President Obama is in danger of losing the biggest stick in his foreclosure prevention arsenal.This legislation will allow judges to basically say, "I'm sorry you owe $400,000 on a house that today is only worth $200,000. Presto! Now you only owe $200,000." Of course, someone has to take the loss. It will be the banks, and they will pass much of the loss on to future borrowers (i.e. current renters).
The administration's plan to stem the housing crisis depends on Congress amending the bankruptcy laws to allow judges to modify mortgages, in particular by reducing principal to make monthly payments more affordable.
The so-called cramdown provision could put pressure on loan servicers to modify mortgages before borrowers file for bankruptcy.
A major critique of the voluntary modification programs is that servicers aren't doing enough to help struggling borrowers. But servicers will likely be more aggressive in working with homeowners if they know that the borrowers can turn to judges for relief. ...
But congressional Democrats, who first introduced a bill broadening judges' power two years ago, are running into trouble gathering the support needed to pass the legislation. The House postponed a vote on the measure until early this week after a group of centrist Democrats voiced concerns. And its future in the Senate remains in doubt with many powerful Republicans strongly opposed to the legislation.
This legislation will likely lead to higher mortgage rates in the future. A mortgage interest rate is composed of two components: the risk-free rate and the risk premium. The risk-free rate is basically just the rate of return on Treasury bills. The risk premium is an additional rate of return to compensate the lender for the risk of issuing the mortgage. The risk premium currently covers two significant risks: interest rate risk, the risk that interest rates will increase in the future, and default risk, the risk that the borrower won't repay the loan. This cramdown legislation will let banks know that in the future they will also need to account for a third risk: legal/legislative risk, the risk that politicians will change the law to modify existing contracts. This added risk will mean a higher risk premium, and thus higher mortgage rates.
President Obama's cramdown legislation is an example of irresponsible existing homeowners getting a bailout at the expense of future homeowners.
Update: The problem is not the specific cramdowns that Obama is proposing, nor cramdowns in the past. The risk is the precedent that is being set by having politicians coming in and modifying existing contracts. Banks now have to worry more that any of the terms of a mortgage that they issue may be changed, at the whims of politicians, in favor of the borrower.
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If this passes, I will never be able to own a home. Im at the point where I dont really care anymore to be honest. Why should I be able to afford a home, I only make $110K a year?
ReplyDeleteThe bank takes a loss by selling the property for what it's worth, or they take a loss by writing down principal. Little difference there. The difference is what happens if house values CONTINUE to decline. If they've sold their REO at market, they won't take further losses. If they've written down principal for current borrowers there's the not insignificant chance that take further losses.
ReplyDelete-Jim A
But since we the tax payers are bailing out the banks and their losses it more of the" right hand/left hand" issue so do the banks lose???
ReplyDeleteJames, I think you are wrong on this one. I encourage you to read Tanta's Just Say Yes to Cram-Downs", and the associated comments. Here is one of Tanta's responses in the comments:
ReplyDelete[begin quoted objection]Thus, I'm concerned that since there is no way for the consumer to refuse this option, rates rise for everyone even though the majority of the benefit extends to aggressive or stupid borrowers. [end quoted objection]
[begin Tanta Response]
So your argument would be that, in the decades prior to 1993, home mortgage interest rates were very high and Chapter 13 cram downs were rampant, right?
There was no prohibition on modifications for principal residences before 1978. There was no prohibition on cram downs for principal residences before 1993.
Anyone who wants to tell me that home mortgage interest rates where exhorbitant in 1991-1993 will be telling me some real news. I have not yet forgotten those years.
[end Tanta response]
Note that cramdowns apply only to principal residences (eliminating most investors), that they are not a guarantee (judge decides after looking at how you spent that cash-out refi money), and that the alternative is foreclosure (which can involve lender losses of 50% or more).
DonCoyote
I never understood why mortgages were exempt from bankruptcy in the first place. The effect of cramdowns will be that banks will be forced to make better assessments of the risks, which will be good for everybody in the long run.
