President Obama, he of the 68% approval rating, asked Congress to allow bankruptcy judges to reduce the principal amounts of mortgages on primary residences (they can already modify almost all other loans in bankruptcy). The goal was to pressure mortgage lenders, or the investors who now own those mortgages, to modify the mortgages themselves to give homeowners a better option than foreclosure. Because, you know, we have a housing foreclosure crisis going on. But after passing the House, the measure got only 45 votes in the Senate, with zero Republican support and twelve Democrats defecting.
Banks campaigned against the measure by – get this – threatening that it would destabilize financial markets. The New York Times reported:
A letter signed by 12 industry organizations this week to senators warned that the legislation would “have the unintended consequence of further destabilizing the markets.”
Translation: banks are weak; weak banks are dangerous; therefore Congress should not do things that might be bad for banks.
According to the Washington Post:
[Senator Richard] Durbin negotiated with Bank of America, J.P. Morgan Chase and Wells Fargo for weeks, hoping their support would bridge the gap. Even after the proposal was weakened significantly, the financial services industry refused to sign on.
I know the main legitimate argument against bankruptcy cramdowns: it increases the riskiness of mortgages, and therefore mortgage rates would have to go up a little for everyone. (Which sounds fine with me.) But the way this issue played out had nothing to do with what would be best for the country as a whole; it had everything to do with what the banks wanted.
Instead of bankruptcy cramdowns, the Times reports that the banks got a reduction in the insurance premiums they will pay the FDIC for deposit insurance – which is like a group of car owners voting themselves lower premiums on their auto insurance. But because there is zero chance the government will let insured depositors lose money, any shortfall in the premiums paid by banks to the FDIC will be made up by the taxpayer.
Not that this should surprise anyone.
By James Kwak
The Baseline Scenario 
Let’s get rid of those damn senators who always vote with the banks
Cramdowns strike me as changing the rules of the game after it has been played… I do not see why someone who took out a loan they could never afford to buy a house they could never afford should suddenly get special treatment by Congress. Where is the special treatment for people who saved and borrowed responsibly? Or are we just chumps?
I am no friend of banks, but I am also no friend of overleveraged speculators. I want to see all of the rules play out as originally written. I want everyone — from borrowers to lenders to “investors” — to get precisely what they signed up for. Does this make me an extremist?
If allowing cramdowns is a good idea (and I agree it is), then I propose they should be allowed only for future mortgages, not for existing ones. That does not help anybody in the immediate crisis, of course, but it does preserve the integrity of the system.
First of all, let’s keep in mind what banks are really scared of: if mortgages get crammed down, they are immediately adjusted on the banks’ balance sheets. And the banks have made abundantly clear that they will do absolutely everything in their power to avoid admitting the extent of their problems. I forget the wise man who first said this, but we will know this crisis is over the first time economic news has to be revised upward.
Secondly, to Nemo’s point about changing the rules only for future mortgages: that seems to me a bit like the decision (which actually happened) by baseball to ban the spitball but grandfather existing pitchers. Can you imagine having to keep track of whether a relief pitcher was in the league seven years ago?
Fifteen years from now there will be bankruptcy proceedings and fifteen years of debts will have accrued between now and then, and the judge and the creditors will still be trying to figure out if the petitioner has a “special” mortgage.
We’re better off recognizing that this was always the more fair way of handling debts within bankruptcy and the creation of “protected classes” on non-discharge debts is a case of a loophole intended for sympathetic cases (child support obligations, etc) that grew wildly as every politically connected claimant pleaded with the government for special treatment (student loans, mortgages, etc). Let’s put an end to it.
Yes, it’s an odious tangle, where there’s no way to attempt reform without rewarding malefactors. I guess a reformer has to ask, who are the more culpable and systemically more dangerous, the reckless lenders or the reckless borrowers? In answering “the lenders” and making them take the cramdown, reform would have to accept its own moral cramdown in rewarding the undeserving borrowers. That’s where a system like this gets you.
Certainly the borrowers who played this rotten game are among the antisocial. They helped to drive up prices and to price more and more people who could not or would not go deep into debt out of the housing market (and also to drive up rents).
The result has been a system that rewards aggression and criminality and punishes responsibility, lifestyle modesty, living within one’s means. You would think any sane, reasonable person would consider such a system to be depraved and disgusting on its face, worthy of destruction.
Which is why I’m unable to see any “integrity of the system” at all, and why I’m unable to believe in any of these anodyne reforms.
As we see here, where even such meager reforms face such tremendous entrenched opposition, how could anyone think that significant reform has any chance? It cannot be done within this system. By now we shouldn’t even say, feudal reaction is entrenched in the system; rather, it is this system itself.
Certainly the so-called “two parties” are mere functionaries of this reaction. The administration has openly declared that its overriding priority is the crapulence of the big banks, and everything else will be dictated by this priority.
I’ve been looking through your site (first visit) and am puzzled that you seem to think Obama is trying to save (recover, heal, boost, etc.) the economy instead of destroy it. I think you’ve started with a weak foundation. Can you name one thing (since October when his presidency became a given) he has put in place that has helped? Have you uncovered something in his background that would indicate he knows anything about anything?
Interest rates going up is one thing, but I would be concerned that cram downs would lead to a drastic change in loan to value ratios that the banks would be willing to lend at. If your investment is put at risk by a decline in value of the underlying security, as a lender I would take steps to insure that the value of my loan never fell below the value of the house. I do not know if that is 80% LTV, 70% LTV or 50% LTV, but I would definitely require significantly more equity up front. I think some unintended consequences would be home equity lines would become harder to get and first time home buyers would have a much more difficult time getting into a house because down payment sizes would increase. In themselves, I do not know that these are bad things, but I do not know that they would be particularly helpful in solving the current crisis.
James,
I don’t like the idea of cram-downs. The government shouldn’t be in the business of modifying contracts after the fact: we step further down the line of a government of men rather than a government of laws.
Congress should instead address the problem in a way that doesn’t call into question the validity of contracts in the US: repeal the changes in the bankruptcy code made under the previous congress, investigate fraudulent lending and prosecute offenders, etc. The investors in MBS will take a hit anyway when their underlying assets deteriorate, so that’s not a concern. (Well, except for the fact that the Fed is now the sole investor in MBS.)
Fifteen years from now there will be bankruptcy proceedings and fifteen years of debts will have accrued between now and then, and the judge and the creditors will still be trying to figure out if the petitioner has a “special” mortgage.
Not at all! Just keep the contracts the way they were written! Nemo is arguing *against* special, crammed-down mortgages. A better baseball metaphor would be this hypothetical: say that an entire generation of players had used performance enhancing drugs. This was discovered and called into question all of their achievements over the last decade, but despite this, the records that they set were allowed to stand.
Errrr, wait a second…
Anyway, the core problem is to preserve the sanctity of contract. It’s an incredibly valuable asset of the U.S. economy. If fraud can be established, prosecute vigorously, but otherwise use bankruptcy relief and other measures
based on the rule of law to address the situation.
And, of course, what’s good for the goose is good for the gander: allow big banks to go bankrupt, allow counter-parties to absorb losses no matter how politically connected they are, etc. Just follow the law.
Cheers,
Carson
Russ,
Reforms are one thing: we can and should reform the laws. Modifying existing legal contracts when no fraud has been established is something very different. (See my comments below.)
