So it's been quite awhile since I've posted anything. I've had my hands full trying to bring lenders to the table to work with my clients. We have had some successes and some disappointments, but mostly it's waiting around for lenders to get back to us.
One exciting development is the prospect of a change to the Bankruptcy Code that will allow judges to treat home loans like any other secured debt. Under current law, if your car, boat, farm, or vacation home is worth less than the loan(s) secured by it, the judge can reduce the principal balance to reflect the lender's actual secured value, and adjust the payment terms accordingly. In bankruptcy circles, this is referred to as a "cramdown." For the past several years, home loans, especially first position loans, have been off limits to this sort of treatment.
Senator Richard Durbin has been trying to change that. He first introduced legislation to fix this issue back in 2007, and again in 2008, but the Bush Administration made it clear that any such measure would receive a veto. Now that we have an Obama Administration (President Obama has long expressed support for this type of reform), many people believe that the present form of the bill could be approved in the coming weeks. The proposal is being called the "Helping Families Save Their Homes in Bankruptcy Act of 2009."
Senator Durbin, along with Representative John Conyers, Jr. in the House, have worked on getting the measures through their respective chambers in Congress. The House version has already been amended and approved by the House Judiciary Committee, and floor hearings started earlier this week. The Senate version is still in the Judiciary Committee. The Senate bill is SB 61, and the House version is HR 200.
For obvious reasons, the lending industry is fighting against the proposal tooth and nail. Banking trade groups are using scare tactics by claiming that the cost of home loans will go up as much as $297 per month - of course, no evidence is offered in support of such a wild claim.
In fact, Professor Adam Levitin with the Georgetown University Law Center did a statistical analysis of actual loan rates the last time bankruptcy judges had this power. From 1981 to 1993, some parts of the country allowed judges to cramdown home loans, while other parts of the country did not allow it. As a result, we had a two tiered bankruptcy system, and the ability to compare home loan rates in cramdown areas to rates in non-cramdown areas. The result? Rates were not higher in the cramdown areas.
If passed, the changes proposed will give homeowners leverage to get lenders to make reasonable, sustainable changes to their loans. This is because most lenders will want to avoid bankruptcy like the plague - especially on homes with severely under water values.
One last benefit of the current proposal ties back to TILA. If a homeowner can show that the lender violated TILA in such a way as to give the owner a right to rescind, the judge would have the power to invalidate the debt entirely. This is a huge risk for lenders, especially on loans made during the bubble, because so many signings were done with mobile notaries and little to no follow up or oversight. While some may see this as a heavy penalty, take a look at the Bankruptcy Code sometime - it's full of heavy penalties that are intended to punish a debtor or creditor who fails to play by the rules.
Hi Jason,
Cromdowns are great but open a huge problem with the Bankruptcy judges in the system. They can act largely like little despots without practical risk of appeal (since one party is probabaly indigent), and without uniformity.
thanks
Stuart
I don't know too much about all of it. I wish something positve would happen. Foreclosures are really clouding up the market and there are more and more each day.
@Stuart:
There is and always will be a lack of uniformity in how judges handle many bankruptcy issues. This is actually by design - while the Bankruptcy Code is a set of federal laws, there is a large, intentional interplay with State laws. For example, exemption and exclusion rules vary greatly from state to state, and they always have. This reflects the regional differences in how State Legislatures view debts and obligations - the States can make changes to their rules (in California, most of these rules are in the Code of Civil Procedure), and the BK courts in that state will adjust how debtors are treated accordingly.
As far as judges acting like little despots, I don't know about your experience, but from my own experience appearing before judges, they are usually thoughtful, take their responsibilities seriously, and mostly want to get matters through the system and off their calendars.
Frankly, compared to lenders acting like little despots, I would much rather take my chances with the judge.
Great post. This problem with the economy, loss of jobs, bad lending deals, irresponsible buyers, over heated market of the past, gotta have it now attitude, increased greed from consumers and corporations all came together as a perfect storm and has caused many individuals and businesses to enter into bankruptcy proceedings that may take years to figure out and correct. At the very least it has kept the real estate business very interesting.
Hi Jason,
I have experience on both a personal and corporate level on workouts and collecting debt. I've seen some crazy things...but I agree the lenders are worse.
What's the difference to the bank whether the loan is a cram-down or a foreclosure? Either way, they are getting current market value for the home. With the first option, it would seem that there would actually be lower costs - no real estate commission, etc. Not only that, but fewer homes on the market would start to RAISE home values, which means that the bank would start getting higher appraisals on remaining loans, and so on!
