John Conyers' Bankrupt Proposal

Jesse Walker | February 13, 2009

Todd Zywicki explains what's wrong with John Conyers' bill to let bankruptcy judges modify mortgage contracts. Here's the first of several solid objections:

Mortgage modification would indeed provide a windfall for some troubled homeowners -- but its costs will be borne by aspiring future homeowners, and by any American who uses credit of any kind, from car loans to credit cards. The ripple effects could further roil America's consumer credit markets.

In the first place, mortgage costs will rise. If bankruptcy judges can rewrite mortgage loans after they are made, it will increase the risk of mortgage lending at the time they are made. Increased risk increases the overall cost of lending, which in turn will require future borrowers to pay higher interest rates and upfront costs, such as higher down payments and points. This is illustrated by a recent example: In 2005, Congress eliminated the power of bankruptcy judges to modify auto loans. A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform.

Zywicki also notes the incentives the law would create for filing bankruptcy, and the opportunities it would open for bankruptcy abuse. Read the whole thing.

Comments

|2.13.09 @ 12:57PM|#

Here's a little thought experiment for the boys and girls out there in radioland:

What if a large percentage of the home owners Congress and the nattering classes want so much to "protect" from the depredations of the Snidely Whiplashes of the world would actually be better off as a result of foreclosure?

Speaking from personal experience, being chained to a difficult-if-not-impossible-to-sell house sucks. I finally found somebody to take it off my hands (at a loss), but it took nearly four years.

|2.13.09 @ 1:00PM|#

And- this is a lot more about saving the banks from the pain and suffering of widespread forclosures and writedowns.

But some of you probably knew that.

Curious George|2.13.09 @ 1:04PM|#

This is just part of the attempt to destroy the free market system in the US. If you can't enter into a contract and rely on it and its terms then does anyone wish to guess what will happen to your ability to get a mortgage or a loan?

How about home improvement or buying a car if you knew the government could alter the essentials anytime it wished.

Facism is alive and well in Hussein World.

DADIODADDY|2.13.09 @ 1:11PM|#

When banks and insurance companies set rates for interest (mortgage, credit card or policy charges they include a provision for risk (i.e. credit card companies adjust their interest rates based on actual & projected deliquencies and defualts). Give courts the ability to modify the terms of a loan/mortage/policy after the fact and watch what happens to those rates & charges before the fact. There'll be lots of money available, but no one will be able to afford to take the loan.

Adam|2.13.09 @ 1:12PM|#

Couldn't the arguments against this proposal be equally invoked as arguments against the whole concept of bankruptcy law? To my knowledge, it is relatively non-controversial that when a person (legal or natural) cannot pay his/her/its debts, that debtor and the creditors should go to court and figure out how to split up what's left.

It seems to me that either everything's on the table, or nothing is. But why treat certain types of debt differently? That has the ring of special-interest lobbying, akin to tax incentives for spcific behaviour.

If Zywicki believes that we should do away with bankruptcy law, I'd be very open to the argument. But on what grounds should we treat car loans, mortgages, lines of credit, medical bills, etc. differently?

|2.13.09 @ 1:16PM|#

John Conyers is a typical big city Democrat. He loves income redistribution and placing individuals failure's blame on anyone other than the individuals who failed. Nothing really new in all of this.

His wife, OTOH, is bat shit insane.

|2.13.09 @ 1:36PM|#

And- this is a lot more about saving the banks from the pain and suffering of widespread forclosures and writedowns.

How so? Banks can avoid foreclosuring or calling a default on their own loans anytime they want by renegotiating the loan.

There's no way they can avoid writing down an overvalued loan, though, whether they write it down through voluntary renegotiation or have it written down for them by a bankruptcy court.

|2.13.09 @ 1:44PM|#

Has anyone else noticed that a lot of Liberals tend not to think past the first ripple in their theories? They want a pony in every pot, but can't seem to figure out what happens once the ponies get potted. There are unintended consequences to every government action, but the Libs can't seem to reconcile those with their wants.

|2.13.09 @ 1:53PM|#

Silentz,

Here's an uncharitable way of looking at that: It's not that they don't care about unintended consequences, it's that they are comfortable with them occurring so that they can expand the scope of government to deal with them as well. Government as a perpetually renewing pseudo-necessity.

|2.13.09 @ 1:56PM|#

Someone please correct me if I am wrong, but weren't mortgage modifications already allowed before the bankruptcy law re-write a few years ago ?

If so, then why would going back to that standard be such a bad idea?

|2.13.09 @ 2:03PM|#

"Someone please correct me if I am wrong, but weren't mortgage modifications already allowed before the bankruptcy law re-write a few years ago ?"


