Sunday, October 07, 2007
And Tanta, my nominee for the position of Mortgage Czar, has written an excellent post over at Calculated Risk about proposed changes to bankruptcy law allowing judges to reduce the secured portion of mortgage debt to the actual value of the principal residence, while throwing the rest of the debt into the bucket of unsecured debt to be addressed in the repayment plan. Go over and read the sanity. There are so many dishonest shills out there muddying the waters that it is terribly important to get honest perspectives. I am in favor of this proposal. There is a hot argument in the comments.
Because I am greatly in favor of honest debate, let me also link to another excellent and honest blogger who takes the opposite POV, Paul Jackson of Housing Wire. Paul takes the position that this change in law would hurt the securitized pools used to fund most mortgages. That is a big issue, because the bottom line is that mortgage lending is done with investors' money, and if the money of the investors dries up, people will not be able to get mortgages.
I believe Paul is wrong for two reasons. The first is that the reality is that an investor's security is really only the market value of the mortgaged property. Therefore this does not take anything away from an investor. Because of deranged lending and underwriting, there are tons of investors out there with rights to be paid on loans that are 20%, 30% and in some cases, even 40% unsecured. I'm talking first liens! That's a problem, but it is a problem that can only be fixed with better originations and careful use of workouts.
The second reason is that if you are an investor, in many cases the bankruptcy cram down (in which the secured portion of the debt is altered to reflect the property value, and the rest of the debt is thrown into the repayment plan for unsecured debts), actually gives the investor the opportunity to recover more at less cost than foreclosure and subsequent resale of the property. Nobody can force a borrower to keep paying a loan that is now 25% more than the property's worth. Nobody. If the investor has to recover by foreclosure and resale, the carrying costs and commissions on that property are actually going to eat up more of the residual value than showing up in bankruptcy court.
IMO, the situation for mortgages is genuinely so bad that cram downs are the best thing for the industry. The reality is that some of the securitized pools are governed by master servicing agreements that really prevent the drastic measures which are needed in the industry to cope. Heavily tranched mortgage pools have created conflicting interests between the different owners of payment rights from some of these pools. In some cases, the master servicing agreements specify that only a certain portion of the loans in the pools can be modified!
Why do I disagree with Paul? Because I sit here looking at the actual situation, and those looking at OFHEO stats are completely clueless. Residual recovery in many areas is dropping by several percent a month, and has cut well into the 80% LTV of "prime" lending. Next year it will get much worse. There is way too much property on the market in most areas for absorption, and the trend is worsening.
Thanks for the kind linkage. But just to be clear, because I think my argument was misconstrued in your post: I'm less concerned about the investors here -- they will have to take their lumps regardless, and a large part of the securities out there are in a race to zero anyway. I'm much more concerned that this change will cause further repricing of risk, which will hurt ALL borrowers -- but hurt subprime borrowers most. I don't see why all borrowers should have to shoulder this burden, and why we should further constrict the market for the audience that most desperately needs loan product. I also think there are far more reasonable solutions out there that can accomplish more (keep in mind that bankruptcy filings have fallen off a cliff since BAPCPA).
Looking at rate spreads, those gaps are bound to get larger if something like this passes -- and that isn't good for any of us. Even the prime borrower with a more traditional mortgage.
Paul - I'm concerned about access to credit too. But I don't see that this measure will hurt access. Sure, it will make lenders think twice before writing risky loans. That's a good thing.
As for subprime, doable subprime loans are a very different matter from dicey subprime loans. I think the best thing we can do for subprime borrowers is shut down risky subprime loans. It's the decent subprime borrower that gets crushed into the dust when bad subprime lending becomes prevalent, IMO. They are the ones who can't recover.
Needless to say, Cheryl is suffering watching his agitation. Please pray for them both.