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The Sandbag Plan

posted by Elizabeth Warren

I've been struggling to understand the real point of the Administration's headline-grabbing plan to deal with subprime mortgages. Now, thanks to Bob, I've read it, and the plan seems to be nothing more than a guideline for when some lenders or servicers might let some borrowers extend lower interest payments for a while before the interest jumps up later. The loan on the house stays the same, even the family owes much more than the house is now worth--a circumstance that will cut off any refinancing option and any real resolution of the problem. The plan doesn't require any new laws or government intervention because no one is bound to anything. I can't quite figure out what the plan accomplishes that the lenders couldn't do without the plan--if they were in a mood to deal fairly with borrowers, acknowledge their losses, and start cleaning up the mess before it takes down the whole economy. So why trumpet a plan that doesn't do anything? CongressDaily (no link) found the answer: "'Totally will sandbag the bankruptcy stuff,' one lobbyist said of the White House announcement." So that's what the plan is designed to accomplish--kill off the bankruptcy proposal to deal with home mortgages.

In a piece entitled, "Bankers Hope Bush Subprime Plan Will Scuttle House Bill," CongressDaily reports that "the mortgage industry hopes a White House plan designed to aid subprime borrowers at risk of losing their houses will help scuttle congressional efforts to refashion mortgages through the bankruptcy code. . . The announcement comes as Congress moves ahead with plans to make it easier for bankruptcy judges to refashion home mortgages that are on the verge of foreclosure -- legislation bitterly opposed by the housing industry. Bankers said they hope to use the White House approach as a prime example of why the bankruptcy legislation should not move forward, emphasizing that a voluntary effort can cover many of the estimated 2 million subprime loans that are scheduled to reset to higher rates over the next two years."

Bankers evidently dislike the bankruptcy proposals because they give borrowers some real power:  they can write down the mortgage to the value of the property, and they can rewrite the mortgage into a fixed instrument.  "Voluntary," according to the banks, is much better.

Of course, if the bankruptcy laws changed, the negotiations outside bankruptcy would change too.  If families had the option to declare bankruptcy and cut the mortgage down to the size of the property, some mortgage servicers might start returning homeowner's phone calls and talking over other options.

Bankruptcy can't fix the whole subprime problem, and it is not a perfect solution even for those who would be helped.  Families have to be in really bad shape to go bankrupt, and many will resist either because of the stigma or because they won't qualify for relief.  But bankruptcy could help some of the families hit hardest.  It would also move this crisis through the system faster.  If a bankruptcy court determines that the family can't afford the home even with a decent mortgage, then they will have to give it up. A bankruptcy amendment will not put off the day of reckoning.  It will help move toward a more stable (and more realistic) housing market faster.

So the administration's subprime mortgage plan is the bank lobby's dream.  "Totally will sandbag the bankruptcy stuff." And totally sandbag American homeowners and would be homeowners. 


The American Securitization Forum wrote the rate freeze presented to the public by the President and the Treasury Secretary.
It can be found it at americansecuritization.com

The framework allows servicers to modify loans without borrower signatures.

Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 13, third paragraph from bottom of page

Counseling and modification expenses are to be charged to securitized trust cash flows, so service providers, like Countrywide, which has a representative on the board of the American Securitization Forum, will profit from the process.

Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 7, first full paragraph

Appraised value for modifications are based on the date of origination, even if the current value is much less.
Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 2, second bullet

According to the American Securitization Forum's Framework for the rate freeze, borrowers will not have to document current income to be eligible for refinancing, even if they received initial loans with embellished incomes

Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 3, FICO test

Some of the firms that may profit from the rate freeze are members of the industry group that authored the plan.

The teaser freezer plan is not bad as far as it goes, but is grossly inadequate if it is touted as a comprehensive solution. First, the current foreclosure crisis has very little to do with ARM rate resets and payment increases; 70% of 2005 and 2006 subprime ARMs now in default have not reached reset dates, and the plan does nothing for borrowers who are already delinquent. Early payment defaults, i.e. homeowners falling behind on poorly-underwritten loans in the first 12 months, will continue to be a major contributor to mounting foreclosures.

Second, the plan rejected FDIC chair Sheila Bair's proposal to convert subprime ARMs to fixed loans, and instead suggests merely deferring rate increases for five years. This aspect really illustrates the greed of ASF and the industry negotiators. The only borrowers who will face the postponed reset (usually from about 8% to about 11%), are those trapped in their loans for five more years by declining property values or marginal credit. The beneficiaries of this squeeze are the residual and lower tranche investors, who want to extract economic rents from the worse-off borrowers, even at the cost of precipitating foreclosure losses that wipe out all interest and typically 40% of principal. The borrowers stuck in temporarily-modified loans after five years are probably the most in need of permanent relief.

I see two positives (they are small) in the plan. First, giving servicers permission and encouragement to modify loans in groups, without re-undewriting borrowers or even contacting them, can potentially save thousands of homes, and that is a good thing. Second, the reverse steering of borrowers, i.e. encouraging subprime borrowers to appliy for FHA refinancing, is a welcome turnaround from the past subprime servicer tactic of encouraging delinquent borrowers to get yet another subprime mortgage.

The permission to charge investors for counseling and modification costs predates this plan, but it is also a very useful tool, that counselors need to know about and demand.

As always, the complexity of the issues do not lend themselves well to sound bite descriptions.

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