Under Chapter 13, a judge could cram down the value of a secured debt to the value of the callateral. This didn't happen much to homes because most home owners chose Chapter 7, unsed their state homestead exemption and reaffirmed the debt on their house. Two things have happened since then, the value of real estate started to go down, and the rat bastards in Congress took chapter 7 away as an option for anyone with a job.

|2.13.09 @ 2:03PM|#

How so? Banks can avoid foreclosuring or calling a default on their own loans anytime they want by renegotiating the loan.

Never heard of the Prisoner's Game?

Kolohe|2.13.09 @ 2:26PM|#

what Adam and ChiTom said.

Also, and this may just be my elitist glibertarian fascistic tendencies, perhaps it's not such a bad idea for consumer credit to become a little more expensive.

|2.13.09 @ 2:28PM|#

My expectation is that these "homeowner rescues" will involve taxpayer assistance to the homeowner which will be passed directly along to the banks. Not to mention saving them from the not insignificant costs directly resulting from foreclosure.

Lord Jubjub|2.13.09 @ 2:31PM|#

Remember all of those bad securities everyone is holding?

They are backed by the mortgages that will be crammed down. Bankers don't want to change the collateral on the mortgage because they don't want to be sued by the bondholders.

|2.13.09 @ 2:37PM|#

Sugar Free-1:53

I agree with your analysis.

However, Jesse and Zywicki, are speculating as to the effects of the judges being able to "cram down" the mortgages. For many years, the judges had this power to cram down. I note that Jesse did not include this in his article. I also note that he failed to include the fact that credit markets did not freeze as a result thereof.

IMO, they grossly overstate the possible ramificatios. Cry me a river for the banks. Are we forgetting the humongous misallocation of resources occaisoned by the banks having their way with both state and federal authorities in so many areas? Mandatory arbitration clauses forcing borrowers to resolve disputes in foreign jurisdictions-often with the borrower being informed of the same by way of a mailing AFTER the borrower had opened the account. How about charging people 39 bucks for a bounced check or deliberately processing deposits on the day after the deposit was made? Ditto for credit card late fees.

No, what is best for free enterprise is letting the banks fail.

Wicks Cherrycoke|2.13.09 @ 2:37PM|#

Lord Jubjub writes:

"Remember all of those bad securities everyone is holding?

They are backed by the mortgages that will be crammed down. Bankers don't want to change the collateral on the mortgage because they don't want to be sued by the bondholders."

And how many of those who will "benefit" from mortgage cramdowns hold those very securities in their 401k plans, money market accounts, etc.,who will then scream bloody murder when their investments tank because the mortgages which backed up their investments were crammed down...and will then demand a government bailout for their lost investments...and so on, and so on.....

|2.13.09 @ 2:38PM|#

Never heard of the Prisoner's Game?

Sure. Explain to me how that prevents a bank from voluntarily rewriting a mortgage when that is in the bank's best interest.

Of course, a bank may err in determining what's in its best interest, but how is that my business (unless I am a shareholder of the bank)?

|2.13.09 @ 2:40PM|#

The banks have used government to get their way. The law is most lopsided in favor of the banks. That is not free enterprise.

|2.13.09 @ 2:43PM|#

I am not in the banking business, so forgive me if this is niave. The fact is that mortgages are no recourse in most if not all states. That means that if a homeowner is under water on his house, he can just walk away from it and leave the bank holding the bag. That should give the home owner the leverage to cram down the value of his mortgage on his own. If I am a bank and I know the home owner can walk away and leave me stuck with a house that may or may not sell in this market and leave me with no recourse on what is left on the note, it is in my interest re-negotiate the note down to some number nearing the value of the collateral and at a payment the borrower could afford.

I think there are two reasons this is not happening. First, banks are by their nature un-creative institutions run by objectively stupid and inflexible people who would gladly cut off their own noses to spite their face. Second, the objectively stupid people who have been promoted to run banks created MBS so that no one bank owns mortgages anymore thus preventing the kind of one on one work outs that should be occuring.

New World Dan|2.13.09 @ 2:43PM|#

Adam,

To greatly overlysimplify things, there are 2 basic kinds of debt. General debt and asset backed debt. Asset backed debt usually gets lower interest rates because in case of default, the creditor gets the first chance to recover by means of the asset.

Now, with that out of the way, I think there are some reasonable ways that a bankruptcy court might temporarily alter a mortgage that aren't absurd. Converting the mortgage to interest only for a limited period. Possibly waiving mortgage insurance.

