Megan McArdle has some serious thoughts about home mortgage modification, concluding that facilitating workouts that allow the homeowner to keep the house may be less useful than facilitating short sales.
Speaking as a non-expert, I wonder whether this isn’t the (possibly) right solution to the wrong problem. Â Foreclosures are terrible for families, and not great for banks. Â But it’s housing abandonment that’s the nightmare for the neighborhood. Â In some cases, abandonment happens without foreclosure: Â the owner walks, but the bank decides it would rather own a bad loan than an empty, unsaleable property, and never perfects its title.
So what we ought to be aiming for, first and foremost, is keeping the structure occupied. Â There are homeowners who can’t afford their mortgages, even with modifications, but who could afford to pay a market rent. Â But banks don’t like being in the landlord business. Were that’s not true, it’s still usually the case that someone would rent the property for more than it costs to maintain.
What’s needed, it seems to me, is a quick nuisance-abatement process that can wipe out both the equity and the debt on places that aren’t occupied and aren’t being maintained, and maybe some assistance for the owners of neighboring properties - who have the biggest stake in preventing deterioration - to buy the “empties.”
Perhaps if we made abandonment the worst outcome for the banks, they’d figure out what to do to avoid it.
Nothing like enlightened self-interest to light a fire under them. Your proposal would be one way to do it.
"Perhaps if we made abandonment the worst outcome for the banks, they’d figure out what to do to avoid it."
That's one way to do it - slam some banking CEO's in jail, and they'd be motivated.
As a bankruptcy lawyer I work on the front lines of this issue, and I can find very little sense in the McArdle post to justify the label "serious thoughts". For one thing, she proclaims that, "Proponents of cramdowns have begun a recent love affair with the pre-1977 bankruptcy code." I have not until now heard anything like such a hankering for that obsolete law from anyone, much less anyone knowledgeable; this doesn't engender confidence as to how well plugged in she is to the realities of the issue. Her categorization of defaulted mortgagors is arbitrary, conclusory and not very useful. The idea that "government should be trying to streamline the process of arranging for a short sale" overlooks that this would require the government to fast-track adjudicate every case in as much detail as a bankruptcy court would, forcing cancellation or reduction of various creditors claims to free up both the house and some cash for the owners. Making something like this depend on the voluntary cooperation of even one lender, much less two or more as would often be the needed, would be entirely useless. If it did work, it would be just like cramdown — except you make sure the owner who most values that particular property has to get out. She completely overlooks that most such owners have other serious debt issues as well. There is no enlightenment here.
McArdle's authorship is practically guaranteed to discredit an idea. For an idea how vapid she is, see her recent piece in the print magazine about how, despite her prestigious MBA, she can't budget.
Ken Doran says:
"As a bankruptcy lawyer I work on the front lines of this issue, and I can find very little sense in the McArdle post to justify the label “serious thoughts”. "
I wouldn't go so far as to say that McArdle never has serious thoughts, but they are few and far between.
She can be summarzied as a glibertarian Chicago propagandist, with the odd personal quirk where she deviates from the party line.
That's an . . . interesting . . . reading of my Dave Ramsey piece. Honi soit qui mal y pense, and all that.
Ken Doran, whether or not you've heard it, there is quite a meme on the left half of the finance blogosphere that since cramdown was a piece of the pre-78 code, undoing it must have been a big giveaway to the banks. As you and I both know, this is not an accurate reading of what happened with the new bankruptcy code. Moreover, most of the advocates of such a policy are unclear on the distinction between 7 and 13, and unaware that most Chapter 13's fail. If making cramdowns a major piece of the code lured many more people into Chapter 13s, as I suspect it would, this would be good for your business, but not necessarily good for the people involved. The more marginal the case, the more the negatives of bankruptcy start to weight against the positives. Plus it's not like our nation's bankruptcy attorneys or courts have a lot of spare capacity to devote to millions of homeowners who want their principal written down.
As for the rest, I'm not sure exactly what your objection is. My characterization of people who default on their mortgage as fundamentally people of goodwill, though perhaps unwise, rather than willing deadbeats, but it's the characterization most favorable to offering principal-reducing mods. For most Americans, anyone who deliberately stiffs their creditors for financial gain should be treated more harshly by the bankruptcy courts, not less. I'm sure many of them do have much other debt, and perhaps their finances are not salvageable-but again, that weighs against a principal reducing modification, since that's just a giveaway to other creditors. It might be an argument for cramdowns in BK, but that smounts to a massive changing of the rules under which mortgages were written, and would have substantial effects on the mortgage market that would not necessarily be either salutary, or popular.
It's certainly true that streamlining short sales is tricky. But that's also true of streamlining modifications, or anything else that the government might do to intervene in the housing markets. Either the government strongly enforces-in which case, it's some sort of bankruptcy lite for which we currently have no apparatus-or the government doesn't, in which case, it looks . . . well, a great deal like modifications look right now. But there's no reason to think that short sales would be worse in this regard; at least people wouldn't throw their savings after the house.
