(snip)"A lot of people have raised questions in the comments regarding proposed changes to federal bankruptcy law to accommodate modifications of mortgage loans [ the bill is known as HR 3609 - sic].
Here's the issue, in a nutshell. Until the 2005 bankruptcy reform, insolvent homeowners could choose Chapter 7 (liquidation) or Chapter 13 (repayment plan) bankruptcy. After the reform bill, for practical purposes most homeowners are limited to Chapter 13."(snip)
(snip)"You can think of Chapter 13 as itself a kind of loan modification: the court establishes a 3-5 year repayment plan for all the borrower's debts, with the unpaid remainder discharged at the end of the repayment plan period. In Chapter 13, the debtor can keep a mortgaged home, as long as he continues to make mortgage payments throughout the plan period, and makes up any past-due amounts (including fees) during the repayment period as determined by the repayment plan. If the borrower does not or cannot continue to pay the mortgage, the stay is lifted and the lender can foreclose.
However, secured debts can be restructured or modified in a Chapter 13 bankruptcy, and secured creditors, except the mortgage lender on a principal residence, can be subject to what is called a "cram down." This happens when the amount of the debt is greater than the value of the collateral securing it; the court reduces the value of the secured debt to the market value of the collateral, with the remainder being treated as unsecured (and subject to the same repayment plan/discharge terms as any other unsecured debt)"(snip)
(snip)"Nonetheless, that reliable source of comic relief, the Mortgage Bankers Association, wants you to think that allowing cram downs or other kinds of loan restructuring would, um, ruin the party:
“Giving judges free rein to rewrite the terms of a mortgage would further destabilize the mortgage backed securities market and will exacerbate the serious credit crunch that is currently hindering the ability of thousands of Americans to get an affordable mortgage,” said Kurt Pfotenhauer, Senior Vice President for Government Affairs and Public Policy for MBA. “The current legislation gives no guidance as to the proper parameters for judges to modify existing loan contracts.”
By allowing judges to rewrite loan contracts and provide whatever relief they individually deem appropriate, HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured. As a result, lenders and investors would likely demand a higher premium for offering these loans. This premium could come in the form of higher fees, a higher interest rate or the requirement for a larger downpayment, all of which would serve to make the American dream of homeownership less attainable for many Americans.
In other words, the MBA implicitly admits that in the post-1993 era lenders have made low- or no-down loans at interest rates that, while high enough in terms of the blood they extract from strapped borrowers, are still lower than what they would have been if the lenders had had a healthy fear of BK court restructurings. Of course it's beyond ludicrous to argue that being forced to take what they can reasonably get by a BK judge is the "destabilizing" factor here, but you can count on the mortgage industry be ludicrous when dollars are on the table.
In fact, I have some sympathy with the view that mortgage lenders "perform a valuable social service through their loans." That's why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I'm here to tell you that you will certainly not "forget" to model negative HPA in your ratings models, and will probably pay more than a few seconds' attention to your appraisals. You might even decide that, if a loan does get into trouble, you're better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you'll accept."(snip)
(snip)"But I think my favorite part of the MBA lament is this: "HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured." Translation: lenders mark to model, but if you let them, BK judges will mark to market.
Is it possible that BK judges would use the lowest plausible "distressed liquidation value" to determine the secured part of the mortgage loan? Sure it is. BK judges don't have parts of their job descriptions that refer to supporting home values or keeping those comps up or controlling "price discovery." The cram down is, precisely, the "mark to market" you don't want to get, which is why the risk of it used to function as a brake on lender stupidity."(snip)
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however, this gov't sanctioned 'mark to market' which would result from HR 3609 would also cause an immediate readjustment in assessed values of surrounding real estate ... which in turn would vastly reduce property tax revenues ... which would also officially reduce the equity of surrounding real estate owners ... and which would also officially reduce the market price of mortgage backed securities held in the portfolios of mortgage companies / banks / hedge funds etc.
For the 'subprime borrower' HR 3609 would apparently allow the homeowner to go into Chapter 13 bankruptcy, make reduced payments per the court ordered payment plan for the next 5 years (while still living in the house), and then emerge with the balance of the outstanding mortgage reduced from whatever it is today based on the actual purchase price paid to whatever the house is actually worth in terms of market resale price. This represents the potential for 15-25-35% losses to be 'crammed' onto the mortgage lenders, and a 15-25-35% gift being bestowed on subprime borrowers by the bankruptcy court.
Obviously if this bill becomes law there is going to be a huge line of distressed homeowners at the courthouse steps ... and 6 months later there will be a long line of financial institutions at the courthouse steps as well !!! Just as obviously, mortgage lenders are going to become EXTREMELY conscious of the losses that could be 'crammed' against their own bottom lines by future mortgage loans going into bankruptcy in an environment of falling housing prices ... meaning that they are going to tighten creditworthiness / down payment / income verification requirements to extreme levels when writing future mortgage loans.
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