PrintBanned since Congress reformed the bankruptcy laws in 2006, cram downs are making a come back and may reappear in thousands of bankruptcy courts. Whether that’s a good thing or a bad thing depends on who you ask, because every side has its own studies and experts to prove its case.
Cram downs are judgments by bankruptcy courts that force longer terms, cut mortgage rates, or reduce loan balances. For the past three years, mortgages have been excluded from bankruptcy proceedings, but advocates—including the Obama Administration—argue cram downs will allow families to stay in their homes and keep them from foreclosure. Opponents in the financial services industry argue they will create even great instability in the credit markets and raise the cost of mortgages for everyone.
Legislation passed the House last Thursday to undo the 2006 law. It’s due in the Senate soon but there passage is less sure. The House version will almost certainly be amended to limit its scope, perhaps to restrict the change only to subprime mortgages, or only to existing mortgages, but not future loans.
These changes, if adopted in the Senate, could greatly alter the impact of the bankruptcy change on the housing markets. However, should the broader House version prevail, here’s what to expect:
Housing Markets: Four Percent Reduction in
Foreclosures.
In 2007, about 310,000 individuals filed for bankruptcy under Chapter 13. However, unemployment filings and foreclosures have doubled since then. Some five million Americans are currently unemployed. About 900,000 foreclosures are expected this year. The Congressional Budget Office expects the change in the law itself will result in a four to five percent increase in filings as homeowners choose bankruptcy because it will protect their home. The CBO estimates that it could help 350,000 families over the next 10 years, or 35,000 a year.
With at least 900,000 foreclosures predicted this year, that’s about a 4 percent reduction in the inventories of discounted REO properties expected to hit the market. Many families would keep their homes and some neighborhoods would be spared the consequences of foreclosure. Additionally, the existence of the cram down option will put pressure on lenders to write down principals as well as interest, reducing payment to a level where more families will be able to afford to stay in their homez. Even so, bankruptcy reform by itself is far from a panacea for the foreclosure crisis.
Taxpayers: Government $17 Million Profit
The Federal government would actually make money on the deal, about $17 million between 2009 and 2018, mostly in additional bankruptcy filing fees, according to the CBO. However, they did not factor into their estimates the TARP funds that might be needed if the dire predictions of the financial services industry come true.
Lenders: 150 Basis Points per Loan?
One way to calculate what the change might mean to lenders is to assume judges would reduce the debt by 30 percent on the approximately $575 billion in very delinquent subprime and Alt-A mortgages in the U.S. That works out to a loss of $190 billion. But it doesn’t stop there. Bankruptcy is no assurance that lenders will end up with a healthy loan. Securitized subprime loan modifications fail about 54 percent but the rate under a cram down, after payments are reduced, should be much lower than the failure rate under the old bankruptcy law.
The legislation takes that risk into account and lenders would get a substantial cut of the proceeds from a sale of the home if the homeowner sold soon after finalizing his bankruptcy plan. The mortgage company would get 90 percent for a sale within one year, 70 percent after the second year, and half after three years. The amount falls over time to 10 percent in the fifth year.
The losses to lenders and damage to investor confidence in mortgage backed securities would have a cost to consumers as well. The Mortgage Banker’s Association estimates cram downs would tack an additional 150 basis points onto the cost of a loan, wiping out the discounts the Federal government got by nationalizing lenders. However, a new study by Adam Levitin of Georgetown University found no empirical evidence that the proposed mortgage cram down will have a meaningful impact on mortgage interest rates. He looked at the pricing of mortgages that currently permit cram down, such as second homes, and compared them to the pricing of mortgages on primary residences which don’t allow cram downs.
Filing a Chapter 13 bankruptcy is a fairly onerous procedure and many borrowers may choose foreclosure rather than bankruptcy. Assuming most borrowers who file can’t pay their mortgage anyway, the losses lenders would suffer might not be any higher under the bankruptcy proposal and may in fact be lower. On the other hand, lenders may have reason to fear the losses cram downs may generate when judges drive the principal on loans below what could be realized by foreclosing and selling REOs at a discount.
