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Keeping bankruptcy judges, and logic, at bay

bankruptcycram downcramdownDick DurbinforeclosuremortgageS 895

Foreclosure Long Beach Free-marketeers and banking industry allies cheered yesterday when the Senate buried a proposal to let bankruptcy judges "cram down" home mortgage debt. Under current law, when homeowners file for personal bankruptcy, the court cannot alter the terms of the loans they hold on the homes they live in. Loans for vacation homes, investment properties, farms, commercial bulidings are all fair game for bankruptcy judges, but principle-residence mortgages are not. As a result, mortgage holders who file for bankruptcy are pretty much compelled to sell their homes to pay off whatever they owe. On Thursday, Sen. Dick Durbin (D-Ill.) sponsored an amendment to S 895, a bill to avert some foreclosures that would have put home mortgages on the same bankruptcy footing as other types of loans, but the amendment was defeated, 51-45.

Score another one for bank-industry lobbyists, who persuasively argued that exposing home mortgages to cramdowns would raise future interest rates. Of course it would. But so what?

One of the Big Important Lessons of the most recent housing bubble is that the U.S. has gone too far in its efforts to encourage home ownership. Guarding against cramdowns is one of several ways the feds and states work to make home ownership more affordable; others include the tax deduction for mortgage interest, measures that cap property tax increases (such as California's Proposition 13), and federal mortgage guarantee and insurance programs. These mechanisms have not just reduced the price of borrowing enough to allow some renters to buy houses; they've also encouraged speculators to try to create wealth out of thin air by betting the banks' money on rising property values. Many banks were happy to go along for the ride even if it meant lending sums that couldn't possibly be repaid. They just wanted the fees from the loan, not the long-term revenue stream, which they sold (along with the risk of default) to investors -- among them Fannie Mae and Freddie Mac, which Congress created and maintained ostensibly to protect would-be borrowers against a shortage of loans.

Traditionally, lenders assumed the repayment or credit risk, which was offset by their ability to repossess and resell the properties in question. Borrowers, meanwhile, assumed the investment risk -- that is, the risk that the property wouldn't prove to be as valuable as they'd hoped. Allowing bankruptcy courts to cram down home mortgage debt would make lenders share some of the investment risk with borrower, and they would almost certainly respond by charging higher interest rates (although the experience with farm and commercial loans suggests the increase would be small). More important, though, they'd also pay a lot more attention to the borrower's ability to repay. And after the debacle we're still mired in, who doesn't want that?

I understand the moral hazard argument. Responsible folks would suffer in the future if we intervened on behalf of the binge borrowers. Setting aside for a moment the number of borrowers who aren't to blame for their current troubles (e.g., those who lost their jobs, or who were fraudulently steered into subprime loans), consider what the aid here would be. Judges would have the power to write down mortgage debt only to the point that it matches the current, presumably depressed value of the house. If borrowers couldn't afford the payments at that level, there would be no cramdown. In other words, write-downs would happen only if they were better for the lenders in the long run than foreclosing and reselling the home.

Rational lenders would be doing those modifications anyway, regardless of the indignation felt by "responsible" homeowners. But a large percentage of the loans in trouble are owned by investors (through complex securities) and managed by loan servicing companies, which have been deterred from writing down debt by opposition from investors. The mere prospect of cramdowns may help servicers overcome investors' reluctance to making significant but economically rational modifications before borrowers go into bankruptcy. Of course, the banking industry might have prefered the alternative offered by S 895: it would provide servicers that modify loans immunity against investors' lawsuits. But that's more of an assault on the sanctity of contracts than allowing cramdowns would be -- the bankruptcy process, after all, is designed to tear up contracts in an effort to mitigate all parties' losses.

Credit: AP Photo / Nick Ut


Comments () | Archives (8)

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Once again the Republicans (and a few Democrats) carry the water for the big guys, and screw the middle class. Someone can renegotiate for their vacation home, but a family in their primary residence can't. We are throwing people out on the street, but God forbid we take away someones vacation home. What is right about that?

