March 6, 2009

 

The issue of mortgage ‘cram-downs’ – allowing bankruptcy judges to reduce principle on primary residential mortgage loans – is in the news again as a version of legislation passed in the house of ‘representatives’ yesterday.  This is an extremely important issue and the passage of such legislation would be an unmitigated disaster for our economy.

 

Where does the money come from?

 

First, it is important to understand that banks do not directly loan the majority of the mortgage money in existence.  This money comes from secondary market investors in the form of their purchase of mortgage-backed securities (MBS).  While securitization has taken a beating in the media over the past year, it is important to remember that not all MBS are collateralized debt obligations and exotic derivative products.  Today, the overwhelming majority of secondary market investment comes from investor purchases of government-backed MBS in the form of FHA and GSE (Fannie Mae and Freddie Mac) loan pools.  Already, such securitizations are under a considerable amount of strain – and for obvious reasons.  The international economy continues to operate under extreme stress.  Potential purchasers of MBS have greatly reduced capital access and are under pressure to make sound investments that will perform well in the short-term, as well as over time.  The American economy, upon which the strength of MBS ultimately rests, continues to face a variety of challenges.  Specific to MBS performance, continued job losses, declines in home values and questions regarding the underlying strength of major financial institutions are drawing ambiguous answers from even the most astute observers and analysts. 

 

Understand, next, that secondary market investor purchases of MBS are the source of funding for mortgage loans.  Absent these successful securitizations, the flow of money stops.  Today, these securitizations are made possible only due to the now-explicit guarantee of such securities by the federal government.  Absent this guarantee, purchases of MBS are simply too risky to attract the prerequisite capital.  If you think things are rough now, imagine an economy where the flow of mortgage dollars simply stops, cutting off any possibility of mortgage refinance, purchase and, therefore, of sale.  In this worst-case scenario, all citizens are equally impacted up and down the economic spectrum.  Need to refinance to lower your monthly payment or move from an adjustable rate to a fixed rate loan?  No option.  Looking to purchase a home?  No option.  Pay your mortgage just fine, but need to sell your home due to a job transfer or downsizing?  Sorry, no option if prospective purchasers cannot obtain financing.

 

Just like your father said, money does not in fact grow on trees.  It has to come from somewhere.  It can come from investors in the secondary market, or it can come from the taxpayer in the form of a completely nationalized mortgage finance market.  Today, the market is partially nationalized in that MBS are explicitly backed by taxpayer dollars.  Again, absent this explicit guarantee, the flow of investment dollars into mortgage-backed securities, and hence residential mortgages, would grind to a halt.  Take a moment to ponder the repercussions. 

 

Question for our Congress

 

Ironically, and perhaps I should expect nothing better at this point, the mainstream media has labeled this proposal as ‘help for homeowners’.  In reality, this proposal would be a disaster for homeowners.  Which leads me to pose this question to Barney Frank and other members of congress:

 

Do you understand the consequences of passing this legislation into law?

 

The first and immediate consequence would be a dramatic surge of bankruptcy filings, clogging the courts and further delaying any hope of bottoming out the decline in home values or in the overall financial economy.  Debtors and creditors alike would be put into a state of suspended animation as the courts worked through this tsunami of new filings.

 

The next repercussion of passing this poorly thought out legislation into law would be a dramatic increase in mortgage rates, and therefore a big increase in monthly mortgage payments for new home buyers or those looking to refinance.  In other words, we would get exactly the opposite of what these same ‘representatives’ have been working towards for over a year now.  Instead of ‘affordability’, we would see the opposite – and with increases in mortgage rates, the deflation of home values would continue unabated.  The reason for this is simple.  If investors’ principle can be written down arbitrarily in court, these same investors must seek a higher overall return to compensate for increased principal risk.  If the increase in principal risk is perceived to be dramatic, increases in overall yield must be equally dramatic.  If the increase in principal risk cannot be quantified, overall yield demanded will likely be higher than anything we have seen in a generation.  As with any security, an investor expects lower return with a low-risk investment, but seeks higher return for greater risk.  Allowing bankruptcy judges across the country to reduce principal owed on primary residential mortgage transactions injects unpredictable risk into the risk/reward calculation of investors.