HERE! HERE!
I've been beating this drum for 6 months. This, to date, is the only thing on the horizon that will deal wiht the ELEPHANT IN THE ROOM, negative equity.
Aloha Jason,
Banks should become nationalized non-profit entities whose sole purpose is to assist and promote economic development of our industries, commercial entities, and individual citizens instead of enriching a minuscule minority of international bankers at everyone else's expense.
Thomas Jefferson, (Attributed)
3rd president of US (1743 - 1826)
Peace,
Very interesting, It would be nice if more laws used common sense instead of the billions we are just signing off on for foolishness.
"As far as judges acting like little despots, I don't know about your experience, but from my own experience appearing before judges, they are usually thoughtful, take their responsibilities seriously, and mostly want to get matters through the system and off their calendars."
I agree and this is one of the reasons I believe the home owner will get a better shake in bankruptcy court rather than being at the mercy of the lender, which is the current quagmore. I worked with the U.S. Trustees office for some time and I have a tremendous respect for bankrutpcy judges.
I love this post.
Jason,
Thanks for the update! Please continue to keep us abreast of what is happening.
Kathy Opatka Re/Max OCEAN CITY, MARYLAND
Won't this increase the number of people willing to file bancruptcy?
Won't this increase the number of people willing to file bancruptcy?
Jason - I am thinking along the line of Kim. Why the heck wouldn't someon file for bankruptcy and get his mortgage reduced? I can almost see trumped up hardships. I hate to agree with the banks, but what IS the worth of a contract if isn't even upheld by the courts? Would not an investor think twice about investing in mortgages at certain projected rates of return, when it would just be rolling the dice. Explain what I am missing.
@Wendy:
Thank you for your post. In answer to some of the points you raise, please consider the following:
In reality, the risk of "trumped up hardships" is very small, especially after the 2005 amendments to the Bankruptcy Code. In fact, under the current rules, some people who really do need the protection of the bankruptcy system cannot find relief - and all because mortgage bankers and credit card companies spent millions lobbying Congress for the 2005 changes.
As far as the "worth of a contract," our deeply rooted notions of fairness and due process require us to consider the value of an asset offered up as collateral for a secured obligation. If the collateral's value is less than the debt it secures, then it is fundamentally unfair to treat the debt as though it's worth its face value. After all, would you pay full value for a $500,000 home loan secured by a home worth $300,000?
These notions of fairness are not just words. To give you an historical perspective, around the time our Constitution was being written, back in England people were forced into Debtors' Prisons, Work Houses, and into indentured servitude because of debt problems. Our founding fathers saw this issue as something to avoid in the United States - that's why Bankruptcy is specifically mentioned in the Constitution. Perhaps the better question is this: should regular people have to work themselves to death or exhaust their retirement savings, just to keep some bank off their backs? In America, the answer to that question has generally been "no."
Regarding your final question about investors thinking twice, I agree with that sentiment 100%. Investors should have thought twice during the real estate bubble.
The sad truth is this: trillions of dollars in international investment money were all looking for a home, and as a result, investors were willing to take bigger risks just to park their money somewhere. Wall Street did to residential mortgages what had already been done (and successfully, I might add) with commercial real estate loans by securitizing them. The dirty little secret is that Wall Street sold these securities by telling investors "Hey, these are backed by home loans, and market values are rising at double-digit rates. Besides, everybody pays their home loans, and everybody needs shelter." ...Famous last words.
The problems were 1) money became too available in general, 2) anyone who could fog a mirror could get a home loan, 3) eager investors didn't do their homework, 4) investment sponsors downplayed default risk and focused instead on the artificially increasing home values, and 5) homeowners bought in to the whole "it's okay, put your equity to work for you, you can always sell later if you have financial problems" line of reasoning.
Sound investment requires understanding and limiting risk. In this case, investors got it wrong, so shouldn't they bear some of the pain of the current meltdown?
Thanks Jason for writing this article. I completely agree with (Thomas Jefferson)The predatroy lending practices and bankruptcy courts pander to the banks and institutions.In Sweden they nationalized the banks......
Jason - Thank you very much for your edifying explanation. I'll study it!
Interesting article...lets see what happens!
Jason,
Lenders so far have been rather reluctant to work with homeowners in distress, seemingly against their best interests. If the bankruptcy law changes, it would get them moving. The study about cramdown effects and rising interest rates is a nice proof to lenders that their argument doesn't hold water.
Good point in terms of the potential for this change to catalyze lenders being more flexible. Lord know the market needs the lenders to get real to get things moving.