Cram Downs: Let Judges Modify Mortgages AgainMany 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 MoveOn.org 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.


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29 Comments

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reverse_mortgage

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April 11 2013 at 8:22 AM Report abuse rate up rate down Reply
cbasilovecchio

Banks are in the businness to make money-there only reason for existance is to make money by using the commodity know as money. Period.
As for mortgages they require a note that is signed to them with terms and conditions for the repayment of that note---AT A PROFIT.
they build,which they charge for,such things as rick and insurance against almost everything that could happen if something were to go wrong.
HISTORY has shown,if it can go wrong,it seems to be only a question of When it will go wrong.
The lender have been collecting these "charges " via higher interest rates for over 100 years.Time to make good on all that money they collected.
Redo the notes to market value and get back to making a profit.
STOP trying to recover your protected losses.
The FEDS gave you money to bail you out,but they didn't know you would use it to make new money instead of putting your mortgage house in order.But ,hey,banks and lender exist for one purpose only,to make money from money.

April 07 2011 at 6:08 PM Report abuse rate up rate down Reply
1 reply to cbasilovecchio's comment
Wayne

cbasilovecchio - Listen carefully - Everyone knows banks are in business to loan money and to make money. That is a given fact. What banks are not allowed to do is steal money or property. The problem here is, the banks don't (in most cases) own the loan. They have no real contract with the homeowners except being their servicer. With that said, this is why they rushed out to scam the people into these modifications. They needed a contract from the home owner so they could forclose on them, otherwise they could not foreclose at at. Then, in a lot of cases they misled, faked, and decietfully held back the modification so the homeowner would get frustrated and leave their homes. Just walk away from them. This is all a scam. The real deciet comes into play when the banks offer the modification, which is a contract from a contract they don't own. How is this posible? I know all of this first hand. Since I know alot the Bank won't touch me even though I have begged them to foreclose on me. I have accused them of Raceteering to their face and have filed complaints to Arizona Attorney Generals Office accusing the bank Raceteering also. If anyone thinks the banks own the homes then tell me why there are so many homes in all the States that can't be sold becuse they can't get a clear and clean title. Just look at the state of Massachusetts. The Judge just about went bezerk when he discovered all of this and stopped all foreclosures. There is so much to this and I am tired right at the moment or I would go more into great detail. Do your research and you will understand alot more of this. When you do, you'll be amazed how corrupt everything is with all of this.

April 07 2011 at 8:59 PM Report abuse rate up rate down Reply
stevesjcbs123

I am not completly hard hearted. If someone feels he/she has been duped by a mortgage company, I am fine with reducing your mortgage. In return, I expect that person to immediately surrender their drivers license and voter registration card. If you are incapable of making resonable and responsible choices with your family's home, you have clearly demonstrated you should not be allowed to endanger others on the road or have the capacity to make an informed decision about an elected official

April 07 2011 at 12:47 PM Report abuse rate up rate down Reply
2 replies to stevesjcbs123's comment
jkennedy806

Well steve, according to your philosophy, that should close up Washington for good, we've been duped by those morons for way over 10 years now, they too are incapable of making resonable and responsible choices with the nation's income and endanger others with out the capcity of an informed decision about another elected official. Let me see what is the difference between the US nation defaulting or not balancing the nation's budget and the homeowner being duped -- who got bailed out first the BANKS or the homeowner, oh the homeowner isn't being bailed out.

April 07 2011 at 2:31 PM Report abuse +1 rate up rate down Reply
Wayne

stevesjcbs123 --- I am completely disturbed by your ignorant statement. jkennedy ..... you are too polite with the likes of this A$$hole. If I had more time right at the moment, I myself would put him in his place. Let's see if he replies to this or crawls back in his hole. I will be back on later.

April 07 2011 at 4:15 PM Report abuse rate up rate down Reply
stevesjcbs123

Do we really want to start down the slippery slope of allowing judges to re-write signed legal contracts?

April 07 2011 at 12:39 PM Report abuse +1 rate up rate down Reply
1 reply to stevesjcbs123's comment
jkennedy806

Yes, and on the bankster's dime too!!!

April 07 2011 at 2:32 PM Report abuse -1 rate up rate down Reply
cbasilovecchio

Let the truth be told.
Great article.
I have a question.Did the banks pay back the $700 billion or most of the TARP money?
Why not give the lender 50% of the write off on any "cram down"
using the paid back TARP money.
I believe they won't need very much of that $700 billion,because
after maybe less that half of it is used ($350B for $700 B in "cram downs")
the housing market would stabalize and the "cram down" dollars needed would
continually become less based on the fair market value.

