Harry Moroz
Cramdown Dustup
The House’s aborted vote on legislation that would allow bankruptcy judges to reduce the principal and interest rates of mortgages on primary residences, a practice currently barred, has predictably caused quite a dust up, as the New Democrat Coalition has raised concerns about who is eligible for modification. According to their argument, the moderate Coalition wants modification in bankruptcy to be a last resort: the compromises they have forced into the legislation will require homeowners to seek loan modifications prior to filing for bankruptcy, permit judges to prohibit such “cramdown” in bankruptcy if a “qualified loan modification” offer was made to a homeowner (a “qualified” modification seems to be one that lowers monthly payments to 31% of income), and restrict cramdowns to loans that are unaffordable to borrowers (rather than all mortgages that are worth more than the houses they cover).
David Waldman at CongressMatters has thoroughly documented the interference that Rep. Ellen Tauscher [D-CA] has been running for the New Democrats. Indeed, her latest claim that requiring homeowners to contact their mortgage lenders before seeking bankruptcy will somehow lead to more (and better) modifications on the part of banks is hard to believe:
The banks have got to stop falling on the ball and start answering their phone…We need to get these qualified loan modification programs up and running.
After all, the Hope for Homeowners program, begun in October of 2008, had only closed on 22 loans as of January. Tauscher seems to miss the point that, though modification in bankruptcy should be a last resort for homeowners, the option is what incentivizes banks to modify before bankruptcy. The “heinous practice” (according to Tauscher) of modifications that actually raise a borrower’s monthly payments is, in fact, more likely under the compromise plan, as mortgage holders seek to keep their mortgages out of bankruptcy as long as possible without reducing the amount currently owed.
Why hold homeowners “responsible” for contacting their mortgage holders while blaming banks for “falling on the ball”?
Changes to the bankruptcy modification bill should seek to limit the number of homeowners who re-default and suffer foreclosure after their mortgage is modified in bankruptcy, a double-whammy to both the homeowner and the housing market. In this respect, limiting modifiable loans to unaffordable ones is undesirable: modification in bankruptcy might in fact be best for homeowners who can afford their current mortgage payments but are underwater. Homeowners with trouble paying their bills because of a high adjustable rate alone will be protected by bankruptcy protection, but those suffering from, say, job loss as well as high interest rates are at risk of the double bankruptcy-foreclosure whammy, a situation income requirements do nothing to stop (Citigroup just announced a program to assist this latter group.).
Still, as Adam Levitin of Georgetown law wrote in a paper earlier this month, bankruptcy modification is uniquely beneficial because it provides:
a solution for both of the distinct mortgage crises—negative equity and payment shock. Bankruptcy modification would help negative equity homeowners by eliminating their negative equity position (“cramdown”), which would reduce their incentive to abandon the property. Likewise, homeowners who are unable to afford their mortgage because of a rate reset, due to the expiration of a teaser rate or to the resetting of an adjustable rate mortgage or to the reamortization of an option-ARM could modify their loans to make monthly payments fixed and affordable...
Tauscher and the New Dems are most concerned about homeowners who might use bankruptcy to improve their equity position: their compromise seeks to make principal write downs the absolute last option. Concern for how to prevent more foreclosures would better serve homeowners and the housing market.
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Posted at 7:49 PM, Mar 03, 2009 in
Housing
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