Don’t Ask, Just Cram: It’s Time to Put Mortgage Modifications Back into Judges’ Hands

Don’t Ask, Just Cram: It’s Time to Put Mortgage Modifications Back into Judges’ Hands

By Abigail Field Posted 12:00PM 04/06/11 Columns, Real Estate, Credit

Many state attorneys general, federal law enforcers and regulators say they want big banks to pay for their fraudulent foreclosures and abusive mortgage servicing practices by reducing what borrowers owe them by some $20 billion. That’s the amount the banks allegedly saved by doing a lousy job servicing troubled mortgages. (That math is questionable at best, Yves Smith noted when that figure began making the rounds.)

But the solution to this problem is not a settlement with the banks that mandates principal write-downs. Principals on these loans should be reduced, but it should be done in the most efficient, effective way: Congress should give bankruptcy judges back a power they once had — the right to reduce the principal on a mortgage to the home’s current market value. In other words: Bring back the cram down.

Reducing mortgage principals to homes’ current market value is critical step to healing our economy. First, it would stop many foreclosures because borrowers would be able to afford to keep their homes. Reducing foreclosures would preserve property values and cut back on a big source of the oversupply in the housing market. Moreover, after cram downs, people could more easily sell their homes and move to where jobs are. Sales wouldn’t be “short” anymore. Finally, in a post-cram-down America, people would have more disposable income, which would allow discretionary consumer spending to rise.

Why Voluntary, Bank-Run Modification Programs Fail

So why shouldn’t regulators simply include write downs in the settlement between law enforcement and the banks? Because the Home Affordable Modification Program has shown that any system that relies on banks to chose among borrowers and design their modifications will fail. Back in the 1980s, this country experienced a similar failure of voluntary programs to solve a huge problem with underwater mortgages triggered by the popping of an agricultural real estate bubble.

As the Federal Reserve Bank of Cleveland explained in its analysis of what happened then to family farms:

“Many farmers, like many homeowners now, were in danger of losing their primary residences, with little prospect of relief under the bankruptcy options available to farmers at that time….

Moratoriums on foreclosures in a number of farm states slowed the rising tide of farm foreclosures somewhat, but they provided only a temporary reprieve as the fundamental economic factors … left many farmers unable to service their existing debt and with almost no possibility of renegotiating their secured loans with creditors….

…voluntary modification efforts, even when subsidized by the government, did not lead agricultural lenders to negotiate loan modifications.”

That phrase “with little prospect of relief under the bankruptcy options available” is key. Our current bankruptcy laws allow debtors in bankruptcy to force banks to reduce the principal on most loans secured by property to the current market value of that property, but not all.

For example, if a debtor owes $500,000 on a yacht that’s now worth $300,000, the debtor can keep the yacht by paying every penny of the $300,000, and as much of the rest as the bankruptcy process allows. Ditto for a limo. More to the point, bankruptcy judges can “cram down” the principal on mortgages securing vacations homes and investment properties — but for the most common mortgage of all, the one securing the loan on a person’s primary residence, they cannot.

A Solution That Has Worked Before

At least, not anymore. Home mortgages could be crammed down nationwide until 1978, when Congress changed the rules. Even after that, thanks to disagreement among courts on how to interpret the rule change, they could be crammed down in some parts of the country until a 1993 Supreme Court decision ended the practice completely.

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In the 1980s, the Cleveland Fed explained, the bankruptcy code didn’t let allow family farm mortgages to be crammed down either. But when voluntary programs failed, Congress created special bankruptcy law provisions to authorize farm cram downs. Then, as now, reported the Cleveland Fed, the banks warned of financial doomsday, saying cram downs “would flood bankruptcy courts, permit abuse by borrowers who could afford to pay their loans, and reduce the availability of credit, among other things.” None of those things happened.

Instead, the cram down law “worked without working”: It was rarely used actively, but banks sustainably modified mortgages anyway. As soon as borrowers had leverage — negotiating with the threat of a cram down behind them — banks started cutting meaningful deals.

To be fair to then-Speaker Nancy Pelosi’s House of Representatives, it passed a cram down bill in 2009. But the Senate failed to get the job done, as President Obama and some powerful groups like and labor unions largely sat that fight out.

How Banks Beat Back Cram Downs

What was the argument that the banking lobby used to kill the bill?

Surely it wasn’t the claptrap about “moral hazard.” Unlike the banks and their executives bailed out by the taxpayers, homeowners aren’t “encouraged” by a principal reduction “bailout” to make increasingly risky, self-interested decisions, secure in the knowledge the the government will save their bacon if it falls in the fire again. That’s behavior by bankers is a real and present hazard to our financial system.