April 07 2011 at 11:56 AM Report abuse rate up rate down Reply
alchenkin

I fully agree with this article. While banks and securities firms were "de-regulated", borrowers were cornered with regulations and compelled (as I was, in Florida) to default before they would consider any assistance.
Bankrupcy and Foreclosure judges should be permitted to use the "cram-down" as a legitimate way to return these properties to performing loans and restore the values that have been eroded by oportunistic lenders. Let's save the American dream!
--Alan Chenkin
http://.chenkin.blogspot.com

April 07 2011 at 11:25 AM Report abuse rate up rate down Reply
2 replies to alchenkin's comment
stevesjcbs123

Most people have not had to face foreclosure. They took out responsible loans and managed their family finances. Why should we reward irresponsible behavior?

April 07 2011 at 12:42 PM Report abuse +1 rate up rate down Reply
Wayne

Hey F-Nuts stevesjcbs .... if only you knew what your talking or rather typing about. The banksters are being rewarded for their criminal behavior. Nothing Reccorded, the development of MERS, Mortgage Pools ... oh wait ... am I talking over your head???? Should I continue ... nah ... your guns aren't loaded and your too easy of a target. One word to ya steve-o ... F**ktard!!!

April 07 2011 at 4:20 PM Report abuse rate up rate down Reply
cduediligence

American Homeowner having depleted a lifetime of savings and barely hanging on in asset poverty can’t afford the top tier legal help required to even have a chance against the Banks legal legions. The American Middleclass had better wake up and fight for ownership of their piece of America.

There are so many opportunities to prove over and over again that predatory lending, sloppy securitization and, due process liberties were the norm and throw serious doubt into the banks claim there is nothing to see here…their legitimate claim to the property as the secured asset is certainly arguable.

Let’s be clear...6 men, I assume they are men, from Fannie and Freddie earned 35 million dollars as federal employee's these last two years while the law firms they hired and fired continue to squeeze displaced American homeowners for their life savings!

If, the Banks followed the rules… the properly executed original documents will support that. Once discovery is compelled there are plenty of records on each loan from every involved institution to clearly document what should have happened. Careful scrutiny of all the records can clearly document an arguable position in any number of Federal and State courts.

Or, the Banks agree to just terms. Middle class America might depend on it! Homeowners must fight individually! All that is required is the loan level due diligence and the will to argue the truth!!… http://diligencegroupllc.net/

American Middle-class Homeowner

-AMH

April 07 2011 at 10:31 AM Report abuse rate up rate down Reply
garwils4

If you can't afford a house don't buy it.

April 07 2011 at 10:04 AM Report abuse +1 rate up rate down Reply
garykellar123

Mortgage rates are historically low you can easily refinance these days your mortgage to 3%. It is the best way to save money. Search online for "Mortgage Refinance 123" they did 3.54% refinance and free analysis of my current mortgage. Learnt the refi secrets there.

April 07 2011 at 4:36 AM Report abuse -1 rate up rate down Reply
cscouten

"Bring back the cram down." Sounds simple, but that is just another patch on a symptom, not a real solution that addresses the root cause of today's lending meltdown. This country can no longer afford patches that skirt the real problem, nor a 'lost decade' waiting for inflation to bring real estate values back above water.

Root cause of the housing problem is illiquid assets (e.g., RMBS, HELOC 2nd mortgage loans) held on the balance sheets of financial institutions at inflated 'mark to market' values. Aside from the fact that listing such assets at inflated value is basically dishonest, it provides a perverse incentive for the financial institution to 'duck, delay, then deny' when it comes to useful mortgage modification for the millions of underwater loans in the country today. Writing down those inflated asset values might lead to a need for the institution to raise more reserve capital. No wonder bankers condone the dishonest practice!

But, what to do?

Trust the market. Create a marketplace for illiquid assets and require its use.

Proposal: Require the GSE institutions and banks insured by FDIC to sell a small part, 1% (or perhaps even less), of their "mark to market" asset portfolio each year in an open market - the specific items to be selected by the bank regulator from a numbered list (using a random number generator to avoid selection bias) - and adjust valuation of the entity's mark to market asset portfolio up or down depending on whether the sale brings in more or less than balance sheet valuation of assets sold. Each entity would be prohibited from bidding on its own assets, and would be prohibited from sharing information not generally available or engaging in other practices that could corrupt the open market. This requirement for honest valuation via open market sales will quickly remove today's perverse incentive for the key financial institutions and servicer firms to stall mortgage loan modification in order to preserve the strong balance sheet illusion. The result will promote sound and sustainable banking practice, and unclog our real estate finance system so people can begin buying, selling and building homes again and businesses can get back to doing business.

April 06 2011 at 11:36 PM Report abuse rate up rate down Reply