Cheers,
Carson
Having looked through this site and not found what you are looking for, you may want to refer to Warren Buffet who just thanked Obama, and others, for saving the US from “an economic Pearl Harbour”. Not a bad place to start. Buffet also acknowledges “we are still at war”
Regardless of all of the new regulation and policy relating to mortgage modifications, how could anyone have thought cram down legislation would have been approved with all of the money the banking lobbies insert into the system? Once can only push so much. For additional insight into this and other financial issues, please see http://www.bobgreenfest.wordpress.com.
Bankruptcy is available to just about any kind of shady, hair-brained business you can imagine. But, in the wisdom of Congress, it is not available for personal mortgages and student loans. Why? Lack of lobbying clout.
Bankruptcy rules are adjusted all the time (most notably in 2005, when they took a dramatically anti-consumer turn.) What about all the people who had accumulated large amounts of credit card debt pre-2005 and then had the rules for discharging that debt changed on them? Where was the concern about “changing the rules of the game” then?
Destabilizing will occur if there is not enough money in the FDIC to protect the depositor.
The real estate market will continue to destabilize as foreclosures and jingle mail dump more and more real estate on the market to be sold at bargain basement prices. Investors and home owners will lose more money when the value of non-foreclosed real estate continues to fall.
The few investors with CDS will benefit at the expense of the rest of us. Short term gain is still the name of the game.
Actually, it is probably in the banks and the nation’s best interest to allow cramdowns now. I would argue that it is future cramdowns that the banks don’t want and that’s why they are fighting it now. The banks know these mortgages are going to go into foreclosure and they will end up being sold for pennies on the dollars now because of the horribly bad CURRENT housing market. The banks are trying to protect their future leverage granted by the foreclosure process. I would be willing to bet that if we had a 2-3 year window on cramdowns that the banks would be far more open to the idea then granting permanent cramdown powers.
ODB – RIP,
The bankruptcy changes were atrocious and, without a doubt, written by the banks because they saw the credit collapse coming. There was plenty of (sadly impotent) outrage over the changes on both the left and right (I spend time on both sides of the blogosphere.)
We are now in the fortunate position that, due to general public outrage, that law can be repealed. We should do that, and relax them even further as a slap at the banks. That is absolutely appropriate and legal.
What we *shouldn’t* do is modify existing contracts by government fiat, unless fraud can be established in a court of law. Government of laws, not men.
Cheers,
Carson
Nemo: “I do not see why someone who took out a loan they could never afford to buy a house they could never afford should suddenly get special treatment by Congress.”
In our society, people who go bankrupt get special treatment. They don’t go to debtors’ prison anymore. Their creditors take a hit.
Nemo: “I want to see all of the rules play out as originally written. I want everyone — from borrowers to lenders to “investors” — to get precisely what they signed up for.”
That’s a good principle. However, the details of the bankruptcy law are the background for loans, not explicitly part of the loan agreements. Changing the law for existing loans may seem unfair, because they might not have been made under the new rules. However, is it fair to treat mortgages differently from other loans in bankruptcy? If the rules were unfair to start with, how is it unfair to change them in order to make them more fair?
If you change the contract after the promise was made, you dissolve
trust. It may help some people temporarily, but once that occurs on the grand scale proposed it will immediately change the economic landscape forever. Overall TRUST is as precious as freedom.
Take that away, and we have no way to invest in each other, as everyone would know a promise (contract) is just paper – it no longer is a stable and trustworthy instrument.
Kids won’t play a game once they realize a cheater (“rule-changer”)
is always winning due to their behavior. The financial markets operate the same way – and so do international agreements that prevent wars. Break this trust (breaking the mortgage contracts) on this scale, and the economic problem we hope to avoid will be compounded dramatically. If a person or company fails to pay, let the original logic crafted into the document take it’s financial course.
I believe if TRUST is undermined by the millions (saving foreclosures),
the problem will change to “What can I do with my wealth? Where can I invest? What can I invest in that is real?”
And the answer to that will be much different that before. I don’t believe it will be pretty.
Somewhat in line with Nemo’s point above about changing the rules, I suspect that opposition for cram-down came from many sources in addition to banks. These are sources who have a vested interest in making sure current interest rates don’t rise… BONDHOLDERS.
Any holder of a bond, or a CDO-style instrument, sees their investment drop substantially in value even when interest rates rise very slightly. If cramdown causes interest rates to rise, then holders of _existing bonds_ could see sharp losses.
I’m not expressing personal opposition to cramdown. I’m simply noting that the headline might read:
“Round 1: Bond Market Ownz Obama”
http://www.bloomberg.com/apps/news?pid=20601109&sid=aJJ9n3NhQa1s&refer=home
Renegotiating massive contractual webs like this is really hard. That is one of the reasons moderate inflation is useful – it allows for rapid renegotiation of currency-denominated social contracts without keelhauling the whole country to get a little reform. (Until, of course, everyone hedges against inflation with TIPS and CDS, at which time inflation creates its own contractual web.)
Adam,
Perhaps so. The banks and MBS investors, then, should investigate principal reductions on their own. Think about what it would mean if the government could modify any contract as it saw fit “for the greater good.” The ramifications would be profoundly inimical to our liberties.
Please, everyone, bear in mind that the party in power in the federal government may not always be one that you are inclined to agree with. Perhaps sooner than you think!
Cheers,
Carson
Please, we are not talking about “debtors’ prison”. We are talking about what happens when you lose a bet with borrowed money, and who exactly gets to bear the cost of that. Mostly, we are talking about whether you get to keep that overpriced house you never should have bought, or whether it goes on the market for someone else to buy.
Every transaction — from buying medicine to crossing the street — takes place against the backdrop of existing law. You knew the rules when you took out the mortgage to buy too much house, but you did it anyway, because you were betting house prices would appreciate 20% per year forever. That is fine, but I do not see why anybody other than you should bear the cost of that decision.
Carson Gross is right about the “rule of law” vs. the “rule of men”. I do not think laws should be changed retroactively without an overwhelmingly good reason. Rewarding housing speculators in order to punish lenders does not qualify, in my opinion.
(And yes, the 2005 bankruptcy bill was an abomination. What does that have to do with this subject?)
I’m surprised that several points haven’t been made here:
1) Bankruptcy ALREADY permits the dissolution of many (all?) other types of contracts, including mortgages. The only difference is that now mortgages on primary residences would be in that group. How is that a complete destruction of the history of US contract law?
2) We are talking about bankruptcy. Very few people eagerly seek out bankruptcy in the normal course of events. Yes, many scam the system and it would be great if those loopholes were plugged. It would also be good if the “stigma” of bankruptcy were revived – at least insofar as yo are not likely to get a mortgage, credit card, car loan etc for seven or so years. The same lenders who are terrified of the “risk” of bankruptcy modifications are the same people who will happily give a recently bankrupt consumer the means to plunge right back into debt.
3) If this results in higher equity requirements, that is all good. The housing market must contract to the point that a median income will pay for a median priced house with 20% down. This desperate desire to re-inflate the bubble and call it “recovery” is folly.
The ability to renegotiate loans is now and always has been an option lenders can offer borrowers. They simply choose not to for reasons mentioned by others (hit to the balance sheet). What is wrong here is that lenders know the government (taxpayers) will bail them out if a load fails, but borrowers (taxpayers) are “held to the contract” come hell or high water, without bankruptcy as a recourse. Perhaps if there was no taxpayer bailout of the banks possible in the first place, banks would be more conciliatory with borrowers without being forced to be so with the creation of yet another law. In a twisted way, you need cramdown laws because you have a system where lenders can afford to not work with borrowers to keep the loans working. Bottom line: too much government intervention in the first place.