Paying attention to the bankruptcy law preferences of people who don't know the difference between Chapters 7 and 13 is about as useful as crediting the military reform preferences of people who don't know the difference between a ship and a tank. I urge ignoring them. I believe it is correct that home mortgage cramdown was at least not prohibited before 1978, but it was essentially a technicality. Back then home prices were considered to be guaranteed to go up forever (the conventional wisdom until a couple of years ago), and mortgage lending was extremely conservative by recent standards. The present avalanche of foreclosures and upside down mortgages hardly imaginable then, much less a motivating factor in legislative battles. I believe the protections for mortgage lenders were sought and received based on a much more general claim of "We have this important, stable, conservative, self-regulated market; you really shouldn't mess with it." But I was just a young lawyer then; ask UCLA law prof Ken Klee, a key draftsman of the '78 Code; I would be interested in what he has to say. As to your categories, I do not recognize the complexity and variety of the situations I see in those breakdowns. What does or does not make sense in a particular situation depends on many other financial factors. In my experience, a short sale is rarely any kind of a solution for the holder of a troubled mortgage. Much depends not just on the vagaries of the situation, but on 50 state legal regimes, which vary drastically. I just don't see this as being a useful approach unless there is a mechanism to enforce — not just urge — cancellation or modification of multiple claims on a fast track. That is what cramdown is — except cramdown allows for the possibly of the current owner staying with a marked-to-market mortgage, if the numbers otherwise work.
Just a note: if people in 1978 thought home prices were guaranteed to go up forever, they had very short memories. They might, however, have been relying on the probity of an industry that had not yet popularized the no-doc option ARM with 105% LTV. (And the late 70s, with the beginning of toxic-waste liability, were certainly the era of banks deciding not to foreclose on abandoned properties, at least on the commercial side.)
But I think this may lose sight of Mark's original point, namely how best to preserve the value of underwater properties as housing stock and as part of functioning neighborhoods (insofar as they ever were). I think in some areas it may be far too late already, and the sensible thing would be to buy out the remaining residents, help them resettle somewhere with decent infrastructure, and then bulldoze the "neighborhoods" that never should have been built in the first place. Eminent domain could simplify some of the debt/equity issues.
"Back then home prices were considered to be guaranteed to go up forever" was intended to have a bit of hyperbole in it, but only a bit.
I get your point, but if a short sale won't help you, I don't see how a cramdown would either, unless the judge just arbitrarily writes down the principal to what you can afford to pay in rent. If you can make your obligations without the burden of your excessive mortgage payment, then a short sale will help you; if you still can't, you need bankruptcy, but a cramdown will put you in no better income/expense position than you were before, because the mortgage payment on a house crammed down to FMV would still probably be higher than renting elsewhere. (It will help you years down the road, but to me bankruptcy is supposed to be for a fresh start, not a freebie enhancement of home equity.) Cramdowns work well on cars and similar assets because they depreciate really rapidly. Even in California, cars have probably still depreciated faster than homes in most places.
One thing I think we should note is that I was using cramdown colloquially to refer to anyone who wants a mortgage modification, not just people who need to file bankruptcy, so certainly what I said wouldn't necessarily match your experience. But I should think that the three categories pretty effectively cover most people: either you have an expense/income problem (usually unexpected), or you have a spending problem which prevents you from matching income to expenditure. I know that at least some of people in category one made some unwise choices about living up to the edge of their incomes, but the immediate problem is the sudden disconnect between income and expenditure, not that they simply ran up debts buying stuff they couldn't afford when they bought it.
But perhaps we should take this to an email/IM interview for my blog. I'd be very interested in hearing what your experience is out in the bankruptcy trenches-from what I understand, it's gotten pretty crazy out there.
I have been using "cramdown" to mean a change to the terms of secured debt imposed in a bankruptcy organization, such as Chapter 13 or Chapter 11. I had never heard it used otherwise, or used at all by anyone except a bankruptcy specialist, until very recently. We may thus have been talking past each other to some extent. Such a result will not help anything close to all troubled mortgage-owers, but it most certainly will help a goodly number in today's market. There are many people who could handle a market rate mortgage for 100 percent of actual current market value, but in today's collapsed market are stuck with a mortgage for well over 100 percent, and sometimes above-market interest as well. Current law "protects" lenders from such cramdown (as to home mortgages, although not as to most other secured debt), so they get a foreclosure instead and a far worse bath. And yet another house that might have retained its owner-occupant becomes and REO. Even so, for various reasons, lenders virtually never are willing to make those terms voluntarily. I would continue to emphasize that every situation is complicated by non-mortgage factors, and bankruptcy courts are experienced in evaluating those entire packages. I would be happy to discuss this further; kendoran@execpc.com.