 

Worse still is this same congress’s likely reaction to rapid increases in mortgage rates and/or declines in securitizations.  More than likely, in reaction to contracting supply of investment capital, congress will step in to make investors whole.  Recent trends would support this hypothesis.  In very simple terms, if a $150,000 mortgage obligation is reduced by a bankruptcy judge to $80,000, congress will step in with the difference.  The difference, of course, will come from your tax dollars.  Remember once again that government does not really have any money.  The only money government has is that which is confiscated through taxation, or that which is borrowed.  Either way, this is paid for by the tax payer – either through increased rates of taxation, or through inflation: the ‘stealth tax’ on every dollar held or earned.  Once these economically illiterate career politicians realize they have just killed the market for mortgage-backed securities, they will need to revive it.  As we have seen, they will feel compelled to ‘do something.’  The thing to do will be to prevent investors from taking losses on risk that was added after the fact.  In other words, when investors bought these securities, they did so with the understanding that principal could not be written down in court.  They are unlikely to throw continued good money after bad.  To keep the secondary market dollars flowing into mortgages, government will have to make these investors whole, or at least severely limit the haircut they will take.  Whether that means paying out $70,000 in our example above, or perhaps only paying out $50,000, it is clear that secondary market investors will get something or the flow of investment capital will stop.

 

And this leads to the third repercussion.  Unless government steps up with further guarantees, the flow of investment capital into the mortgage-backed securities (which serve as the feeder mechanism for mortgage loans and therefore mortgage lending as we know it) will shut down.  This will have a devastating impact on the overall economy and greatly exacerbate all of the negative dynamics already in play.  Home sales will grind to a halt.  Mortgage delinquencies will skyrocket beyond anything we have ever seen.  Both bank and non-bank lending operations will be out of business.  The foreclosure rate and all of the associated problems that go with it will climb to uncharted territory.

 

A lose/lose for taxpayers

 

Either way, this is a lose/lose proposition for tax payers.  If mortgage funding dries up, the repercussions for the overall economy in which we live and work as both consumers and producers will go from bad to much, much worse.  If government steps in to keep investors whole and subsidize the flow of capital into mortgage-backed securities, it will be taxpayers who bear the ultimate burden not just in the short-term, but for generations to come.

 

The case for deflation

 

Clearly our ‘representatives’ have a very limited understanding of how finance works.  But what is the answer?  The only way out of this capital markets crisis is the exact opposite of the efforts of our government for the past two years.  Instead of supporting measures to reinflate a debt and credit bubble, and to recreate price and credit inflation that was unsustainable, we must support the deflationary dynamic and allow the market to weed out the inefficient and the unsustainable.  Prices simply must deflate to sustainable levels if we are to reach a transparent bottom.  Only from this bottoming-out can we seek to rebuild a healthy, functioning and sustainable financial economy with rational flows of capital and sustainable levels of debt.  As we have seen virtually every day for the past two years, all efforts of the federal government to reinflate are doomed to failure.  Worse, however, is that the efforts of the government to reinflate create a variety of long-term unintended and unpredictable consequences. 

 

Within this great deflation there will be pain.  There will job loss and home loss.  There will be bank failures and bankruptcies of inefficient business models in a variety industries.  But these will come at a rapid pace and the pain will be over quickly.  Strong businesses will absorb the weak.  Creditors will be punished for their lack of due diligence.  Stockholders will be punished for their casino mentalities.  But as the strong devour the weak, the end result will be finding a transparent bottom and a solid foundation upon which to rebuild a sound economy.  Current government policies only exacerbate the problem and make finding a bottom more elusive.  Efforts to forestall the inevitable only drag out the bottoming-out and recovery process, creating more pain for all.

 

Perverse Incentives

 

Perhaps the best case of the real-world consequences of government propping up failed business models is the recent announcement by Sheila Blair that the FDIC risks insolvency in the coming year if the premium fees banks pay into the fund are not increased.  This is a case of the strong being pillaged to support the weak.  Instead of allowing market forces to work on failed business models – in the case of banks this would be investors and depositors moving their funds to solvent institutions – government, through the FDIC and outright capital injections, will support the flow of capital into insolvent institutions by guaranteeing it.  This disproportionately affects smaller, move nimble banks by increasing the fees they must pay to prop up the bloated, non-transparent and virtually insolvent institutions such as Citi and Bank of America.  Further, investor capital is induced based on explicit guarantees of large bank debt.  Why invest in a healthy but smaller bank when your capital will be guaranteed by the government even when invested in an international zombie bank?  Why move your deposits away from a Citi or Bank of America when the government will guarantee them?  Thus are perverse incentives injected into the market through government policy.  The end result, in simplistic economic terms, is the inefficient use of capital.  Understand that this is not the market failing, or making a poor decision.  This is government injecting incentive into the market in favor of inefficiency.  And it will not end well.  Not even government can guarantee a failed business model or an insolvent bank indefinitely.  Sooner or later, reality hits.  And the longer this reality is forestalled, the harder it hits. 