The country would be better off is the mortgage payment shortfall, of which foreclosures are just a symptom, were significantly reduced. Bankruptcy cramdown could have been usefully coupled with provisions to strip borrowers of the non-recourse nature of their loans. If walking away were to become a de jure bankruptcy, with the exposure of considerable assets to creditors, then staying current even if the financial equation doesn’t quite make sense for the next 2 to 5 years would be encouraged. And once more pressure is placed on holding the marginal borrowers to their contracts, the ability to be generous to folks who are really dead should be greater. But I am afraid that it is getting very late in the day for this – too many borrowers have already left with too many assets in their pockets to reasonable fund a more generous program for the near hopeless.
Carson: “Anyway, the core problem is to preserve the sanctity of contract.”
Sanctity of contract went out the window when we allowed bankruptcy.
Carson, you refer below to “government of laws, not men”. This is precisely what I deny we have. It’s clear that “the law” has been corrupted to serve calcified feudal interests, bolster their entrenchments, and prevent even modest reform, let alone real solutions.
That’s why I’m not a “reformer”, and I do not call for “reform within the system”. I don’t believe any such thing can happen.
This gang wanted to place itself outside and above the law, and it had the political clout to do so.
Where the crimes and the criminals are in fact above the law, the law cannot confront them. They can only be confronted on their own battlefield.
Sooner than I think? How about my whole life?
And if there was any doubt, the last eight years were just about as repulsive as can be imagined. Unfortunately, where it comes to economic policy Obama seems intent on adding to these years.
not to sound diluted… but between the swine flu and special interest bankruptcy is our government prepared to actually lead us into the future.
.
or is this it, an overpaid lobbyist organization that pre-determines near meaningless outcomes… the world is not a perfect place and this internal dickering over who best serves special interests has got to be gnawing at anyone with some common sense.
.
as a citizen of the most powerful country on earth i can see 1 of 2 reality’s… our government is full of diabolical geniuses, or we have no idea whos in charge, what were going to do, how much anything is worth, what a better system looks like, or how to fix or address the energy problem in a meaningful way ‘mpg standards anyone’
.
im of the mind that government can get to big and powerful and this is what has happened
and by near meaningless government dictated outcomes… imean crisis lazer tag…. its one thing to do something visible… its quite another to enforce rule of law, creating meaningful representation for all party’s that is just, carrying the weight of the American public
.
Nemo,
“…because you were betting house prices would appreciate 20% per year forever. That is fine, but I do not see why anybody other than you should bear the cost of that decision.”
Either the bank was making the same bet (increasing home value) or the bank failed to due proper due diligence in making sure that they were lending money to someone capable of paying. These were not one-sided bets.
Thank you, Rockfish. Great points – I was wondering when someone was going to touch on these aspects. If anyone is worried about speculators, they are already taken care of under existing bankruptcy laws. They get the cramdowns on their other, multiple residences. Those who only own a primary residence are unfairly disadvantaged under existing bankruptcy law. So that argument’s moot.
Why is the discussion focused only on cramdowns – reducing the principle. Why is there limited-to-no discussion on extending the term of loans to 40 or 50 years?
Would this not help make the payments more affordable for the people who over-extended themselves without giving them a ‘free-lunch’?
Min,
Totally. I say we bring back debtors prison and, perhaps, indentured servitude.
In all seriousness, you are right that there is moral hazard by having bankruptcy. But you have to have something to deal with debts that cannot be repaid. Among the various options available we have chosen a bankruptcy regime, with well defined procedures for resolving the debts.
It ain’t perfect, but it is is. And we should use it.
Cheers,
Carson
I thought that the banks were fine with this, but it was the holders of senior paper which were being asked to take a haircut out of order.
From the FT:
Russ,
Intriguing comments. I see your argument. How do you propose confronting the banks “on their own battlefield”?
Nemo,
I follow your posts, because they usually make a lot of sense. I’m not following you on this one; maybe you can help me.
Why should the “rule of law” allow bankruptcy courts to modify most other kinds of loans…but not for personal mortgages? Seems like that makes your “rule of law” argument inconsistent. What am I missing?
Hmmm…so banks beg and receive hundreds of billions of dollars from taxpayers when they cannot meet their legal obligations under the “rule of law.”
But when their individual mortgage customers cannot meet their legal obligations, the banks argue that the “rule of law” is supreme.
Just what about this is not hypocritical and logically contradictory?
Carson,
The “rule of law” argument is specious unless banks absolutely insist on paying off their legal obligations instead of begging U.S. taxpayers for hundreds of billions of dollars when banks can’t meet their obligations under the “rule of law.”
Once the banking industry insists that that accepting taxpayer money to change the rules of the game is wrong, I’ll buy your “rule of law” argument.
After watching the actions of big banks during this crisis, it’s clear to me that “rule of law” and insisting on not modifying existing legal obligations is a red herring. The banks’ actions prove that “rule of self-interest” is far more important to them.
How could anyone who’s followed this crisis and this blog be shocked at that?
Hi Phil,
While I suppose it’s still way too early to think seriously about revolution, there’s still a lot short of that an intrepid government (if we had one) could do to fight for the people vs. pseudo-legally entrenched organized crime.
While I personally would have let the big banks go down, since America is going to have to take its economic medicine sooner or later, and it would’ve been better and not as hard to start taking it now, even if one wanted to try to prop them up and “recover” them you could still simply (behind closed doors) lay down “the law” which is the price of their becoming wards of the state.
The executive branch, if it chooses, can make things very unpleasant for any entity or cadre which couldn’t even exist except at the leisure of the government. This was true of the banks even when the good times rolled, let alone now when they are haggard zombies pumped full of artificial cash and propaganda infusions.
There’s the oft-given example of how, when America had to rapidly re-arm, FDR simply ordered American manufacturing, especially the auto companies, to retool for war production. This was not strictly “legal”, and if they’d wanted to fight it out in court they could have at least wasted alot of time, maybe even “won”. But FDR simply would not have stood for that. Indeed, in the famous “nothing to fear but fear itself” inaugural FDR also darkly hinted that he’d use power in whatever way necessary for the good of America, and that he hoped any entrenched domestic enemies (i.e. Wall St and the banks) wouldn’t force him to go beyond the law in doing so.
The terms of cash disbursements, regulatory arm-twisting and threats, prosecutions for looting and fraud, severe tax investigations, government lassitude in enforcing provisions the gangsters find beneficial, and of course the bully pulpit, the rousing of social hatred…these are always available. Indeed to varying extents we’ve seen all of them from the Bush administration against those who would stand up for the people or the environment.
I’m not saying I regard this as a pleasant prospect. But as I wrote, the notion that this would be abrogating the “rule of law” is fraudulent. On the contrary the law has already abdicated. As the captain said, “I didn’t leave the ship, the ship left me!”
Unfortunately, as I also said, there’s little hope that anything within the existing party calcification can undertake such a project. I guess for anybody who wants to retrieve real democracy, the first order of business is to break the “two” party logjam and find a way to real participatory, proportional democracy. (Here again the so-called “laws” would be against us and in favor of the entrenched stagnation.)
That’s a great point, Roger. Although it’s not widely discussed, the mortgage modification plan that the Obama administration put in place does use 40-year term extension to lower monthly costs, and you can already get 40-year-terms on Fannie and Freddie refinances from the FHFA modification plan from back in November or whenever it was.
