“…thanks to a 1993 Supreme Court decision, homeowners saddled with mortgage debt on their primary residences have not been able to take refuge in the bankruptcy courts. The unanimous ruling by the court found that when Congress rewrote the bankruptcy code in 1978, it specifically gave “favorable treatment” to mortgage lenders “to encourage the flow of capital into the home-lending market,” as Justice John Paul Stevens wrote in a concurring opinion…

…Durbin was trying to get rid of that favorable treatment. Why? Because, as Bair told me in an email, “It would have been a powerful bargaining chip for borrowers.” Without the ability to file for bankruptcy, underwater homeowners unable to pay their mortgages were helpless to prevent foreclosures. With it, however, servicers and banks were far more likely to negotiate the debt load. And if they weren’t, a bankruptcy judge would rule on the appropriate debt to be repaid. For all the talk about the need for principal reduction, this change would have been the easiest way to get it….Indeed, although the financial services industry had pushed hard for their bankruptcy carve-out, they would have been helped, too. Knowing that a borrower can avail himself of bankruptcy court would undoubtedly have a sobering effect on lenders, making them more cautious about underwriting standards.”, Joe Nocera, “Bankrupt Housing Policy”, New York Times, May 20, 2014

“I am sympathetic to Mr. Nocera’s argument here. However, respectfully Mr. Nocera, Mr. Geithner (no banking, mortgage, or securitization experience and one economics class!!!) and Mrs. Bair (basically the same experience as Mr. Geithner’s, maybe a law degree) are not qualified to speak about this topic. If you change the bankruptcy law today, for mortgage contracts written years earlier under a prior bankruptcy law…you are not following “The Rule of Law”. What contracts are you going to abrogate next and for whose benefit? (Clearly, anyone who knows anything about economics, knows this will have a huge negative impact on the free flow of mortgage credit and quite possibly much larger negative economic ramifications.) You could legally change the bankruptcy law now, for new mortgages, but that wouldn’t solve the problem Mr. Nocera raises and it likely would create worse problems than it solves. Mr. Nocera only cites historical mortgage rates in states that had these types of BK laws in the past, as evidence they would have little economic impact. But clearly, we have just gone through an unprecedented housing bubble and bust and lenders and investors views have changed, as a result. If the bankruptcy law was changed as Mr. Nocera suggests, quite possibly lenders and investors would demand larger down payments and/or would no longer provide home equity loans and/or tighten mortgage lending standards and shut out many deserving borrowers from their goal of homeownership or their legitimate need to access the equity in their home, without being forced to sell their home. I think the solution I posted in Statement #192 is better/more realistic and I said roughly the same thing as Ms. Bair’s statement above: ”it gives the borrower some leverage to negotiate with their mortgage lender”.”, Mike Perry, former Chairman and CEO, IndyMac Bank

The Opinion Pages | Op-Ed Columnist |​NYT Now

Bankrupt Housing Policy

The publication of Timothy Geithner’s memoir, “Stress Test,” has caused all the old arguments that were fought during the financial crisis to come rushing to the surface again.

Did the government make a mistake in allowing Lehman Brothers to file for bankruptcy? Was it right to bail out the too-big-to-fail banks despite all the harm they had done to the economy? As Sheila Bair, the former chairwoman of the Federal Deposit Insurance Corporation, put it in her review of “Stress Test”: “Tim’s book has reinvigorated a much-needed debate about whether our financial system should be based on a paradigm of bailouts or on one of accountability.”

And one other thing: It has re-raised the question of why the government wasn’t willing to do more for struggling homeowners, who bore the burden of the Great Recession. In his book, Geithner, the former Treasury secretary, devotes a handful of pages to the Obama administration’s mortgage relief efforts, though the writing comes across as halfhearted, not unlike Geithner’s efforts while he was running the Treasury Department.

But, in the course of perusing another new book about the financial crisis, “Other People’s Houses,” by Jennifer Taub, an associate professor at Vermont Law School, I was reminded of an effort that took place in the spring of 2009 that could have made an enormous difference to homeowners, one that would have required no taxpayer money and might well have become law with a little energetic lobbying from the likes of, well, Tim Geithner. That was an attempt, led by Dick Durbin, the Illinois senator, to change the bankruptcy code so that homeowners who were underwater could modify their mortgages during the bankruptcy process. The moment has been largely forgotten; Taub has done us a favor by putting it back on the table.

As she notes, thanks to a 1993 Supreme Court decision, homeowners saddled with mortgage debt on their primary residences have not been able to take refuge in the bankruptcy courts. The unanimous ruling by the court found that when Congress rewrote the bankruptcy code in 1978, it specifically gave “favorable treatment” to mortgage lenders “to encourage the flow of capital into the home-lending market,” as Justice John Paul Stevens wrote in a concurring opinion. Durbin was trying to get rid of that favorable treatment.

Why? Because, as Bair told me in an email, “It would have been a powerful bargaining chip for borrowers.” Without the ability to file for bankruptcy, underwater homeowners unable to pay their mortgages were helpless to prevent foreclosures. With it, however, servicers and banks were far more likely to negotiate the debt load. And if they weren’t, a bankruptcy judge would rule on the appropriate debt to be repaid. For all the talk about the need for principal reduction, this change would have been the easiest way to get it.

Indeed, although the financial services industry had pushed hard for their bankruptcy carve-out, they would have been helped, too. Knowing that a borrower can avail himself of bankruptcy court would undoubtedly have a sobering effect on lenders, making them more cautious about underwriting standards.

As the financial crisis heated up during his first presidential run, then-candidate Obama said that he favored changing the bankruptcy laws “to make it easier for families to stay in their homes.” But he became convinced that the Democrats should not push for it as part of the controversial bailout legislation, so he backed off, promising to push it once he was in the White House.

Once he was president, however, Obama was rarely heard from on the subject. In late April 2009, with a bankruptcy bill having already passed the House, Durbin offered his amendment on the Senate side. The financial services industry pulled out all the stops, arguing that a right of bankruptcy for a homeowner would increase the cost of home loans, undermine the sanctity of contracts and promote (of course!) moral hazard.

Adam J. Levitin, a professor at Georgetown Law School, believes that nothing untoward would have happened if Durbin’s amendment had passed. He and another researcher looked at interest rate and loan size data from 1978 to 1993 when some jurisdictions did allow homeowner bankruptcies. “The effect on interest rates was small,” he told me. “The sky didn’t fall.”

He added, “This should have been a no-brainer.”

As it turns out, there is one other person who was opposed to the bankruptcy option. That was Tim Geithner. He writes in his book that he didn’t think it was “a particularly wise or effective strategy.” Although Geithner says the votes weren’t there for Durbin’s amendment, it did get 45 votes. How many more might it have gotten if the Treasury Department and the White House had come out strongly in support?

Which leads to one other unanswered question about the financial crisis. Why is it that the fear of moral hazard only applies to homeowners, and not to the banks?

Posted on May 20, 2014, in Postings. Bookmark the permalink. Leave a comment.

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