 

Unintended consequence?

 

Sadly, the long-term, unintended consequences of government’s injection of incentive into the market are often very difficult to predict.  In the case of bankruptcy ‘cram-downs’, however, the consequences are quite clear: a dramatic increase in cost, followed by either the disappearance or nationalization of mortgage finance.  Support for such a measure suggests profound ignorance of how the financial market in general, and mortgage financing specifically, works.  Or, such support suggests ulterior motive.  The events of the coming weeks and months will point to which motivates our congress.

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21 Responses to “Taxpayer Cram-Down”


  1. My response to a comment that appeared on another board is instructive:

    COMMENT: “Doesn’t anyone else realize that this is a good thing? Essentially its a third party, litigated, modification.

    The loan balance is reduced to the VALUE OF THE PROPERTY. Doesn’t anyone see that a foreclosure does not bring the value of the property, but a significant amount less? In addition, if the borrower can afford it, the remainder, or unsecured portion is paid in full. Nobody gets their interest rate reduced. Back payments are paid over the life of the plan. The plan typically lasts five years.

    For the love of GOD<, please educate yourselves a bit. Some of you who call yourself professionals should be ashamed that you know so little about it.

    Nobody will he hustling to bankruptcy court to ruin their credit over an upside down amount of a few thousand. A chapter 13 requires that you pay to the court a significant portion of your income to satisfy your creditors over a five year period. The equivalent of a court enforced budget. Nobody does this unless they have no other choice. It isn’t fun.

    I am stunned at the ignorance on this. It quacks like a duck,,,,,its a foreclosure,,,,and its a loss either way. And if the plan fails, they auto convert to a chapter 7 and they are out of there.”

    RESPONSE: Your analysis is solid, but incomplete. None of these things you mention address the larger financial issues involved. Forget about the home and the debtor for a moment and look at the financial market.

    The problem right now is supply – the capital markets are frozen, and have been for two years. As a result, your government has put up your tax dollars to guarantee investors in order to avoid the complete shut-off of private money into MBS, and therefore into mortgages to consumers.

    Cram-downs add significant risk to the calculations of MBS investors – risk that cannot easily be predicted or quantified. In the short-term, this amounts to the government coming adjusting legally binding contracts between packager, investor and servicer [b]after the fact[/b]. The repercussions of this precedent to the financial should be obvious.

    Secondly, this significantly increases the risk to investor, thereby driving up the demanded return on capital. This translates into higher prices for the consumer – exactly the opposite of what we need right now.

    Finally, absent additional taxpayer guarantees to the investor in the form of cash to make them whole (or paritally whole), private financing of MBS will literally dry up and disappear. This will result in the complete nationalization of the mortgage finance market as there will be no private investor willing to take the risk. I am not suggesting this will be the outcome – government cannot allow it. So instead government will do what it’s been doing – put taxpayers further on the hook to solve problems of capital market liquidity. In this case, the problems would have been created directly by the government (as opposed to indirectly, as with so many other issues).

    Before you express shock over the ‘ignorance’ of ML-Implode readers, I would suggest you step back and look at all angles and unintended consequences. This has repercussions that go far beyond how any specific mortgage transaction is handled in court.

    Further, how auto loans or unsecured loans are handled in bankruptcy proceedings is not analagous to mortgage loans despite the fact that the former are also securitized. The amounts of capital involved are significantly different and neither of the former effect he broader economy and financial markets to the extent MBS do. Furthermore, neither credit card or auto finance securitization pools are intermingled with government guarantees of taxpayer money the way residential MBS are. Finally, purchasers of unsecured MBS understood up-front the risks involved and priced accordingly (or not, as the case may be). Cram-downs amount to changing the rules of the game in mid-stream, in violation of contract, for MBS investors. Such legislation would also have to include lawsuit protection of both packagers and servicers and an array of contract violations by our government between MBS counterparties.