One thought is that you build equity so slowly in a 40- or 50-year mortgage that it’s almost odd to call it “home ownership”. In a 40-year mortgage it takes about a decade before you’ve paid 10 percent of principal. In a 50-year mortgage it’s 13 years.
I agree with others here – once the banks when on the “dole” as it were, the prior rules no longer apply. We have no obligation to maintain the status quo in terms of their mortgage contracts. If it’s better for the nation to force cramdowns, that should be one of the conditions of our largess.
Of course that is no longer relevant since, yet again regardless of party, our “representatives” (I use the word lightly) have shown their ultimate corruption.
PS: You guys should publish the “List of Shame” of those Senators who voted against the cramdown provisions.
Hi Russ,
Thanks for elaborating on your thoughts. Unfortunately, I can’t disagree with much of anything you said.
As you said, we’ve already seen that the ‘rule of power’ consistently trumps the concept of the “rule of law.” Those with power, such as the financial sector, simply use that power to extract hundreds of billions of dollars after making FAR worse decisions with FAR worse consequences than homeowners who overpay for homes with banks’ written approval.
The “rule of law” simply does not apply to those who exercise their power when (i) the matter is important to them and (ii) making the “rule of law” argument doesn’t favor their interests.
While I much prefer Obama to Bush in most respects, homeowners and other ad-hoc taxpayer groups simply have no lobby that can compete with the power of the financial sector’s.
While we may win more mini-victories under Obama, I don’t see a way to win the war. As you also say, our electoral system will maintain a two-party system. Whoever appeals best to the middle-of-the-road voters will usually occupy office.
That’s not quite right. The reason the banks don’t like cramdown is not that it forces them to realize their losses. They don’t like cramdown because it *increases the size* of their losses.
Without cramdown they can do a NPV calculation and determine whether or not to foreclose and sell or renegotiate with the borrower (and they do renegotiate more than people seem to recognize).
With cramdown they would often be forced to accept a renegotiation that is a substantially larger loss than foreclosure.
By the time homes are in this stage, the banks are already recognizing the losses on their books (it’s future foreclosure expectations that they underestimate; they’re not making up fake values for REO sales). Cramdown would make the losses they are already recognizing larger (and future real losses larger too).
I think that’s a subtle, but important, distinction.
I think a better option, for those who are really intent on cramdowns (I’m not), is to make the cramdown optional for the borrower at the time the mortgage is signed.
The cost of future cramdowns (i.e., higher interest rates) would therefore be borne by those that desire the ability to renegotiate their mortgages in bankruptcy.
It would then be interesting to see if seemingly generous folks like James would still be willing to pay higher interest rates to subsidize other – and perhaps irresponsible – borrowers.
“The problem with socialism is that you eventually,
run out of other people’s money.” – Margaret Thatcher
This is a moment that reveals the nature of our oligarchy.
Allow cram downs for 2nd homes, 3rd homes, boats, recreational vehicles?
Natch.
Allow cram downs for the one and only residence of a working stiff?
No Way! That’s “bad for banks”.
Adam —
These were not one-sided bets.
Correct. And the rules already exist to give everyone precisely what they signed up for. As you may have noticed, the collapse in real estate has had some effect on the banks’ balance sheets, and will continue to do so. This is fitting and proper.
I do not object to changing the rules. I do object to changing them retroactively. I do not see why it is particularly controversial for everyone to receive precisely what they agreed to. (Obviously, I oppose the bail-outs. But that issue is independent of this one; two wrongs do not make a right, etc.)
Phil —
Why should the “rule of law” allow bankruptcy courts to modify most other kinds of loans… but not for personal mortgages?
Because that is the law and has been for 30 years. (Or 15, depending on how you count…) Again, I accept the argument that personal mortgage debt should not be treated specially. I support changing the law to allow cramdowns… But only for future mortgages. (Someone else argued this would be logistically difficult, but I do not buy that. As with any transaction involving money, every mortgage has a perfectly well-defined and well-recorded date of origination.)
But changing the law retroactively is a very bad idea as a matter of principle. First-world countries do not do such things without an overwhelmingly good reason. I do not see that here.
I think Evan Bayh has it exactly right when he concluded that we should not be pursuing policies for the benefit of the 5% of the homeowners with the worst credit that jack up costs on the other 95%.
It does seem like it is strange to allow cram down’s for vacation homes and not first homes. But I think the answer is that you should not allow cram down’s for secured debt. The Ban’s remedy ought to be to foreclose under the contract that was signed. If the debt is recourse and the value of the asset does not cover the cost of the loan, then the difference would be unsecured debt under bankruptcy law. This ought to be the case for a car, 1st home or 4th home.
For what it’s worth, I personally don’t think cramdowns are actually going to work any wonders or do much to help the housing problem. The only people who it reasonably helps are the people who can afford the home, but because the value has fallen so far will never be able to sell the home until it is fully paid off and have decided to forgo putting good money after bad. While that group of people is growing, the vast majority of mortgage foreclosures are going to people who can’t afford them – either because they never could or because they are now without a job and no mortgage modification or cramdown is going to help.
In the end this bad debt has to be written off. I personally think all these homes need to be foreclosed on. What worried me is that there are so many that the market will over correct so far that the above group I mentioned will balloon and the cycle can’t be stopped. If the government is going to do anything, it should be buying up vacant/foreclosed homes where prices have fallen significant to help prevent the markets from over correcting – putting a reasonable floor on the market. Sell them at a later date when the economy and area market can better absorb the volume of homes.
Reading the succinct NYT article referenced here lays out about as well as anything could what is so perverse about our representative government as currently practised. As remarked throughout, the Senate, (you know, those individuals who run for office to “represent” their constituents’ interests): a) “handed a victory to the banking industry…” re allowing bankruptcy judges to alter homeowner mortgages; b) will likely scuttle the House bill re limiting banks ability to charge high fees and penalties, due to the fact that “the industry has more clout” in the Senate; and c) their vote clears the way for legislation “which has several features that the banking industry has sought.” Measures, in other words, that favor the banking cartel. Bank lobbyists provided the rationale by which the Senators could justify their vote, stating that the measure, so beneficial for them, “would result in higher costs for future borrowers.”
Meanwhile, President Obama, who sought the cramdown provision during the election, “has done virtually nothing to move it through Congress.”
More and more clearly, for those who wish to acknowledge it, most people’s interests are not represented by those elected officials who purport to do so.
Nemo: “Rewarding housing speculators in order to punish lenders does not qualify, in my opinion.”
Do you really think that bankruptcy judges would generally reward housing speculators? Besides, isn’t most of the foreclosure problem at the level of subprime borrowers, most of whom are not speculators, but are probably financially pretty clueless? OTOH, a bankruptcy judge might well want to punish a predatory lender who took advantage of their borrower’s naivete. Do we want to deny the judge that option?
Note that this is precisely why James labels this as a “crisis” when it really isn’t.
Cramdown is basically a wealth redistribution from the majority of borrowers who have good credit to the minority of borrowers with bad credit. That is, had it passed, the cramdown bill would have required all borrowers to pay higher interest rates to subsidize the few that would actually seek mortgage cramdown in bankruptcy.
But government compelled wealth redistribution is generally hard to sell among U.S. voters, especially when there is no plausible moral justification for the transfer. In the absence of systemic economic hardships, the case for wealth transfer arguably can only be made if framed as an immediate crisis.
Mark,
It makes far more sense to benefit 5% of the homeowners with the worst credit than less than 1% of the banks, whose credit is so bad they beg for and take hundreds of billions of dollars of taxpayers money…after those banks had already assumed their risks “under the rule of law.”
