To no one's surprise, (certainly not ours), first lien residential mortgage loan cramdowns will soon be coming to a bankruptcy court near you. Although we haven't seen the bill yet, Dick Durbin's office announced today that he, Chuck ("Bank Run") Schumer and Chris ("I Boinked Princess Leia") Dodd, had cut a deal with Citigroup on a bill that would permit such cramdowns in Chapter 13 bankruptcy proceedings. According to The Wall Street Journal, which broke the story, this "marks a surprising change of direction by the financial-services industry."
Banks have consistently fought such legislation, saying cramdowns would raise borrowing costs for all home buyers and jam courts with homeowners who wouldn't otherwise declare bankruptcy.
"This is the breakthrough we've been waiting for, to have a major financial institution support this legislation will create an incentive for others to come our way," Sen. Durbin said in an interview. "I want to congratulate Citi for being open-minded about this [and] playing a major leadership role."
I thought Barack Obama was the breakthrough we've been waiting for? I guess not.
The WSJ also reports other "open-minded" financial institutions support the bill, but did not identify them. I'd hate to think that Bank of America died and left Citi in charge of the US commercial banking biz. After all, when it comes to "open-mindedness," it's hard to beat BofA, which sometimes is so open-minded that its brains fall out.
Frankly, as described by the WSJ, the bill doesn't sound as bad as many might have feared, even though it goes beyond what the banking industry has been willing to support in the past.
The Democrats' proposal allows judges to force major reductions in home loans, after homeowners certify that they have attempted to contact their lenders about a mortgage reduction before bankruptcy proceedings begin. They do not however have to have engaged in negotiations with their banks.
The cramdown bill would apply to all mortgage loans, including but not limited to subprime loans, written any time prior to the bill's date of enactment. It allows judges the ability to lower principal or interest rate, extend the term of the loan, or any combination of the three. "Cramdown" refers to the ability of judges to lower a mortgage principal so that it is equivalent to the current market value of a home.
In a concession to lenders, if a lender is found to have violated the Truth in Lending Act during bankruptcy proceedings, the institution would be subject to fines, but would not have to forgive the loan, as is the case currently. Major violations would still be subject to full sanctions under the law. The TILA provisions would pre-empt any state lending laws.
I'm certain that many bankers who do not have the heft of major Mastodons like Citi and BofA will be critical. I can admit to a bit of mystification myself as to the fact that the cramdown right will apply only to loans made prior to the date of passage of the legislation. I thought the argument for extending cramdowns to first mortgage loans was to deal with those awful subprime and "exotic" loans made when real estate values were as high as the lenders and borrowers who based their lending decisions upon those values ever rising. Why not single out specific types of loans? Also, why not pick an effective date that is at least no later than mid-2008? Good arguments can be made that an even earlier date should be selected. You're going to effectively "rewrite" some conventional home mortgage loans that were initially prudently underwritten, to the disadvantage of the lender. That's done with second loans, auto loans, and commercial loans, but the lenders of those types of loans set pricing based upon the knowledge that there's the risk that cramdown could occur. That's not the case for first mortgage loans. Is that "fair," in light of the fact that the Democrats who support this bill are all about "fairness"?
We'll be interested to see the effect of this legislation on pricing of loans and loan servicing on pre-effective date mortgage loans. I wonder if prospective purchasers will drive harder bargains on bulk purchases of such loans from the FDIC due to this risk? You think?
At least the cramdown will not apply first loans going forward. Of course, any lender with a brain in his head has to assume that if Congress did it once, Congress could very well do it again, and price the risk accordingly. Moreover, this is likely not only to make first mortgage loans more expensive, but add even more impetus to restrictive underwriting standards. While many people believe that's not a bad effect, let's ask them again in a few years. As I observed when Durbin first started this push, the same folks who scream for cramdowns will be some of the first complaining that lenders aren't making enough loans to those with poor credit, who will likely be members of various classes of the perpetually aggrieved, and supporters of Senator Durbin and the rest of the Gang of Three.