  2. Aaron Krowne Says:

    BWS, it is not the job of the government to intervene in bankruptcies to preserve ANY market. The market needs to move to pricing that will cause it to “clear”, or unclog itself. If that means higher interest rates and lower home prices, what is so bad about that?

    Besides, most of the lending is now going directly through the government, so for all intents and purposes it can set whatever mortgage rates it wants.

    Yes, the private market is dead. And this will probably make it more dead. But the banks and the real estate industry are getting exactly what they deserved for trying to “cram inflated mortgages” (that’s what it is) with the bankruptcy law of 2005.

    The way we should have preserved the private market is by allowing the failed banks to go out of business (just like the failed lenders), continue to wind down Fannie and Freddie when they imploded, and liquidate the portfolios at market prices. Since that was not done, we will be in for decades of economic misery, and closing the bankruptcy door on people is NOT going to help at all.

  3. justin Says:

    objecting to cram downs is a one sided argument to protect mbs investors, however they are already screwed. mbs values have already been written down and the market and model of risk obscuration via securitization is already dead, only the government is keeping the corpse breathing.
    cram downs short circuit the slow process of recognizing deflation in home values and stop the value overshoot due to foreclosure blight on good properties. they also cease the inflexibility of owner as handcuffed renter for eternity with the current solution of ballooning up unpaid interest into the future.
    you want the market to reset, the fastest way is to recognize a loan is better modified to a lower principal, than never repaid at all. this is no gift to owners, they are left with nothing of value unless the market rises.


  4. I dunno….Cramdown was legal in some states until 1993, and there was no meaningful difference in default rates and interest rates.

    The difference now is the separation of the loan servicers from the loan owners, which frequently makes negotiations impossible, which has everyone losing.

    Why should the loan on a primary residence be different from a lone on a vacation residence?

  5. barbedwiresmile Says:

    Guys, which do you prefer? A market solution or a government, state-based solution? You can’t have it both ways. All of you have been proponents of the market finding bottom and opponents of government intervention and it’s perversion of the economy. So here’s where the rubber hits the road.

    You know me well enough to know that I am not making this argument to protect investors or servicers. I’m making this argument to protect the taxpayers. The economic reality of my argument holds true, even if it’s distasteful. Further – look at the political context. Congress has already demonstrated that they will make everyone in the food chain whole with your tax dollars.

    Finally, the difference between primary mortgages and other forms of debt is that we would be changing the rules mid-game, in violation of contract. These MBS were priced and purchased with the understanding that they could not be ‘crammed down.’

    Aaron- on this we agree: “The way we should have preserved the private market is by allowing the failed banks to go out of business (just like the failed lenders), continue to wind down Fannie and Freddie when they imploded, and liquidate the portfolios at market prices. Since that was not done, we will be in for decades of economic misery…”

    Aaron went on to say: “and closing the bankruptcy door on people is NOT going to help at all.” No, but opening it could hurt very badly indeed.

    As always, I appreciate and value all of your thoughts, comments and feedback.

  6. Rick Flairs Says:

    What an idiotic point of view. People with vacation homes,2nd homes are currently and have always been able to cram down these mortgages in a BK 13.

    For the borrowers who had to file a BK – it takes a toll on them both financially and credit wise. The homes that they are in and that they will be getting cram downs on have already LOST the value that is being crammed down. So if they cannot make the payments currently then they’ll walk on the prop. Someone will buy the foreclosed property and the Investor will lose the money that way.

    Anyone against the cram down bill obvioulsy doesn’t understand the mortgage/ financial world.

    Rick

  7. Alex Says:

    The problem with your analysis is that you assume we NEED “investment” in the home market.

    Also, which part of capitalism do you no understand? Bankruptcy is important to ensure corrupt lenders lose when they make risky loans.

    Lower home prices are better for Americans. More Americans can actually “own” thier home rather then be wage slaves in debt to thier banks for thier entire lives.

    This then frees up money to save and invest in “real” business that provides real value.

    High home prices are better for the corrupt lenders / banks / wall-street. High home prices = high commissions, high fees, high interest payments, … usuary.