“most people’s interests are not represented by those elected officials who purport to do so.”
Is that so?
Most people would not expect to renegotiate their mortgage in bankruptcy. Most people would rather not pay higher interest on their mortgage for the minority that would seek mortgage adjustment in bankruptcy. It sounds to me like most peoples interests are well represented by elected officials.
And don’t kid yourself about Obama. He only “sought” this provision because he knew it didn’t have the votes to pass.
Nemo: “Because that is the law and has been for 30 years. (Or 15, depending on how you count…)”
Apparently it is 7 years, FWIW. According to Lenn Harley at
http://activerain.com/blogsview/970231/THE-BANKRUPTCY-CRAMDOWN-MORTGAGE-MODIFICATION-JUST-MIGHT
“Folks with second homes and vacation homes can already be modified by a bankruptcy judge. It is only the primary residence that cannot be modified. This is the result of bank lobbying when the new bankruptcy laws were written in 2002. Why should home owners be denied that ability for their residential property on which they owe far more than market value? Negative equity has made paupers of many fine American home owners who did nothing more than purchase a home.”
From realtor.org: “The size of the second-home market is significant. NAR’s analysis of U.S. Census Bureau data shows there are 8.1 million vacation homes and 40.5 million investment units in the United States, compared with 75.5 million owner-occupied homes.” So those types of mortgages that can be subject to cram downs under existing bankruptcy law represent about 40% of the market. Is there a significant difference in interest rates whether you are buying an investment property or vacation home vs a primary residence? If not, I’m wondering if that interest rate argument is a bit of a red herring.
Min —
The blog you cite is simply wrong. The relevant law was passed in 1979, but it was ambiguous, so this question was not fully resolved until a 1993 Supreme Court decision.
Since 1993, the principal on single-family primary residence mortgages can not be written down in bankruptcy. From 1979 to 1993, it depended on which Federal court you were up in. See here or here or here. Yes, I realize all of these authors disagree with me on whether cramdowns are a good idea :-). But the raw fact is that cramdowns have been prohibited since 1979 (or 1993, depending on how you look at it), and had nothing to do with any 2002 legislation.
Nemo,
Thanks for your reply. I think that your argument makes sense only if we lived in a different reality. If the reality were that the “rule of law” applied to everyone…regardless of their lobbying and financial clout…I might agree with you.
I don’t think that the cramdown issue per se is the biggest issue that has many of us disagreeing so strongly with your position.
The issue is that those with power…the big banks are the timely example…do NOT have to play “by the rules.” Their managers can make stupid decisions that garner hundreds of millions or more in bonuses to the managers…and then leave it to the taxpayers to bail them out.
If the big financial institutions with power had to live up to the “rule of law”…and not have to live up to their specific legal obligations…that would be a different world in which your argument would be much more convincing.
James and many of us readers see our government operating through both Dem and GOP administrations to do virtually anything to take care of those that have power. The events of the past months has made it clear to most that our country does not operate as one which goes strictly by “the rule of law” and only changes its actions after the laws have changed. Of course, this is nothing new. It’s simply more clear to more people now than in the past.
Those with power obviously have a big impact on what the laws are at any point. That’s a serious, but separate, issue.
Nemo, please show me that we live in a reality in which those with power even have to wait until they’ve lobbied congress to pass the laws they want.
EXACTLY WHAT LAWS WERE CHANGED THAT SHIFTED THOSE BIG BANKS’ LEGAL OBLIGATIONS FROM THEMSELVES TO THE TAXPAYERS BEFORE THE GOVERNMENT BAILED THEM OUT TO THE TUNE OF HUNDREDS OF BILLIONS IN DIRECT AID.
I am glad that this was defeated. Passing this could have led to some very unfortunate, and unforeseen, consequences.
Phil writes:
It makes far more sense to benefit 5% of the homeowners with the worst credit than less than 1% of the banks, whose credit is so bad they beg for and take hundreds of billions of dollars of taxpayers money…after those banks had already assumed their risks “under the rule of law.”
I disagree that you have framed the question accurately or, even if you have, that you have weighed the two scenarios correctly. We bailout a handful of large organizations because a) each of them has contracts with hundreds of thousands of other economic actors that will be disrupted, cascading into second and third generation disruptions in the millions that will lead to a global economic collapse, costing the government an enormous loss of tax revenue and driving up deficit spending; b) a failing economy needs money injected into it, which cramdown doesn’t do but likely deters, c) the transaction costs of bailing out a few strategically placed organizations are significantly less than those associated with cramming down hundreds of thousands of mortgages in legal fora, and d) cramdown won’t help every homeowner – many foreclosures occur because the homeowner’s income has fallen so low that even a readjusted mortgage is too large to pay.
I have a problem with your response, Nemo.
Lewis Black was in my city last night (Regina, Saskatchewan, Canada), and I went to see his show. He made some right-on comments on the mortgage crisis. I’m paraphrasing here, and I apologize in advance for any errors.
Black noted that recently a law was passed that basically said that when you apply for a mortgage, the lender has a responsibility to make sure you actually have sufficient assets and income to make the mortgage payments. Black said something to the effect that there’s something seriously f***ed up if you have to spell that out before lenders will do that.
Sure people who couldn’t afford rent were getting mortgages. Supposed someone approached you and said “I know you can’t afford rent, but how’d you like a house?” Like any normal human being is gonna say “No, I’ll continue living here in my box.”
Those bankers who approved those loans made huge amounts of money in bonuses and such. So they get to keep their assets and houses, and the ordinary folks have to live on the street?
Besides that, I’ve always had a problem with this attitude of “I didn’t get any help, so I don’t want anyone else to get help.” This is not about “responsible people” being “chumps”. It’s about ordinary people who got in over their heads. It could happen to anyone. If you lose your job and health insurance, or have a serious illness or injury that your insurance won’t cover, you could end up in the same boat.
Steve F
You state as fact (not opinion) that Obama “only ‘sought’ this [cramdown] provision because he knew it didn’t have the votes to pass.”
Where is your evidence of this purported fact?
Of course most people are not going to find themselves in bankruptcy court, nor in food lines, nor at the emergency room without insurance. But for those of our citizenry who do so find themselves, wouldn’t it be so much better a reflection of our society and ourselves if they were accorded some means to address their situations? I believe most people would be in favor of such provisions. Surely not the banking industry, acting in complete self-interest, but the rest of us.
The bill was limited to mortgages issued prior to 2009; do you really believe the bankers bs that this will result in higher interest on all other mortgages going forward?
There is a significant difference in financing a vacation/second home as opposed to owner occupied. I’m not sure what is typical, however, based on the few anecdotes that I’ve heard, second/vacation home financing typically requires an additional 100 bps over what you’d pay if you occupy the house.
This makes sense. The collateral isn’t all that different whether it’s occupied by the owner full time or only on vacation. However, if the lender expects to recover less in bankruptcy, it will charge a higher interest rate to make up the difference.
“but otherwise use bankruptcy relief and other measures
based on the rule of law to address the situation.”