The only specific “hazard” the anti-principal mod lobby mention is that borrowers who are current will default to get mortgage modifications. There’s one big problem with that claim: Mortgage servicers have routinely been telling borrowers who are current that they will have default before they can get help. These are borrowers who were blowing through their savings struggling to stay current on their underwater mortgages, and were reaching out before default to work something out with their banks — responsible borrowers.

The practice of telling these people to default before a modification could even be discussed has become so common that both the state attorneys general’s proposed settlement with mortgage servicers and the banks’ much weaker counteroffer address the issue. This alone makes a mockery of any potential argument about the bad moral consequences of allowing judges to make principal modifications.

And doing the reductions via the bankruptcy code also reduces any incentive to default to get help. Borrowers don’t — and shouldn’t — take bankruptcy lightly.

Fears of Another Financial Industry Meltdown

So what was the argument the bank lobby really used to kill the cram down bill in 2009? I don’t know, but one type of financial doomsday lurks in the background now that didn’t in the 1980s: Bank Bailout II. Mortgage principal write downs in large numbers could push some big banks over the edge — or force them to reveal their present insolvency.

The question is whether enough consumers to bring on that dreaded scenario are willing to face the long, punitive process that is bankruptcy to get mortgage principal write-downs. That begs a second question: If large numbers of write downs led banks to demand another bailout, would they get it? Both are impossible to answer, but the gains are well worth the risks.

If restoring the cram down induces a consumer-bankruptcy-driven financial system failure, that’s an important reality check. The nation would have to face the fact that TARP had failed to get the job done, and that it was time to either fix the big banks’ balance sheets for real, or shut them down. It would prove that we can’t continue to engage in policy theater such as HAMP or leaving mortgage modifications to the discretion of lenders.

Whatever the outcome for banks, Washington needs to suck it up and start instituting good policy.

See full article from DailyFinance:

7 Responses

  1. The only thing we need to do is put handcuff’s on alot of Judges in The United States of Soviet America.

  2. Obama “had chances” to pass cramdown. I use the quotes because their was/is no way that the Geithner/Bernanke administration will ever consider cramdown. I do remember a orchestrated campaign by the Dick Armey group to pay people to wave signs saying that they won’t pay for “their neighbor’s mortgage”. Sometimes propaganda is more effective then outright violence, but not too much different.

  3. First off, banker bailout II would be written about in history books for years to come as the great unwinding….the start of the 2nd Revolution and the bloody end of the kleptocracy that has wrapped it’s tenacles around what was left of the world governments for the last several decades. The death of the Vampire Squid Banking System.

    Second, of course their should be cramdowns….that’s too easy. It’s just that the GOP in it’s fervent desire to please their masters decided that max pain should be directed towards any deadbeats thinking of filing BK, as if it’s something one does lightly in this heavily rigged system of Fico they win, Fico we lose.

    Just remember that the GOP left in the BK rules that 2nd homes could still be written down. 2nd homes are something deadbeats don’t have to worry about, while it’s a handy tool for the wealthy. A million dollars can be stashed in retirement accounts untouched by BK, yet another great tool for the wealthy. But just try and reduce the mortgage of a small farmer hanging on for dear life….FAT CHANCE!

    Third, read again the shaded area above. There’s no mistaking that farms are being lost all across the planet to foreclosure. Tragedy? More than we’ll ever know, until it’s too late. The elite are buying up farm lands all across the globe, knowing full well that anything that’s a guaranteed necessity is a guaranteed profit.

    Jim Rogers, the legendary trader, has been stating for years that the next great wealth creator is farms/food production. Read the following:

    Australians are in danger of becoming servants, not masters, of their own food resources.

    This is not an alarmist view. In a US report last year titled The Great Land Grab, the Oakland Institute said oil-rich, arable-poor Middle East and wealthy Asian countries “are seeking to acquire land as part of a long-term strategy for food security”. Purchases in South America, the subcontinent and Asia have begun.

    Australia and New Zealand are high on China’s list. In June, a Tasmanian real estate agent reported strong interest from China in northern Tasmanian dairy farms.

    The recent release of documents showing what many of us believed all along, that the U.S. and it’s Euro partners that invaded Iraq didn’t do so for the bogus reasons explained before the United Nations. It was, simply put, a grab for oil. The elite that own and run the planet realize that it’s in their best interest to simply take what will benefit them, damn the people. How many good men and women have lost life and limb fighting for what they were told was white, when in reality it was very dark black?

    It’s about time we the people woke up and realized that we have to take back what was and is our birthright, and what we’ve worked for for generations.

    How do we accomplish such a seemingly impossible goal? It’s really very easy: strategic default. This means at first on an individual level…..stop paying these ridiculous usurious fees. Then, on a global scale. We force our governments to default on these ridiculously excessive debts that NONE OF THE PEOPLE have agreed to. I take that back. Geithner, Bernanke, and Lord Dimon have agreed.