Roben Anderson

It's not about screwing anyone, it's about paying for something one can afford. A lot of people took out mortgages that they weren't able to make payments on, and the banks let them. When someone is losing their vacation home, it's because they can afford (in most cases I'm assuming) one of the mortgages, be it vacation home or primary residence.


Allowing someone to retain property while reducing what they originally contracted to pay for it is absurd. Home ownership is a want, not a need.
People need to understand that buying a home requires research, planning, and that there is no need to overreach and buy your "dream home" the first time. That is just stupid.
If I were to sell my second, paid-for home via owner financing to someone who decides to go bankrupt, why should I be punished? Not everyone who finances homes is a rich investor. I bought my first home via owner financing, and I made sure to pay the mortgage first. The lender had the security of the deed of trust.
If you cannot pay your bills, that's too bad. Change your life.

Donna Hughs

It's not about paying for something one can afford; it's about being unable to find a properly valued home in a market that's been highly inflated by banks and investors whose greed has been given full rein through the deregulation occurring over the years, and through the credit rating companies' overriding interest in reaping huge fees from those institutions they're rating as opposed to doing a thorough assessment of the institution's assets (including bundled loans). There are too few credit rating companies essentially controlling the market and able to dictate terms to the institutions they are rating, and Congress hasn't come up with a solution for this yet.

When the bubble bursts, it's not the fault of the homeowner who was unable to find a house that was correctly valued in the first place. Having a place to live is a necessity; waiting for years and years to buy any place at an uninflated price while investors reap huge profits is not an option we a as a society can afford.


People could afford their mortgages until the economy went bust. The ones who couldn't afford the mortgages were used by the banks. The banks made all these bad loans, and then sold them in bulk to wall street. If someone can save their residence by reworking the mortgages, then the banks should do it.
If people can afford the vacation home, then why do they need to refinance it? Primary residences should be the only ones eligible under this program if they are going to make a choice. It IS about screwing people. That's what brought on this whole financial mess. Someone had to lose for the fat cats to satiate their greed. This bill would have passed if the banks weren't using the taxpayers money to lobby congress


I understand the moral hazard argument. Responsible folks would suffer in the future if we intervened on behalf of the binge borrowers.

Let me see if I have this right, the argument is, "Oh dear, if we make nonforeclosure any less painful, soon everyone will be rushing out to get in front of a judge and then where will we all be?"


Jon Healey

If I were to sell my second, paid-for home via owner financing to someone who decides to go bankrupt, why should I be punished?

SR, if the buyer defaults, you lose, too. Folks don't file for bankruptcy to avoid paying bills they can afford to pay; it's because they're incapable of avoiding default. So the right frame of reference is, how does the lender fare in a default vs. in a cramdown? The lender isn't being punished if the cramdown results in a better return on its investment than a foreclosure, particularly when foreclosure sales are returning 40 cents on the dollar.

Remember, as the seller you assume the credit risk. If the borrower defaults in a market as bad as this one, you lose, period, cramdown or no cramdown. The rational thing to do is to cut a deal with the borrower to avoid default.

Countrywide Hater

I didn't chose Countrywide they chose me when my bank sold my mortgage. I could well afford my home at the time. We were hit by a hurricane and Countrywide said oops we forgot to pay your escrowed insurance. I rebuilt the home out my 401k and savings. Now they won't do a modification. They'd rather foreclose and sell it to someone else for half the mortgage owed. This doesn't make since. I got sick I lost my job during the illness and they won't work with me. Countrywide claims the investor Duetche Bank doesn't allow modifications. That's a LIE! They sent me a modification and it was wrong. Countrywide said they would be sending a corrected one and never did instead they sent a summons to foreclose.My insurances and taxes are escrowed yet they force placed insurance with their own ins company Balboa 7 times in 4 months. The modification stated I owed $10K for forced placed insurance., yet they paid my insurance company?????
They won't get my home. I will remove every nail every roof tile every wall until all they have left is the slab. That's my modification!
The bankruptcy judges should be able to modify the terms of the loans. My home was $111K is was just appraised for $39K
Don't roll us all into the same group when you don't know anything of our situations.



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