Cram downs are judgments by bankruptcy courts that force longer terms, cut mortgage rates, or reduce loan balances. For the past three years, mortgages have been excluded from bankruptcy proceedings, but advocates—including the Obama Administration—argue cram downs will allow families to stay in their homes and keep them from foreclosure. Opponents in the financial services industry argue they will create even great instability in the credit markets and raise the cost of mortgages for everyone.
Legislation passed the House last Thursday to undo the 2006 law. It’s due in the Senate soon but there passage is less sure. The House version will almost certainly be amended to limit its scope, perhaps to restrict the change only to subprime mortgages, or only to existing mortgages, but not future loans.
These changes, if adopted in the Senate, could greatly alter the impact of the bankruptcy change on the housing markets. However, should the broader House version prevail, here’s what to expect:
Housing Markets: Four Percent Reduction in
Foreclosures.
In 2007, about 310,000 individuals filed for bankruptcy under Chapter 13. However, unemployment filings and foreclosures have doubled since then. Some five million Americans are currently unemployed. About 900,000 foreclosures are expected this year. The Congressional Budget Office expects the change in the law itself will result in a four to five percent increase in filings as homeowners choose bankruptcy because it will protect their home. The CBO estimates that it could help 350,000 families over the next 10 years, or 35,000 a year.
With at least 900,000 foreclosures predicted this year, that’s about a 4 percent reduction in the inventories of discounted REO properties expected to hit the market. Many families would keep their homes and some neighborhoods would be spared the consequences of foreclosure. Additionally, the existence of the cram down option will put pressure on lenders to write down principals as well as interest, reducing payment to a level where more families will be able to afford to stay in their homez. Even so, bankruptcy reform by itself is far from a panacea for the foreclosure crisis.
Taxpayers: Government $17 Million Profit
The Federal government would actually make money on the deal, about $17 million between 2009 and 2018, mostly in additional bankruptcy filing fees, according to the CBO. However, they did not factor into their estimates the TARP funds that might be needed if the dire predictions of the financial services industry come true.
Lenders: 150 Basis Points per Loan?
One way to calculate what the change might mean to lenders is to assume judges would reduce the debt by 30 percent on the approximately $575 billion in very delinquent subprime and Alt-A mortgages in the U.S. That works out to a loss of $190 billion. But it doesn’t stop there. Bankruptcy is no assurance that lenders will end up with a healthy loan. Securitized subprime loan modifications fail about 54 percent but the rate under a cram down, after payments are reduced, should be much lower than the failure rate under the old bankruptcy law.
The legislation takes that risk into account and lenders would get a substantial cut of the proceeds from a sale of the home if the homeowner sold soon after finalizing his bankruptcy plan. The mortgage company would get 90 percent for a sale within one year, 70 percent after the second year, and half after three years. The amount falls over time to 10 percent in the fifth year.
The losses to lenders and damage to investor confidence in mortgage backed securities would have a cost to consumers as well. The Mortgage Banker’s Association estimates cram downs would tack an additional 150 basis points onto the cost of a loan, wiping out the discounts the Federal government got by nationalizing lenders. However, a new study by Adam Levitin of Georgetown University found no empirical evidence that the proposed mortgage cram down will have a meaningful impact on mortgage interest rates. He looked at the pricing of mortgages that currently permit cram down, such as second homes, and compared them to the pricing of mortgages on primary residences which don’t allow cram downs.
Filing a Chapter 13 bankruptcy is a fairly onerous procedure and many borrowers may choose foreclosure rather than bankruptcy. Assuming most borrowers who file can’t pay their mortgage anyway, the losses lenders would suffer might not be any higher under the bankruptcy proposal and may in fact be lower. On the other hand, lenders may have reason to fear the losses cram downs may generate when judges drive the principal on loans below what could be realized by foreclosing and selling REOs at a discount.
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