Bankruptcy Ploy

Apparently Democrats in Congress aren't satisfied with the billions of dollars that will be required to clean up their Fannie and Freddie mess. As the price for passing Treasury Secretary Hank Paulson's asset-purchase plan, Democrats are pushing a plan to make it easier for borrowers to renege on their mortgage payments yet still keep their home.

As Senator Chris Dodd's Banking Committee Web site explains it, "The only way to really help homeowners keep their homes is to allow borrowers to get the mortgages on their first homes reduced to the market value of those homes through bankruptcy." This may sound like a great idea to troubled borrowers, but since taxpayers are increasingly now the lenders in these transactions, it will simply increase the cost of Mr. Paulson's plan.

The pain may be even more acute for those hoping to buy a home, if markets logically respond by setting mortgage interest rates closer to those on, for example, auto loans or credit cards. A bankruptcy judge is now free to reduce amounts owed on many types of consumer debt. For mortgages, the iron-clad requirement to pay off the loan or lose the house is precisely to encourage lower rates on a less risky investment.

Justice John Paul Stevens described the importance of this principle in 1993 in Nobelman v. American Savings Bank: "At first blush it seems somewhat strange that the Bankruptcy Code should provide less protection to an individual's interest in retaining possession of his or her home than of other assets. The anomaly is, however, explained by the legislative history indicating that favorable treatment of residential mortgages was intended to encourage the flow of capital into the home lending market."

This bailout will not fix the next problems,
all they are doing is cleaning up after each domino
falls.

The next crisis will be default of the cities,
townships, and counties that find out too late that
foreclosed properties will go delinquent on property taxes.

The real solution is to fund the local governments,
city, township, county to figure out how to keep people
in the houses and making payments.

One local city buys foreclosed houses, fixes them up and
then resells them. Kind of like urban renewal, one house at
a time. Perhaps someone will figure out how to do this
prior to the foreclosure/abandonment.

The proposed bankruptcy amendment applies only to homeowners already delinquent and facing foreclosure. If the house went to foreclosure, the bank would buy the property back for its claim. However, after foreclosing, the bank cannot sell the home for more than its market value, so, inevitably, the bank is going to suffer a loss equal to the difference between what’s owed on the property and what it’s worth. If the bankruptcy court converted the “at risk” portion of the mortgage to an unsecured claim, and reset the mortgage to a reasonable market rate, the bank would stand to get get more money in the end.

Joe Sixpack

Let's see who owns the home.

The borrower who has not yet filed bankruptcy owns the home.

If he defaults the bank owns the home.

If the bank bundled that mortgage, then those who bought the bundle get the proceeds off the home, the loan and paper on which is still owned by the bank.

The buyers of the bundle are getting no money.

The bank is getting no money but they own the property if it's in default.

The borrower, if he hasn't filed bankruptcy is living in a house he owns but he isn't making payments on, and now someone wants to give it to him as a Christmas present.

I'd say Joe Sixpack is doing quite well, thank you.

Simple answer: REFINANCE the loan at a fixed rate for a longer term....say 50 years....until the price gets down to what Joe Sixpack could afford when he took out that ridiculously low rate APR loan. Everybody bites the bullet a bit; everybody gets a little bit; and the American taxpayer doesn't have to pay anything.

WSJ incompetence in news reporting.

“cram down” has been part of the bankruptcy code for years. (subject to the rules of course)

What the WSJ inartfully or rather INCOMPETENTLY is trying to articulate is the “lien stripping” provisions of the code.

The LENDER assumes the risk that collateral will diminish in value. This is why home loans were seen as conservative because their value appreciated slooooowly. That is until the bunders created a demand for mortgage papers. Then the LOAN became a commodoty of value seperate and appart from the actual home.

Under the old pre2005 code the undervalued home could be stripped of the unsecured portion of the loan.

Even under the current code, a debtor can DUMP the unsecured credit card debts and replace it with paying the home mortgage.

Also another WSJ reporting blunder, ALL bankrupcy discharges are subject to judicial review. This includes reaffirmation agreements and cram downs and lien stippings.

seriously, the drumbeat of stupidity in the press corps is unbelievable.

If banks foreclose on everyone whose loan is in default, they end up owning the homes and they end up with a huge inventory of REO. They sell what they can at fire sale prices, usually 80 or 90 percent of the FMV, which accelerates the downward pressure on prices and puts even more people underwater.

Homeowners who bought the homes for speculation, as second homes or who could not afford the payments even if refinanced should not be kept in their homes. Start with that as a principle.

Homeowners who bought a home, can make the payments under terms that are similar to those they bought with (before resets, etc.) but who are now under water and have a loan with bad terms, could be helped, and it would be good for the housing market. The home price could be lowered to its current market value and a loan at a standard, low, interest rate, could be given to that homeowner.

The bank loses less than it would if it had to foreclose, and the market doesn't get slammed by one more REO on the street. The homeowner gets a little better deal than they originally bargained for, but as between the homeowner and the bank, who is more responsible for collapse of the housing market, which caused this crisis in the first place?

Under that plan, the bank has to mark to market perhaps 5 percent of the value of that loan instead of 30 percent. If that impacts the bank's ability to maintain its capital requirements, the Fed and Treasury can then consider whether that bank needs a bailout, or whether to let it be taken over. I'm for letting them go under, or at least, let them continue in business, but the shareholders lose their investment and the assets get taken over by new owners.

Another option is to let the banks carry these mortgages "off the books" for a few years, so that they won't be in danger of going under while the bad loans work through the system. At the end of that process, with an orderly disposal of the bad loans, they may have enough capital to survive. If they don't, they never would have made it anyway.

The main thing is to dispose of the assets in an orderly fashion and minimize the losses while also minimizing the disruption to banks and the capital markets while also not making taxpayers have to pay for the mistakes of private, shareholder-owned corporations. In the S&L crisis, those institutions went out of business while the RTC sold off assets and minimized taxpayer losses. Paulson's proposal would have the bank's shareholders remain intact and the taxpayer taking the brunt of the losses. I think that's wrong.

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