    Cram-downs are great, wall-street loses, wall-street cannot bribe DC to enact usury laws, ect..

    Good for Obama. Keep going, put the entire mortgage industry as we know it out of business. They add ZERO value to America, all the did was prop up house prices in an illegal ponzi scheme.

  8. Chris Says:

    I thought the legislation was only for existing mortgages? If it doesn’t protect future mortgages in Bankruptcy then how does that screw the taxpayer or dry up investor funds? The banks played with the money and inflated these home values so something has to be done to slow the amount of people (and Children) being pushed out onto the streets. It seems that everyone wants to make the banks or investors whole when they knew this was a ticking time bomb. Yes the borrower should take a hit and they will in this legislation but so should the bankers.

  9. barbedwiresmile Says:

    Rick- that’s pretty funny. If you don’t think this will incent bankruptcy filings you are kidding yourself. The results, in terms of the effects on investor appetite for MBS, will make our current crisis look fairly mild.

  10. barbedwiresmile Says:

    Alex- I’m not sure you fully read my post. I am 100% for the deflation of this credit bubble. Included in that are still-inflated home values. But the destruction of the mortgage finance market and the inevitable nationalization of mortgage lending that will result when the last will investors finally flee will not serve the purpose of finding a sustainable bottom upon which we can rebuild.

    While I appreciate the different points of view and would never censor a comment, I have to admit that I’m surprised by the level of support for bankruptcy cram-downs.

    Do you not understand that this government has demonstrated that it will step in to fill the inevitable void left by the secondary market?

  11. barbedwiresmile Says:

    Alex: “The problem with your analysis is that you assume we NEED “investment” in the home market.”

    Specifically to this comment- yes, I think we need PRIVATE investment in the mortgage market rather than the taxpayer investment we have currently, and will continue to have ad infinitum.

    “Also, which part of capitalism do you no understand?” C’mon Alex. You are not talking to a neophyte. The part of capitalism I understand is this: if bankruptcy cram-down is passed, the cost of credit will increase artificially for those borrowers who are credit worthy. And it will increase artificially- at the hand of government fiat rather than market forces.

  12. Bobo Lazar Says:

    Stop being a mouthpiece for the Banking industry. The American public would really rather have the Gov’t give us $2 trillion to bail us out, rather than the Bankinging industry and “investors” of MBS and other exotic sham investments. These so-called investors are the same ones that we’re bailing out with the funds being given to BofA, Citi and AIG. Cramdown legislation is necessary not to necessarily have anyone actually file for BK; only to use that THREAT (with actual teeth if such would become necessary) to convince the greedy banks to do the right thing. We can’t protect “investors” who made high risk investments in exotic MBS and other similar schemes. Their exposures are also the more inflated due to the exorbitant interest rates that they were collecting. Now they’ve set themselves up to be burned. Mortgage cramdown is really only a mechanism to be used to strong-arm reluctant lenders into negotiating with consumers who would rather stay in their homes and pay something (based on a reasonable/non-inflated market value) rather than NOTHING! In the end this would be much better for our economy than to let capitalism completely cripple our country and destroy our way of life.

  13. Chris Says:

    Again I ask how does the cost of credit increase when this legislation is only for existing mortgages and does not apply to future mortgages. Did someone miss that amendment to the bill? The bill that passed the house only applies to mortgages originated before the bill is signed so future mortgages don’t get any protection.

  14. barbedwiresmile Says:

    Bobo– I’m a mouthpiece for the banking industry? That’s funny. Perhaps you should read through the site a bit more. It’s obvious that you did not.

    Chris– while the form of possible legislation is unclear, even if the final product excluded mortgages originated from the date of passage onward, the precedent would be priced into future securitizations.

  15. Robin Medecke Says:

    I also see this as an unnecessary duplication of effort. The Fed has already agreed to backstop banks’ losses against principal reduction write-downs, so why does this additional measure need to be taken to effectively force the issue? On a side note, I’d have to ask what bankruptcy judge (or their staff) have the level of familiarity necessary to make an underwriting determination as to the warrantability of such action. It’s best left in the hands of the banks (and servicers) without handing more authority and control over to the government. Haven’t they screwed the market up enough already?

    I may be a bit rusty on my legal studies, but isn’t it the role of the Judiciary to interpret the law (including contracts) rather than overwrite it? The Constitutionality of this proposal disturbs me as well, since it appears the judicial class is being afforded executive rights in enforcement. That just plain stinks.