That is exactly what would be done if the cram down provision were passed. A bankruptcy judge would only be allowed to cram down the mortgage of someone who had filed for bankruptcy. Seriously I dont see this as a big sanctity of contracts issue. The point of Bk is to modify contracts, and every time the BK law has been changed it has affected existing contracts. This is about the laws being stacked in favor of the rich and powerful and not being available to help the little guy. Imagine for a minute that when Chrysler filed that its biggest liablitities could not be discharged in chapter 11. Go ahead and file, but you cant change the pensions or the health care obligations. Chapter 11 would not do much good then would it. Well that is exactly what every GOP and 12 Dem senators want, not for big firms like Chrysler, but for ordinary folks. Mortgage, cant be touched, student loans, cant be touched, child support/alimoney, cant be touched, tax laibilities, cant be touched. On the last point, corporations which go BK usually have losses (negative income) that can offset taxes, but that is not true of individuals, who almost always have positve (if insufficent) income.
So there should be no protection under bankruptcy protection? A car loan is a secured loan, but judges will routinely cram down car loans.
So Nemo, are we safe to assume you’re not against the “changing of the rules” when banks pay less money for their insurance premiums to the FDIC and the taxpayers pay for it???? Do you see that as preserving the “integrity of the system”? They play around with CDOs or credit swaps or whatever you want to call them, we pay for the losses, then you don’t think they could lower the principle on the mortgages so some people who up to this point have been very responsible on their house payments can keep their house??? Oh heaven forbid!!!! Heaven forbid we change the rules for the middle class!!!
These bastards in the banks MIGHT have to pay for their own damned deposit insurance!!! Well, we can change the rules for the banks huh Nemo???? Those poor banks had it so rough all these decades……….
There’s no reason not to believe the bill would result in higher interest rates going forward. Once you establish the precedent of allowing cramdowns, the rational lender will build this possibility into any future lending decisions – i.e., higher interest rates to make up for the potential losses in bankruptcy.
We already pay for a host of programs to help people deal with economic hardship, so why add another? And even if we need another safety net for troubled homeowners, why create it through something as complex as the bankruptcy code. Why not simply give troubled homeowners monthly checks to cover their mortgages?
@Russ:
“While I suppose it’s still way too early to think seriously about revolution, there’s still a lot short of that an intrepid government (if we had one) could do to fight for the people vs. pseudo-legally entrenched organized crime.”
I’ll repeat what I wrote 2 days ago; the key is exposure, with a Pecora-type of comission. Sunshine would go a very long way to mobilize the people in such a way that Senators would be confronted with a stark choice. Do the bidding of the people and keep your job, or bend over to the banksters and thou shall be thrown out of office in no time.
This, or the pitchforks.
Do our public schools still teach people to read?
James,
Your continual anti-bank rants continue to have little rational basis. I’m with Carson Gross who makes an articulate argument for respecting contract law. It is not clear why you continue to argue for anything which benefits the housing market at the expense of anything else.
That’s a very good argument Nemo just made. Very thorough. A lot of people on this blog disagree with you Nemo. Maybe we’re all just illiterate hmmm Nemo???
Dr. Kwack–
now i know how you come by your name. you seem to imply that contracts should be abrogated at a judges whim. surely you know such tinkering with private property/sanctity of contracts would have unintended consequences that will poison the well.
Simon makes some sense to me but you are a complete fool.
Elizabeth Warren on mortgage cramdowns and bankruptcy law: “If this were business property, a chapter 11, or a corporate chapter 7 proceeding, there would be no restriction to write down the secured debt to the value of the collateral,” she said. “The law recognizes everywhere the importance, in a financial crisis, of recognizing losses, taking the hit and moving on,” she said.
She said she could only attribute the existence of the exception to the political clout of the mortgage banking industry. If the cramdown proposals fail in Congress, “It means that the banks are still calling the shots.” (http://www.reuters.com/article/ousivMolt/idUSTRE53Q6T420090427)
Nemo, getting back to your original argument:
> I want to see all of the rules play out as originally written.
I believe your reasoning is incorrect.
Remember there are three parties to every contract. The invisible party that enforces contract law but does not sign the contract is every bit of a party as the two who sign the contract.
The invisible party that enforces contract law never said that they would not change the parameters of enforcement.
I am undecided about whether allowing cramdowns in bankruptcy is a good idea, but the fact is that banks knew that a law change was possible when they made the loans. So I don’t think your logic applies.
I understand Steve F.’s point that if cramdowns had been passed all new home purchasers would likely see higher interest rates, perhaps an average of 100bps. Perhaps less credit would be extended. I looked further into why that particular exception was originally made in the 1970s, and nobody clearly knows. The educated guess by one of the justices, based on testimony at the legislative hearings, was that there was a political desire to make lending more accessible to more potential borrowers. This was done at a time when most mortgages were fixed. Now the only other similar exception made was done in the 2005 bankruptcy changes, with respect to auto loans. Both of these glaring exceptions were done through legislative action; it should have been quite clear to those who sought and won the exceptions that they could be changed through legislative action also. I’m with James on this. Maybe interest rates should be higher; maybe lending standards should be tightened. It is very likely that if they had been, we would not be in this situation. So maybe we need to undo some of these laws or exceptions which were drawn up exclusively to promote home ownership. Clearly that’s not going to happen anytime soon with the cramdowns, however.
I 100% agree with you StatsGuy. I’m with James Carville—I want to come back in my next life as a bondholder. In fact, I’m on my way now to a Buddhist temple to burn some incense to gather karma for being a bondholder in the next life (haha).
Nemo,
Thanks for the references. That clears things up. :)
One thing I found interesting was this statement by Padilla on the “Mortgage Insider” page:
“The ones who stand to lose from bankruptcy modification are not the holders of mortgage-backed securities (MBS), but mortgage servicers, whose ability to assess fees on defaulted mortgages would be curtailed. MBS investors have been quiet about bankruptcy reform; it is servicers and originators who have been the main source of opposition.”
IOW, cramdowns help both borrower and lender. That seems counterintuitive, but a mortgage is not a two person zero sum game. It seems that the banks are against cramdowns because they are the servicers. Verrry interesting.
To evaluate the claims of those who believe that the banking lobby stymied a reform with popular support, I googled for poll results on this issue and here is what I found at Rasumssen Reports, a respected polling firm:
“Forty-five percent (45%) of Americans oppose the federal government subsidizing mortgage payments for financially troubled homeowners, according to a new Rasmussen Reports national telephone survey.
Thirty-eight percent (38%) think government subsidies are a good idea, and 18% are not sure which course is best to follow.
While 61% of Republicans oppose subsidizing mortgages, the plurality of Democrats (48%) support government aid to at-risk homeowners. Among adults not affiliated with either party, 33% favor subsidies, but 45% are against them.
The findings come as President Obama announced on Wednesday a $275-billion taxpayer-backed plan that would help an estimated nine million Americans refinance their mortgage payments or otherwise avoid foreclosure.
A majority (51%), however, say the government should find a way to help all homeowners reduce their payments rather than just help those who face foreclosure. But 15% think government assistance should target only those threatened with foreclosure.
Thirty-one percent (31%) say the government should not get directly involved in the housing market at all. Three percent (3%) are undecided.
Earlier this month, 61% of voters said if Congress passes a plan to help the housing market it should benefit as many homeowners as possible, while 28% said it should help only those in the greatest financial distress.”
In contrast with many of the above commenters’ presumption that their views reflect the popular will, this poll shows the popular will to be consistent with Senator Bayh’s determination to reject a proposal that would benefit a small group of homeowners and impose costs, on a larger group.
HL quotes Prof Warren as follows: Elizabeth Warren on mortgage cramdowns and bankruptcy law: “If this were business property, a chapter 11, or a corporate chapter 7 proceeding, there would be no restriction to write down the secured debt to the value of the collateral,” she said.”