    Is this morally wrong? That question is laughable in light of the current global crisis. Wouldn’t their be mayhem? Quite assuredly! But that’s coming anyway to a street corner near you, you can bet the farm on that, if they don’t take it before you can double down.

    Chris Whalen writes:

    All of these champions of the status quo ante are, ironically enough, serving as agents for the bond holders of the largest US and EU banks, the clients of PIMCO, Black Rock and even my friend David Kotok at Cumberland Advisors. These agents of the global creditor class are betting on the likes of Bernanke, Trichet and Merkel to collect their debts for them like so many China gunboats — and thereby plunge hundreds of millions of people into penury for decades to come.

    It is no small irony that the interests of the banks and bond holders in the US are being protected by a Democrat from Chicago named Barack Obama. Far from being a leftist, Obama is a global technocrat who turned out to be the most perfectly compliant stooge for the interests of the large banks and institutional investors. With Timothy Geithner at Treasury and former JPMorgan banker William Daley at the White House, the only decision Obama needs to make every day is what shirt to wear.

    There’s nothing wrong with individuals defaulting on a debt that is now so far underwater as to seem Titanic like, with absolutely no help coming from government. Get over your false pride and ill-felt shame people. You weren’t a part of the casino, remember?

    Chris Whalen again:

    Barack Obama has already failed that test of leadership by studiously avoiding any response to the US real estate meltdown, but new leaders in many heavily indebted nations will face the same issues — chronic levels of debt that will only grow heavier as and when global interest rates rise. If the ECB manages to bully Prime Minister Kenny in Ireland, do they really expect a more malleable regime after the next election?

    The Irish have had it with being told to eat the debt that their runaway banks created. They are, like Iceland, refusing to sell their children into debt slavery to save the elite and their bondholders.

    Quit thinking that you need to abide by the rules, when the game pieces and the board you’ve been playing on have been foreclosed on and snatched by the banks, with no money down. It’s time to grow a pair and face down these so-called leaders, who are actually followers, and tell them NO!

    As to the problems discussed repeatedly and doggedly on Living Lies, do your due diligence. I have. I looked into the retirement portfolios of my state’s judiciary and lo and behold! PIMCO, Black Rock and Cumberland Advisors! What a coincidence! The judges who are foreclosing on us and our farms are holding up the rear tenacles of the squid as it moves through our states wreaking havoc! They too have eaten the pod!

    Default. Let them eat cake, but take back the farms that grew the ingrediants. And take back your homes. Screw the elite and their bondholders. Default now, for your children’s sake.

  4. Foreclosures that have been idle for 2 years are being sold off left and right. Looks like the Banks want to wash their hands of any filth.

  5. “Principal reductions I don’t think are going to be agreed to by banks, and I don’t think the banks see a need for a penalty when, in their view, they haven’t done anything wrong,” said Ms. Schoenthal, who represents lenders and servicers….” Bloomberg

    If banks still say they have ‘no clue’ as to why they’ve been called in, how credible are their cease & desist submissions? Recitivism is ongoing during settlement discussions with the AGs? The slap on the wrist has failed while ongoing?

    The blatant immorality of TBTF cannot be modified. The banks singular goal is to get thru these talks and get back out on our Main Streets to continue, or invent some new, morally bankrupt, Gang Bang Violation of The People.

    AGs should return home to investigate without relent and to ‘give banks the law’ already in place and violated. Saying it in smaller words is FAILED.

    Cram down sounds perfect. Forget about the banks ‘we prefer not.’ They owe Reparations. How many of us, disparagingly termed ‘deadbeats,’ are standng in line around the country to get a mark down- some kind of consideration- to get lives, the economy, this Nation, back in order. Can we at least change the title to ‘Patriot Deadbeats?’

    WHO is stopping the cure? The banks who say empty words of remorse in court papers, but whose actions demonstrate no capacity to comprehend that they’ve done something wrong? That’s Bargaining with Terrorists 101.

  6. It is time to put judges in Jail.

  7. This article misses the Elephant in the room! IRS REMIC Code. If these loans are part of a securitized REMIC Trust…that actually exists…it CANNOT be pulled out and modified. REMIC’s have to remain stagnant. Nothing in, out,or modified AFTER the closing date of the Trust.

    The Trust suing us contained 6800 loans. It was then split up into 4 REMIC Trusts and the Investment Bank involved kept a big chunk of loans as well. There are NO loan numbers or identifying information for ANY of these pieces.
    That is 1.18 Billion in tax free pass through of income through the REMIC Trusts with NO loan numbers.

    Still waiting for the Judge to tell me which direction OUR loan took. Plaintiff will not answer any discovery. Should we just guess… PICK a

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