ReplyDeleteThe real incentive to buy right now is not the $8K credit, but the $8K credit and the cram down you get when you stop your mortgage payments!! TIME TO BUY FOLKS!!!!
ReplyDeleteWhy are people creaming in their pants over this $8k tax credit? $8000 is such a small, negligible figure in the grand scheme of a $600,000 mortgage (which is really over a million dollars after 30 years of interest) on a crappy rambler in Fairfax County. Big deal. Lower the price!
ReplyDeleteI would argue that cram downs will lower price. Why? Because if lenders know they face cram downs, goodbye the days of making loans without verifying income or even loans where DTI exceeds 3x% of income (pick 38% in Coastal areas, 31% elsewhere). Goodbye funny money means only responsible buy at responsible prices.
ReplyDeleteI say bring on the cram downs. In fact, pass legislation that allows the bankruptcy judge to take back commissions paid on the bankrupt mortgage of everyone in the chain (that would never happen but I can always dream and I'll bet if it did happen re agents would start educating themselves vs. spewing "RE always goes up, land is scarce, blah blah blah).
I thought that the cram down legisltation was only going to apply to existing loans and then, only a certain subset (perhaps ALT A, etc). They were cognizant of the moral hazard argument, and the argument that this would increase rates in the future, but they would essentially gut those arguments if they only applied the cram down to certain existing loans that (in the case of subprime) are unlikely to ever be made again.
ReplyDeleteWas this not the case?
James, I would expect the logic in your posting from a shill of the REIC, but not from an "independent" blogger. If the homeowner has to go through a Chapter 13, he or she will take a big hit with regard to credit rating and finances. The organizations who unwisely lent money to the Chapter 13 homeowner should also have to take a hit.
ReplyDeleteAs other commenters have noted, the Chapter 13 risk is merely a subset of the foreclosure risk. This, the cramdown presents no additional risk factor to mortgage bankers, other than punishing them for not doing diligence on the financial health of applicants. This is efficient capitalism.
And, as others have noted, the mortgage market was not a high desert before 1993, when cramdowns were legal. If mortgage bankers perceived bankruptcy cramdowns as a significant risk, mortgage rates would have shown a higher spread over T-bills and bonds prior to 1993 than today. As far as I know, that was not the case.
Anonymous said...
ReplyDelete"I thought that the cram down legisltation was only going to apply to existing loans and then, only a certain subset (perhaps ALT A, etc)."
The problem is not the specific cramdowns that Obama is proposing, nor cramdowns in the past. The risk is the precedent that is being set by having politicians coming in and modifying existing contracts. Banks now have to worry more that any of the terms of a mortgage that they issue may be changed, at the whims of politicians, in favor of the borrower.
No James, banks only have to worry that if they screw everything up so bad that they destroy the world economy the public is going to have to step in and try to limit the damage they've caused.
ReplyDeleteExactly. I usually agree with James, but this isn't a slippery slope. The federal government isn't going to make a practice of changing the terms of existing contracts. But since we are in the midst of the worst global ecoonomic crisis since the depression and it was caused in large part because of banks giving out ridiculous overpriced mortgages, cram downs make sense. Unless the banks plan on using fraud and irresponsible lending to destroy the economy again in some new way, they don't have to worry about existing contracts being altered unexpectedly.
ReplyDeleteI wonder what, if any, 5th Amendment implications the Obama plan has.
ReplyDeleteWell, I think prospective homebuyers won't have to worry about higher mortgage rates in the future if the banks are nationalized. The Gov't could reduce the principal on loans, but then penalize homeowners who sell their homes for a gain in the future. I guess that's one way the taxpayers can get some of their money back.
"The Gov't could reduce the principal on loans, but then penalize homeowners who sell their homes for a gain in the future."
ReplyDeleteProblem is, there wont be any gaines that reach peak prices until 2090.