This is only half the story and Prof Warren is presumably smart enough to know that she is being disingenuous in telling only half of it. A corporation is just a legal device to organize capital investments in the business. If a person wants to use the corporate form to hold a real estate asset and to have the corporation incur debt to finance it, s/he still has to pay off the debt in full to maintain the economic ownership of the asset. There is no ability for shareholders to use the bankruptcy law to force creditors to write down their corporation’s debts AND still own the equity in those assets. The owner of a mortgaged house is not analogous to the corporation in bankruptcy, s/he is analogous to the corporation’s shareholders. Each must pay off the debt in full to maintain ownership of the encumbered assets.
Great information.
It appears that the majority of voters don’t believe the “foreclosure crisis” myth.
Having read all the comments, what I will say is that the quality of debate is fabulous. The effort put in on these arguments is much appreciated. We need very smart and wise people to see our way through this crisis and reading this blog gives me confidence that, in the end, common sense and wisdom may, just may, be the order of the day. Thanks guys!
I was trying to point out that you need to re-read what I have said, because you completely missed the point.
You are not arguing with anything I actually said (or believe).
Please forgive me for exceeding your subtlety threshold.
The Constitution and Bill of Rights forbid ex post facto laws; that is, you can never be tried for any action that was legal at the time you performed it.
Of course, that only applies to criminal law, so Congress can pass cramdown legislation. My point is that it is a bad idea. I believe the general principle of “no ex post facto” underlies any well-functioning society (and market). If the U.S. gets in the habit of tearing up contracts retroactively based on which interest group happens to hold power, we will truly become a banana republic.
This is also why I oppose bail-outs, by the way. It is not just that “bad people” are being rewarded, or that money is being stolen from the middle class and handed to financiers. It is also that the rules already on the books would long ago have placed many of these financial institutions in bankruptcy or receivership.
I do not want any interest group to be able to change the rules retroactively for themselves, whether over-extended borrowers or insolvent banks. I want everyone to bear the consequences of their own actions according to the rules that were in place at the time. I believe this principle makes for a society that is fair, just, and efficient.
I have now repeated myself a few times, so this will be my last response. Anyone who does not get my point by now never will.
Nemo I think I feel the place that you’re coming from. There were however, a lot of people who were first time buyers and aren’t speculators. Last night I think on Bill Moyers, a guest stated that most people were used to letting the bank tell them if they could afford a home or not. This really used to be true even better, you had to provide proof to the banks to determine your credit worthiness. Why penalize the homeowners. Home buyers changed no laws nor process, it was the lenders and banks that made all of this possible.
Still the attitude that homeowners and banks are somehow equal is stunning. Someone that may end up homeless vs. someone that is burning tax payer bailout money shows the vast difference between these two classes to be nearly galactic in nature. You speak of integrity, but there never was any integrity in this system. The only people deluded in this process were those attempting to purchase a home. I have a few friends that are accountants as well as a family member that is a lender. They know without looking at your documentation most times whether you can afford a thing or not. Believe that there is no bank where this would be considered some sort of magical ability.
What is really troubling for me is that more and more there are two sets of standards. For the regular guy, they say that “Ignorance of the Law is no excuse.” But, those that protect, know and make the law whether officers, lawyers and politicians, all of which couldn’t claim ignorance are repeatedly given passes. Its like the discussion about the torture claims. Today, if there is robbery and murder and all you did was drive the car, guess what, they’re going to charge you with a lot more than driving the car. There is a case in Florida right now where the boyfriend was stealing a car. His girlfriend was killed by the car’s owner. The owner won’t be charged because apparently Florida has a “No retreat law.” The boyfriend who was stealing the care is the one that is being charged with her killing. That’s right, as convoluted as that sounds they know right away who should be charged. So they go and they tell the guy, ‘Well if you hadn’t been attempting to steal this car, your girlfriend wouldn’t have been killed, so this is your fault and no we’re not going to charge the guy that actually pulled the trigger.’
Put Torture Memos, Black Sites, the shredding of the Constitution and the Geneva Convention on the table and suddenly its so complicated they can’t tell who if anyone should be charged. The banks knew what they where doing and THEY are the ones that made it so a person could get a loan solely on what they said without having to provide any proof. Ask yourself first, isn’t the point of providing proof to thwart potentially dishonest borrowers? If you answer that affirmatively then ask yourself, what mad man would do away with a rule that helps him protect his money?
I also agree with you on the rule change thing only, “Too big to Fail” just happens to be that, a rule change.
@johnGalt I think you’re right on this. We’re going to have to vote these politicians with banker tendencies out. I don’t ordinarily use Twitter, but it was born for a purpose such as this.
OK I lied. One last quick thought.
Imagine if every time you entered any agreement, you knew that the other person could (and would) change the terms retroactively if they had sufficient political power.
Would you want to live in that sort of society?
I agree that overleveraged speculators earn no quarter- that’s their gamble. Perhaps mistakenly I understood the flexibility in the legislation was to provide manageable payments for primary residences of bankrupted homeowners.
After RICO and Consumer Fraud investigations have been conducted on the lenders, sellers and investors of these mortgages, we will be more able to clearly understand those “rules as originally written”.
Interesting nobody complains when the autoworkers have to renegotiate their contracts. In fact they applaud it. I BET THOSE AUTOWORKERS WOULD LOVE TO GIVE THEMSELVES A HUGE MULTI-MILLIONDOLLAR BONUS WEEKS BEFORE THEY KNOW THE COMPANY IS GOING DOWN THE TOILET. But when some banker who sits behind a desk, has much better hours, and runs the country into the ground trading risky financial instruments (CDOs or credit swaps), wants to redo his own salary (bonus or options) JimJin doesn’t have any problem with that. JimJin doesn’t even care if they pay themselves huge bonuses about a month before they go running to the government for money. Guys like JimJin are just so afraid those bankers who have run off with multi-million dollar contracts and raised credit card rates on credit card balances retroactively might not be able to foreclose on a home and resell it to the next sucker. Even though if they’d allow the last sucker to lower the principal amount A LITTLE, he could have payed the loan off. If allowing the last person better terms on the loan during a huge economic downturn interferes with profit margins, the banks (and the congressman they bribe) sing out in unison “Contract Law!!!!!!”. I mean, if we lower the principal on these mortgages, guys like JimJin would have us believe that CHAOS would break out tomorrow morning. GIVE ME A BREAK!!!!!!!!!!!!!!
Speaking of cramdowns… Here’s another interesting bankruptcy story from this weekend:
http://blogs.abcnews.com/politicalpunch/2009/05/bankruptcy-atto.html
If it’s true that the Obama administration forced certain senior/secured creditors to accept the Chrysler bankruptcy deal, what could possibly do more violence to the current bankruptcy regime? Forget the damage that would be caused by mortgage cramdowns. If you’re a senior secured creditor to a heavily unionized industry, would you feel comfortable with your claim?
A different perspective on the Chrysler bankruptcy in the NYT. An extract from the article:
“If Chrysler were going into bankruptcy with available exit financing, the bondholders would have every right to fight for their share of the pie, and to argue that other creditors were getting an unfair share. It has no such financing available, other than from a government with no legal obligation to provide it.
If President Obama is willing to let Chrysler die if creditors do not accept his division of the money provided by the government, then creditors of Chrysler face a relatively simple set of questions.
First, can Chrysler raise the needed cash elsewhere? No.