    $75 billion to absorb 31% down to a target DTI of 31% – if that wasn’t enough, now we force-feed it down the banks throats with the BK issue? Sorry, I can’t agree with this as being helpful on any level.

  16. DavidP Says:

    Sorry, I just cannot buy into this conclusion which is the lending industry line. Truth is, all homeowners have paid a much bigger price for the current situation by massive losses in property values. Would consumers pay a higher interest to preserve the values in their properties??? I think so. Not giving the relief worsens the situation for all… remember, each foreclosure increases the inventory of homes to buy and decreases the inventory of buyers (their credit is tanked). The investors want to shift their losses to the taxpayers. In the final analysis, giving a bankruptcy judge the authority to modify will help reduce inventory (modify instead of foreclose keeps a property off the market) which will stabilize the market. Stabilizing the market stops widespread losses of ALL homeowners. Another 10% reduction in property values means a lot of money. Your article only points to the investor protections but does not take into the masses. Remember, this is a country of by the people for the people… the investor community took risk and the day has come.

  17. Rick Flairs Says:

    GET A CLUE! The home prices were pushed up to ridiculous prices because of GREED and corruption. Time for the cram down. Put these idiots out of business, they deserve to be out of business.

    So Alex, your point is to let the realization of the loss of money come from foreclosure and resale at a lower value instead of just cramming the mortgage to what the home is worth?

    You make no POINT with what you are saying. Your definetely wrong though.

  18. Keith Says:

    Made a bad loan? No problem, the Sugar Daddies in Congress will see to it you’re your principle will be protected by keeping the borrower on the hook. The banks can have their cake and eat it too. Moral hazard, apparently, applies only to borrowers.

    The problem with this get away plan is that it ignores a very large and very important group of people: the voters. Politically, it will be tough to explain why Joe and Jane Sixpack will be spending the rest of their lives as debt slaves just to keep these mysterious Wall Street investors in caviar and Aston Martins. Now that 1 in 8 of these voters are under water, they are a rather important voting bloc.

    Really now, how long do the lenders truly expect Joe and Jane to continue paying a mortgage that’s twice the value of their house? It doesn’t take a fiscal genius to realize that the best recourse is to mail the keys back to the bank and walk away. The worst case scenario of spending a little time working out of a bankruptcy beats the hell out of a lifetime of financial servitude. And that’s what borrowers are doing. The vacant houses continue to pile up.

    The lenders are living in a netherworld where they think they are somehow entitled to getting money back. They also live under the delusion that a credit rating means something to a consumer when that person can’t get a car loan or get a credit card. When the hard choice needs to be made between food and credit rating, the consumer will throw the bank under the bus faster than Chainsaw Al can execute mass layoffs.

    When the real estate bubble got going, we crossed the Rubicon. The rules as we knew them no longer apply. The MBAs and high finance people can argue about cram downs until they are blue in the face. Given what they have brought this crisis upon us, I don’t have a great deal of faith in their theories of a “free market”, “capitalism” or much of anything else.

    So, investors, own up to your bad investments the good little capitalists that you claim to be. Accept the cram down, or accept more keys in the mail.

  19. barbedwiresmile Says:

    Keith- your reply, while passionate, makes no sense. This isn’t about lenders. It’s about investors. You know: pension funds, town councils and school boards.

    I suggest you learn more about how finance works before taking such a strong opinion on this issue.

    Even if everything you said about lenders is true, it’s just not relevant.

    The overwhelming majority of these loans are owned by investors, not the lenders who made the loan. If you think institutional bond investors knew what they were buying from Wall Street, you haven’t been paying attention.

    This type of misunderstanding is probably why the same ratings agencies who rated CDOs AAA are still in business, rather than in jail.

  20. barbedwiresmile Says:

    Some more response to email:

    I certainly don’t think I have a monopoly on being right. Clearly I hold the minority opinion on this issue.

    Some have said, including Aaron, that credit is too cheap and rates should be higher. I don’t disagree. The question is how much higher, and who determines this? Like many of you, I think the market should determine price, free of government influence. I don’t see the court- as an arm of government- as a ‘market force’.

