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House Judiciary Cramdown Hearing

posted by Adam Levitin

A great thing about teaching in Washington, D.C., is the ability to drop in on legislative hearings. Today I went to a House Judiciary subcommittee hearing on the cramdown bill, also known as the Emergency Home Ownership and Mortgage Equity Protection Act of 2007(HR 3609). A report is below the break.

To my surprise, the hearing room was packed. There were 90-100 people attending and a strong showing from the subcommittee. Not what one would expect for a technical bankruptcy issue. Substantively, nothing surprising happened, at least when I was attending.

Jack Kemp, Wade Henderson, Mark M. Zandi, John Dodds, and James H. Carr all spoke persuasively in support of the bill. In opposition, David Kittle of the Mortgage Bankers Association continued to peddle the bogus claim of cramdown resulting in a rise in interest rates. They also claimed it would result in an increase in bankruptcy filings. Historically, though, allowing cramdown did not have such an effect.

Faith Schwartz, the director of the HOPE NOW Alliance, which coordinates mortgage servicers' voluntary workout efforts, emphasized that the number of voluntary repayment plans and modifications has risen dramatically in recent months. But Mark Zandi of Moody's Economy.com observed that this doesn't necessarily mean much. First, repayment plans only delay the day of reckoning because they don't change interest rates. They just allow for present arrearage to be paid over time. If the problem is that the interest rate is too high to manage, this is not a solution. And second, the number of modifications is irrelevant--what matters is their quality. If the modification is insufficient, it will fail eventually. A large number of foreclosures in the last quarter of '07 were failed repayment plans and modifications. Moreover, a major problem for voluntary modifications is that servicers are often unable to contact borrowers. As John Dodds of the Philadelphia Unemployment Project pointed out to the incredulous ranking minority member, when debts mount up, debtors often stop opening their mail because all that it contains is bad news.

Finally, it seems that not all committee members understand what happens in cramdown, perhaps because of the technical nature of bankruptcy on this point. The mortgage debt does not become like credit card debt. Instead, it is split into two pieces (and not based on the bankruptcy judge's whim, as some committee members seem to think, but based on a finding of fact, namely the value of the house). The portion of the debt equal to the value of the house is treated just as it would otherwise have been--the lender retains a lien on the property. Only the portion of it that exceeds the value of the house (typically quite small--about $9,000 or 10% of the claim on average historically) becomes like credit card debt. As has been pointed out on this blog before, this is a crucial distinction and one that opponents of the reform legislation routinely ignore or fail to understand.

Comments

Wonder where committee members got the idea that a cram down of mortgage debt makes it like credit card debt? Perhaps they read the editorial page of the Wall Street journal, which has twice made this inapt analogy. Yesterday's WSJ had an op-ed by Dick Armey asserting that the bill would raise interest rates on future mortgages, a claim that Prof. Levitin has explained is implausible at best, given that the bill would only affect pre-existing mortgage.

The op-ed is here, if you are interested in reading a short summary of the position of the bill's opponents: http://online.wsj.com/article/SB120156746465123881.html?mod=special_page_campaign2008_mostpop

Mind boggling if committee members fail to understand the "technical nature of bankruptcy" or if they get their "understanding" of it from WSJ editorials. Weren't most of these learned men and womwn on board in 2005 when they addressed valuation/cram down (in a manner favorable to the credit industry) anent car loans? Perhaps we're witnessing a manifestation of situational obtuseness.

Please sir, I have a question!

Why is the cramdown based on a finding of fact by the court? Why isn't the procedure simply that the lender sells the house, and the shortfall is an unsecured debt provable in the bankruptcy like any other?

Or am I misunderstandng the point? Is the point that interest payments will be reduced after bankruptcy is discharged, and the amount to be paid to redeem the mortgage will be reduced, because part of it will have been discharged as an unsecured debt? If that is the case, will the basis for the valuation be a forced sale, or a sale by a willing seller to a willing buyer?

Marcin,

I think you're confusing state law foreclosure procedures and federal bankruptcy law procedures.

If the lender foreclosed before the debtor filed for bankruptcy and the foreclosure sale produced a deficiency, then that deficiency would be an unsecured debt provable in a subsequent bankruptcy. (But depending on the foreclosure process, the lender may not be allowed to recover a deficiency--varies by state.)

But if the borrower files for bankruptcy before the foreclosure process is complete, the continuation of the foreclosure process is automatically enjoined. When a person filed for bankruptcy, there is an automatic injunction against any collection efforts outside of bankruptcy--the only way for creditors to collect is through the orderly mechanism of the bankruptcy process. That injunction is the very reason many people file for bankruptcy--it stops the foreclosure process.

The reason we don't use a market device like a sale for valuation in chapter 13 bankruptcy is that we want the debtor to be able to retain the house. That can't happen if the house is sold. Chapter 13 bankruptcy is designed to be a repayment plan that allows the debtor to keep his or her property, but requires the debtor to pay all disposable income for the next 3 or 5 years to creditors (basically living on a court-supervised budget--no fun at all).

The homeowner's right to redeem after a default (or, in some circumstances, after a foreclosure sale is completed), is a state law right. Bankruptcy provides an analogous right by permitting debtors to deaccelerate and cure delinquent mortgages.

Cramdown only addresses the size of the lender's secured claim. Other types of modification would impact interest rates/amortization, but the proposed legislation has floors for that.

use mediation services between the consumer and the banks. These services are already paid for by the taxpayer and are located in counties throughout the nation. Ask your local mediation services to help the parties mediate issues regarding credit cards and mortgages. Both the consumer and the bank will benefit when the sit face to face regarding financial debt. I am the chairperson of the Insttute For Medation and Conflict Resolution

How will the cramdown work? Will the debtor have to pay the secured portion of the mortgage(s) in full through the Chapter 13 plan (only feasible if the secured portion is rather small since the plan is only five years max)? Or would the debtor have to refinance to pay the secured portion? Then the "stripped off" portion will be discharged--similar to the way cars work now (well, in fact since BAPCPA you can't strip down purchase money vehicle loans less than 910 days old)?
Could you file a strip down motion in a Chapter 7, so the debtor reaffirms for only the secured portion of the debt? Could the debtor "redeem" a house in Chapter 7?

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