Second, are bondholders likely to do better forcing a liquidation, and standing in line to collect whatever the assets bring at a bankruptcy auction? (What is the bid for an auto assembly plant in Detroit, with machines built to produce cars that will not be produced anymore?)”……
Why Chrysler s Bondholders Should Stop Whining
By FLOYD NORRIS May 2, 2009
These are clearly unusual circumstances; a financial crisis, a serious recession and the US auto industry at some risk of disappearing. Is there anyone else other then the government who can step in to try and effectively restructure the industry? You can disagree with their decision to step in but once that is done, it is contradictory to then dispute their right to make the decisions they deem appropriate, as would any financial instution in the same position. The ultimate decision will now be up to the bankruptcy judge
There would certainly be others willing to step in with DIP financing to restructure the auto industry, but only if there were any certainty that Obama would not meddle in the process. No DIP financier would risk sinking money into Chrysler with a high probability of Obama thugs entering the picture.
And there’s nothing contradictory about criticize Obama’s decisions in the auto bailout, even after accepting the decision to step in. (criticize the administration? – shocking I’m sure)
The problem is that Obama doesn’t seem to be making decisions based on what’s best for the future financial viability of the industry – the result that would be obtained in a true free market or if the bankruptcy process were run without administration thuggery. Rather, Obama seems to be rewarding unions that supported him during his campaign. In a pure bankruptcy scenario, unions would have fared much worse than secured creditors who would get the deal that they bargained for, i.e., priority. So the long-term problem is one of incentives. Does it make any sense for future investors to sink money in industries that might be subject to thuggery by the administration?
This all seems really great for Obama. I’m sure industry interest groups are lining up to donate to ensure their own “Obama priority” in any future bankruptcies/bailouts. Sound like a banana republic? It should.
My understanding is that your premise is incorrect. DIP financing has been generally unavailable for months for any large firm which wants to go through a restructured bankruptcy. That is why Circuit City and other retail outlets absolutely had to go to liquidation. They could not restructure because they could not get the financing. That is what the discussion has been about for months regarding these firms, and that’s why bankruptcy was not considered an option “on the table” for so long for these car companies.
Maybe the best approach is no bailouts for anybody, including auto companies, banks, insurance companies, home loan borrowers, etc. The moral hazard of these bailouts just leads to more over risky investing and corruption and the country is too corrupt as it is. The bailouts obviously are also a way for the government to control the people and companies in an improper way.
Let’s keep it simple: a contract is a contract, no changing the rules in the middle of the game. Let the losers lose and the winners win.
DIP financing is always available, but at a price that corresponds to the likelihood that the restructuring will work, i.e. that the firm is economically viable. To say that DIP financing was unavailable is to say that the firm is not economically viable and should not be restructured.
I find it difficult to believe that, in the long run, Chrysler is not an economically viable firm that would normally attract DIP financing. The problem is that no DIP financier was willing to risk the government elevating union claims above senior secured creditors – including those of DIP financiers.
That’s not what this publication seems to say (written in the last month): http://www.gibbonslaw.com/news_publications/articles.php?action=display_publication&publication_id=2734 or most other pieces I’ve read on the subject since the credit meltdown started.
The piece you cite is saying exactly what I did: DIP financing is available, but at a price that reflects the current conditions, e.g., higher credit spreads.
Perhaps you should actually read the whole thing, but here’s a relevant snippet:
“In today’s economy, the limited number of banks willing to make DIP loans will demand increased interest rates and higher fees, significantly shorter loan terms, and other provisions that will make the DIP financing much less debtor-friendly. Nevertheless, as the risk:reward calculus of DIP loans is more widely understood, it seems likely that alternative sources of capital will step up to provide DIP financing in situations where banks are unwilling to make new loans and/or extend old ones.”
As I said, there’s still DIP financing, just under more stringent terms.
There is DIP financining available, unfortunately in this case only from the governments on an acceptable overall basis.
NEW YORK (Dow Jones)–Chrysler LLC said Friday it will ask a judge on Monday for permission to begin borrowing on a $4.5 billion debtor-in-possession loan to support its operations while in bankruptcy.
Corinne Ball, a lawyer for the auto maker, said at a court hearing that Chrysler wouldn’t seek approval to tap the loan Friday, its first day in court since filing for bankruptcy on Thursday. She said the company would file details of the loan with the court later Friday.
According to a term sheet filed with the U.S. Bankruptcy Court in Manhattan, Chrysler will seek approval to tap $1.8 billion of the financing on an interim basis.
The U.S. and Canadian governments are providing the $4.5 billion loan to help carry Chrysler through the bankruptcy case.
In the term sheet outlining the deal, Chrysler will pay its bankruptcy lenders – the U.S. Treasury Department and Export Development Canada – at least 5% interest on the loan.
Treasury is providing 74% of the financing with Export Development Canada putting up the remaining 26%, according to court papers. The two lenders will also receive promissory notes, equal to 6.67% of their loan commitments, when the loan matures.
By the way, assuming it was valid comment to say “no DIP financier was willing to risk the government elevating union claims above senior secured creditors – including those of DIP financiers.” – why would the bankruptcy court also agree?
This whole agrument seems irrelevant anyway. We have a domestic auto industry heading off a cliff because of years of poor leadership; we have major financial institutions who are insolvent; unemployment at record highs, a global recession….the not vert reassuring good news is “the economy is getting worse more slowly”. In this context, the only institution that can step in and try to mitigate the damage is the government. Its seems ridiculous, to say nothing of disingenuous, for those auto execs and bankers who brought us this mess to now say “let’s us fix it as we know best”!
If you’re calling this DIP financing, then Chrysler already had DIP financing last year, when the US taxpayers loaned them $4B with no strings attached. In fact, the US taxpayer can expect to lose all of the prior loan.
The current $4.5B loan is not what I’d call DIP financing. No DIP financier would agree to the deal that the UAW extracted. In reality, this is simply a wealth transfer from US taxpayers to UAW members.
A simple, but reasonably credible answer is that bankruptcy judges are notorious for their preference to save firms, even non-economically viable firms, at whatever cost to existing creditors. I’d also bet that no bankruptcy judge would be willing to disapprove a reorganization plan over the wishes of a popular administration – bankruptcy judges aren’t used to this type of political pressure, so would be unlikely to oppose it.
Also, you shouldn’t limit the blame auto execs and bankers, when the unions share more than their fair share.
So if I understand your points 1- Obama’s people are thugs; 2- DIP financing would be provided by non-government under terms that allow Chrysler to survive, restructure and protect the taxpayer; 3- bankruptcy judges will “give-in” to political pressure and do the wrong thing.
Executives are handsomely rewarded to lead companies, make decisions and deal with difficult issues. While competitors in the auto industry in the US, somehow managed to build strong companies that can withstand the recession, Chrysler and GM, did not do so. Must be a rationale for this as well.
1. Precisely. Absolutely. Yes indeed.
2. Quite possibly. If the process had not been overrun by the Obama thugocracy but rather been governed by normal bankruptcy priority rules, then I think DIP financing would have been available. The unions would not have fared well, however, but the companies would have emerged intact.
3. Yes. Bankruptcy judges have a certain amount of discretion in approving restructuring plans. In this case, I think the bankruptcy judge would likely cave, both due to a general preference for saving dying firms as well as from the additional pressure from the Obama thugocracy.
As to your last point… Foreign competitors in the US auto industry aren’t saddled with unwieldy union agreements/contracts and pension plans. Not that this isn’t also the result of poor management. For too many years Big Three management caved to union demands, paving the road to financial distress.