Actually, I wonder how many forclosures could be avoided by eliminating mortgage insurance. Or perhaps, just putting it entirely on the lender. How many lenders would carry it to 80% LTV if it was comming out of their own pocket.

In summary, I have an appointment in 2 hours to refinance my house.

Adam|2.13.09 @ 2:54PM|#

New World Dan, thanks. But I know the difference between secured and unsecured debt; I'm just not clear on why one type should be subject to being amended by a bankruptcy court and the other shouldn't.

No Name Guy|2.13.09 @ 3:08PM|#

What New World Dan said to Adam re secured vs. unsecured debt.

Adam: Because an asset backed debt is specifically taken by the creditor under the premise that I have something that CAN'T be crammed down. If the debtor defaults, I get said asset - period. The terms of unsecured debt - well, every one knows it CAN be adjusted by a bankruptcy court. That's why credit cards are 18% and mortgages are 6%. See the risk premium there?

John - actually, you can sue for a deficiency judgement, at least in Washington (I'm talking the state, not the rat hole city that encompases the District of Columbia). The process is different that a typical foreclosure (e.g. a Trustee Sale, which is a non-judicial process, since most security instruments are not true mortgages, but deeds of trust). Despite that, a judicial foreclosure of a deed of trust is a possibility, with a subsequent entering of a deficiency judgement. Said judgement is then typically partially satisfied by the subsequent sherriffs sale of the property in question, leaving the debtor on the hook for the remainder.

The V.A. is noted for going after deficiency judgements on loans they back. Default, they'll come after you for every dime.

(I'll cavet that is how it was when I was in the title insurance business some 12 years ago).

Bronwyn|2.13.09 @ 3:12PM|#

(I'm guessing) Wouldn't it be because the secured type, being tied to a hard asset, changes in value while unsecured debt does not?

Bronwyn|2.13.09 @ 3:13PM|#

Oh.

|2.13.09 @ 3:19PM|#

No Name Guy,

That was my impression to. But several people have since told me that most states required mortgages to be no recourse. Apparently WA state is an exception.

Adam|2.13.09 @ 3:41PM|#

No Name Guy, I see what you're saying but the point about "every one knows [unsecured debt] CAN be adjusted by a bankruptcy court" seems rather weak since that's just an issue of timing - change the rules today and everyone will know that secured debt CAN beadjusted by a bankruptcy court. Of course, changing rules in mid-game is problematic, but you could use that argument against anything (we can't get rid of ethanol subsidies because people have planned around them).

As for the broader matter of the difference between the two types of debt, I see what you're saying. But isn't the proposal to make mortgage terms open for adjustment, rather than the nature of the debt? It'll still be secured by the same asset as before. And if secured debt entitles you to the asset and unsecured debt entitles you to nothing - isn't that just an argument for which should take precedence in the hierarchy of creditors?

I don't want the state involved in these matters, either. It's just that once you have bankruptcy legislation in place, that bridge has been crossed.

|2.13.09 @ 3:48PM|#

John and No Name Guy-

In Massachusetts, the banks can sue for the deficiency as well.

|2.13.09 @ 4:17PM|#

"In Massachusetts, the banks can sue for the deficiency as well."

Even where they can, the debt is an unsecured debt that can be written off in bankruptcy. Even under the new rules, you can still go into Chapter 13 and it gets rolled up with all the other unsecured debt.

Invisible Finger|2.13.09 @ 4:48PM|#

The house subsequently falls in value to $250,000, at which point the borrower files for bankruptcy, the mortgage principal is written down, and the homeowner keeps all the goodies purchased with the home-equity loan. Several years from now, however, the house appreciates in value back to $300,000 or more -- at which point the homeowner sells the house for a tidy profit.

Nothing in Mr. Conyers's proposed legislation would prevent this scenario from occurring.

The only problem here is that THIS ISN'T HOW CRAMDOWNS IN BANKRUPTCIES WORK.

The 150K crammed down doesn't vanish, it goes into the "unsecured debt" pile which is then subject to a different monthly payment plan than the mortgage. 90% of the time the bankrupted person can't cover those monthly payments and the cram down instead becomes a foreclosure.

The only thing I agree with is "At the very least, Congress should extend the time period for allowing lenders to recapture home appreciation beyond five years." Otherwise, it's a lame-brained article.

|2.13.09 @ 5:11PM|#

Point of law: the 2005 law did not remove the judges ability to modify all car loans, only recent (910 days prior to filing) car loans where the money was used to purchase the car. The judge can still modify the hell out of those 7 year loans.

Grants|2.17.09 @ 1:15PM|#

This is illustrated by a recent example: In 2005, Congress eliminated the power of bankruptcy judges to modify auto loans. A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform.