Hostage Value

The secured transactions course nearly always includes a discussion of hostage value, and the bankruptcy course offers the antidote.  But the subprime mortgage market is giving us a new teachable moment.   

Because foreclosures in Massachusetts have tripled in the last year, the governor set up a $250 million rescue fund to try to help families get out of crazy mortgages and into affordable, fixed mortgages. The Globe reports today that so far not one single family has qualified for the rescue.  Other states with similar funds are also reporting dismal results. There are many reasons for the failure, but a critical problem is the hostage value of the house. 

A side note for the Not-Commercial-Law-Jocks:  "Hostage value" in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to reposses the collateral.  The classic example was the old practice of taking a security interest in all of a family's household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released.  This version of the practice involving household goods is now banned by the FTC.  In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions (see Bob Lawless's recent post).

Rescue programs limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender.  But the mortgage lenders want more.  If they don't get it, they won't release the mortgage--even though the lenders won't get anything close to 100% of the value of the home if they are forced to foreclose.  They hold the home hostage:  Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home. 

The mortgage lenders are counting on the leverage of their hostage taking to do better than 100% payment.  So long as they hang on. rescue efforts are irrelevant and renegotiation won't work.

The bankruptcy amendments that passed the House this week would break the hostage value of the home. The amendment would give families a chance to negotiate deals that would take them out of ruinous mortgages and let them get into something that is affordable--with or without a rescue plan.  The mortgage industry oppses the bill, saying it will decide "voluntarily" when they will or will not turn a homeowner loose--which is another way of saying they want to hang on to the hostage value.