    I cannot see a scenario where government changing the rules in mid-game will not lead to increased costs (and other unintended consequences) for consumers. Additionally, I cannot see a scenario where this does not further reduce the attractiveness of MBS, thereby drying up private mortgage funding further and putting government in the long-term position of mortgage financier.

    I can’t buy the argument about bad loans, as this has mostly nothing to do with lenders. It’s the investor that’s on the hook for the loan, not the lender. So using cram-downs as means of ‘punishing’ the investor for the actions of the lender -especially when the security was fraudulently rated, makes no sense to me.

    I am unconfortable with government doling out ‘punishments’ based on popular trends and opinions.

  21. Bobo Lazar Says:

    Here’s a great example of how the “cram-down” legislation HELPS EVERYONE – INVESTORS INCLUDED!

    The new “Cram-Down” legislation will allow Bankruptcy Judges the discretion to modify the mortgage principal balances on primary residences, in addition to completely removing most other junior deeds of trust. In the past, virtually any secured debt on the planet could be modified, unless it was the principal residence. It made no sense whatsoever. But now this new legislation may bring equity to the modification of secured debt. The following example shows how this new legislation could possibly play out in a Chapter 13 case involving a family from Southern California:

    Joe and Jill bought a home in Southern California for $1,000,000.00 in January, 2007. They received a stated income/stated asset loan, and put no money down. They have a 80% first to Countrywide and 20% second to New Century. Two months after the purchase, the wife was laid off and the husband’s income was recently slashed in half due to the economy. Their income went from $15,000 per month now down to $5,000 per month. They have 3 kids and are financing two vehicles. They have amassed $250,000.00 in credit card debt just robbing peter to pay paul and stay in their home. The house is now worth $450,000. They could just walk away from the home and under CC 580b, the lenders could only pursue the property. THERE IS NO RECOURSE AT ALL AGAINST JOE AND JILL. So why not walk? In that case, a foreclosure would provide the second $0.00 and the first would receive about $380,000 once all the costs of foreclosure complete its course. Presently, their expenses are as follows:

    $5,322.00 First Mortgage

    $2,414.00 Second Mortgage

    $1,040.00 Property Taxes

    $ 500.00 Insurance and HOA fees

    $ 650.00 Auto Payment

    $ 550.00 Auto Payment

    $10,476.00 TOTAL

    Under current laws, the cars could be reduced to the fair market value, interest rates cut, and loans recast over 60 months. Total payments would go from $1200 per month to $650 per month.

    But the substantial changes under the new legislation arise from mortgage modification. The second lien would be entirely removed(this is not new and can presently be done under existing laws). But the new legislation would then allow the first mortgage to be reduced from $800,000 to $450,000. The 6.5% interest rate could then be reduced to 2%. Finally, the $450,000 could be spread over 40 years. The result: $1,363.00. Thats right, their combined mortgage payment could be reduced from $7,736.00 per month to $1,363.00 a month, a savings of $6,373 per month or over $76,000 per year in interest payments!

    Additionally, they save $550,000 in principal reduction, eliminate $250,000 in credit card debt, and rewrite the vehicle loans. In all, they go from paying $10,476.00 per month for the home and cars to $2,979.00 for the home and cars, saving nearly $7500 per month. In 5 years, they are then debt free, have the cars paid off, and continue paying the $1,363.00 mortgage payment. Its a no brainer for anyone wanting to save their home from foreclosure. Under the new laws, it seems everyone wins.

    Are the banks mad? They say they are, but I’m not sure why. Most banks do not hold these stated income/asset loans. Rather, when Wall Street got drunk, they were sold off in the form of Mortgage Backed Securities and Collateral Debt Obligations and traded to institutional investors. All the banks typically do is service the loans for profit. So I’m not really sure why the gripe?

    Should the investors be mad? They say they are, but again I’m again not sure why? In the forgoing example they get $450,000.00 as opposed to $380,000.00 in a foreclosure. They save $70,000.00, and in a market where real estate continues to fall and where they could stand to lose thousands more at a later foreclosure date.

    This new legislation must still pass the Senate before hitting the President’s desk. There is talk of amendments to the legislation. Its certainty still is unknown. But one thing is certain. If this legislation passes as it is presently written, California’s (and the rest of the Nation’s!) Real Estate Market will begin to stabilize. This is simply because “walk aways” will no longer make sense and housing supply will stop increasing.


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