Francisco Torralba writes:
First of all, settle on a bankruptcy text and stick to it. The latest
overhaul of the Bankruptcy Code took place as recently as 2005.
Regulatory uncertainty inhibits lenders.Second, lawmakers
should give the two parties in a contract more leeway to renegotiate
their loans. I applaud the congressmen’s proposals to allow
modifications of the terms of the original loans, but they could go
further. For example, they should allow converting 30-year adjustable
rate mortgages (ARM) into 50-year fixed-rate mortgages.The
modifications could be proposed by the court, but then they should
require consent from both mortgagee and lender. Two of the bills under consideration — the ones by Senator Durbin
(D-IL) and Representative Miller (D-NC) — allow the bankruptcy court
to modify the terms of the loan without restrictions, not even
agreement in writing between the parties. Giving such power to the
court has at least two effects. First, it tilts the balance towards the
consumer — in a free negotiation between mortgagee and bank, the
latter would have the upper hand. Second, it increases the uncertainty
of the bank’s payoffs. Both effects reduce the supply of debt.Congress
should also modify the Code so that the least creditworthy borrowers
have more incentives to file for Chapter 7 instead of Chapter 13.Going beyond the current problems, better ex ante disclosure would be welcome. Most borrowers don’t understand 95 percent of the legal mumbo jumbo on their contracts. Mortgage applicants should be given worst-case scenario simulations of their monthly payments.
We could also set a floor on “teaser” introductory mortgage payments. Hybrid ARM’s,
for example, start out carrying a low, fixed rate. Two to five years
later the interest rate resets to a higher, floating level. Option ARM’s
let the borrower initially make interest-only payments, minimum
payments (often below the interest accrued), or fixed, low-rate
payments, also until the first reset date. Any of those schemes make
mortgages affordable, but only for the first few years. Legislation
could provide, for example, that initial monthly payments never be
below 80 percent of the expected payment after the first reset date.
Here is Francisco’s blog, if you don’t already know it.
As I’ve said before, in today’s environment, loan modifications are not that simple. It’s not just between a lender and a borrower. There are third-party investors who own most of the loans. If you allow loan mods, then you redistribute cash flows to investors. The whole securities market in mortgages would have to adapt. You would create a mess.
Arnold’s point that 3rd parties own the loans actually works against his argument. Mortgage cramdowns aren’t allowed in personal bankruptcy (unlike in business or farm bankruptcy) largely because when the previous bankruptcy reform was passed in 1978 this was not the case and banks and individuals found it relatively easy to negotiate when a homeowner was approaching foreclosure. I’m not sure allowing cramdowns (where a judget decides the value of the house and also picks an interest rate) is an answer, but if we see foreclosures increase it will be the logical legislative option.
And we’ve only made ONE significant change to the bankruptcy code in 30 years–the original post’s complaint that we keep tinkering with the code is nonsensical.
How much does stretching a 30-year fixed to 50-year
fixed really help? A mortgage calculator online says
monthly payments go from $600 to $526 on $100k at 6%.
Not exactly save-the-day.
“allow the bankruptcy court to modify the terms of the loan without restrictions, not even agreement in writing between the parties…Both effects reduce the supply of debt”
Of course it will reduce the supply of debt. Lenders are not stupid. If something like this is passed, they would just charge more and we would go back to the good old days of 20% down. Housing prices will really tumble then. As mentioned before, for lenders that portfolio their loans, no big deal. For those that securitize, some major changes would have to take place. No investor would go for it in its current form.
“Most borrowers don’t understand 95 percent of the legal mumbo jumbo on their contracts. Mortgage applicants should be given worst-case scenario simulations of their monthly payments.”
Even though this is sad and true, it is mind boggling. This is probably the biggest financial decision people make in their lives. Read the $#@! contract! It is not that hard and guess what, you can always ask questions. Maybe more summary pages and worse case scenarios would help.
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