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Homeowners in Bankruptcy

posted by Adam Levitin

Katie Porter makes some excellent observations about the Carroll and Li study of homeowners in bankruptcy. There's another crucial point to add: the study's conclusions only tell us, at best, about bankruptcy today. It shouldn't be much of a surprise that bankruptcy doesn't have a huge impact on homeownership retention precisely because it is impossible to modify single-family principal residence mortgages in bankruptcy. The study is looking at a bankruptcy system with both hands tied behind its back. Given that bankruptcy already results in a 15% higher level of homeownership retention than foreclosure, one would expect a much greater impact if debtors could adjust their mortgages to make them affordable.

Consider--Credit Suisse has found that voluntary loan modifications that reduce monthly payments have an 83% success rate in the current market. Involuntary modifications could be even more significant than voluntary modifications. If bankruptcy modification were allowed and we saw a similar success rate in homeownership retention, that would be a big accomplishment indeed.

Thus, I think a fairer interpretation of the study's findings are that currently bankruptcy helps a bit with homeownership retention, even though it is working with the very modest tool set of the stay and a chance to de-accelerate and cure, and that with a broader tool set to modify mortgages, bankruptcy could make a big difference in homeownership retention.

Comments

Big is too small of a word Adam. Huge, Gi-normous. If I can add a little something.... the effects would be huge even if we were able to just re-write the "toxic" mortgages. In other words even if there were a compromise in the legislation and we didn't want to cart blanch grant everyone who files bankruptcy the ability to re-write mortgages. If we were able just to modify the “exotics”, that legislation would have a huge benefit. Changing those 80/20s; the ARMS; the interest only; the teaser rate ARMs, would have a huge national impact. Even if we modified the traditional 30 year fixed to place any arrearage back into the mortgage (value permitting) would end in more interest over the life of the mortgage than by curing over 5 years in a 13.

Maybe instead of arbitrarily buying MBOs, the government could buy only the Mortgages that are in a Chapter 13 Bankruptcy. Then the government and the American Citizens would know exactly how much we spent and what the true value of the note really is. It would restore liquidity by providing a stream of income from borrower to the Mortgage Co or straight to the Government itself. If the Government owns the note the Government could get the money and the interest. That would be a safer investment because you would have US Bankruptcy Judges doing what they do best… weighing the equities. If all of those toxic mortgages were re-written in Bankruptcy and pooled into some government type bonds or something, I would invest in that because I would have a better knowledge of what their true worth actually is. The government would have to service them or farm them off but I think the 13 Trustees would be uniquely situated to handle that task. It could be for just five years or expand that task longer, I know if a % cut was in it for them the 13 Trustees would jump at the chance. Even if it was just five years that would be five years of positive cash flow. That could get us over the hump.

I know I’m crazy but if anyone thinks so at least tell me why. Just trying to kick some ideas around.

You don't need cramdown. The states have the power to do pretty much the same thing, through eminent domain. All they have to do is seize the mortgages, pay fair value to the indenture trustee, and restructure the mortgage. It's Constitutional: Kelo. The eminent domain eliminates the tranche warfare and second lien problems, and may ultimately be a break-even or modest profit for the state. It is pretty much the same result as cramdown, in a different institutional milieu. Oh, and no need to file CH13.

Of course, we would need a state with some credit or decent tax revenues. And that might be as unlikely as asking for a US Congress that can actually pass legislation.

Hilarious Joe S. -

Ever done an eminent domain action?

Here's a hint: there is a jury trial right involved.

If someone doesn't want to sell at the state's price in eminent domain, they can drag out the proceeding a VERY long time. You regularly see it with the last homeowner holding out for big bucks for the last parcel needed for some development project.

Practically, eminent domain powers would give states no real advantage over a straight offer to just buy the mortgages at distress sale prices.

At least your last comment seems to indicate you know your suggestion won't work because the states are broke.

I hope your post was satire.

McCain's new plan would have the federal government buy mortgages directly, and then modify them:

http://money.cnn.com/2008/10/08/news/economy/McCain_mortgage_plan/?postversion=2008100812

McCain mortgage plan shifts costs to taxpayers

Under McCain's newly announced plan, the government would take the hit for writing down mortgage balances for at-risk borrowers.

By Les Christie, CNNMoney..com staff writer
Last Updated: October 8, 2008: 12:50 PM ET

NEW YORK (CNNMoney.com) -- Under a mortgage rescue plan announced at the debate Tuesday night by Senator John McCain, much of the burden of paying to keep troubled borrowers in their homes will shift to taxpayers.

McCain's original plan called for lenders to write down the value of these mortgages, and take those losses. McCain unveiled the new $300 billion plan in response to the first question of the debate.

He said, "I would order the Secretary of Treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished values of those homes, and let people make those - be able to make those payments and stay in their homes."

The government would convert failing mortgages into low-interest, FHA-insured loans.

"Millions of borrowers" would be eligible for the program, dubbed the American Homeownership Resurgence Plan, according to McCain economic advisor, Doug Holtz-Eakin.

To qualify, homeowners would have to be delinquent in their payments already, or be likely to fall behind in the near future. They would have to live in the home in question - no investment properties would be eligible - and have had demonstrated their credit-worthiness when they purchased the property by putting down a substantial down payment and by providing documentation of their income and assets - no liar loans.

EMERGENCY LEGISLATION to allow Bankruptcy Judges the Authority and the right to modify and provide a principal reduction on PRIMARY HOMES. This seems to be a real solution to the mortgage mess and if congress changes the Bankruptcy Code millions of homeowners will soon be able to modify their mortgages with substantial principal reductions without being at the mercy of their lender’s discretion. Since a change in bankruptcy laws in chapters 7 and 13 cases are the equivalent of Federal Court Orders, there is nothing the lender can do to prevent such modification, and must accept the new loan terms. IMHO

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