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Thursday, September 17, 2009

We can't carry the big banks forever

We can keep feeding the big banks. It may keep them alive. Not as useful citizens. But alive. To get credit back in the economy and get the financial sector's huge mistakes off our backs, we will need to cut them down to size and make the lenders as well as the borrowers suffer.

Stiglitz calls for cutting them up, Kuttner posits a transactions tax, but the New Deal remedy of forced negotiations to reduce principle has not been effectively tried. It needs to be done. Here are two more reports on how and why.

Cramdown Is Back: Banks Against Homeowners, Round 2
Ryan Grim
Huffington Post
First Posted: 09- 8-09 11:01 PM

House Financial Services Committee Chairman Barney Frank (D-Mass.) tells the Huffington Post he plans to revive the effort to give bankruptcy judges the authority to renegotiate home mortgages -- by making it part of this fall's much-anticipated financial regulatory reform bill.

Wall Street banks scored an overwhelming victory in April when they soundly defeated a cramdown measure in the Senate. Only 45 Democrats voted with homeowners, dealing the measure the kind of defeat that often sends legislation off into the wilderness for years, if not for good.

Frank and Senate Majority Whip Dick Durbin (D-Ill.), who led the bill in the upper chamber, both said after its defeat that it was finished. Frank was dismissive when, about a week after the vote, HuffPost asked if cramdown might come back. "Excuse me, what planet were you on last week? The vote was 45 to 51. Why would you ask that? Do I think there's a likelihood we could overturn 45-51? No," said Frank. "I wish it weren't the case."

But since then, foreclosures have continued unabated and the unemployment rate has continued to climb, increasing to 9.7 percent last month. Both forces feed on each other and create a drag on the economy.

The Obama administration had high hopes for the law Congress passed intended to encourage mortgage modifications. The law is all carrot, however, and no stick. Cramdown is the stick. If banks think they could get hit in bankruptcy court, they're more likely to bargain.

On Tuesday, Frank was asked by HuffPost if he had plans to readdress cramdown. "Yes, as I will announce tomorrow, and I told this to bankers, given the slow pace of modifications, for whatever reason: they're not putting enough people on it, they're not taking it seriously, there are legal obstacles. As of now my intention would be to include the bankruptcy on primary residences in the reg reform."

Frank said that he met in Boston recently with Senate Majority Leader Harry Reid (D-Nev.), Charles Schumer (D-N.Y.), Jack Reed (D-R.I.) and Tim Johnson (D-S.D.); the latter three are all on the Senate Banking Committee. They told him, he said, that they were ready to make a serious push at major financial regulatory reform before the year was out. Frank guessed the House would act by October.

President Obama needs a win against the financial sector to blunt the populist anger rising about bailouts and bonuses. Frank thinks the must-pass reg reform could be the perfect vehicle to attach cramdown to.

He acknowledged that cramdown hadn't been able to pass on its own, but said that "it could be that the eagerness to get the bigger picture, gets that one done."

Regulatory reform could wind up being a major boon to consumers, with a chunk of credit card reform thrown in, too. Frank said that if credit card companies continue to jack up rates in advance of the effective date of the reform bill recently passed, "we could move that effective date up a few months in the reg reform bill." Other possibilities include a consumer financial protection agency and a provision that would mandate an audit of the Federal Reserve.

Frank said that as the foreclosure crisis has stretched on, Democrats who were skeptical of the need for cramdown authority have approached him to say that they now see the argument.

Rep. Brad Miller (D-N.C.), a lead proponent of cramdown in the House, said he ran into Durbin about two months ago and thanked him for his efforts. Durbin, he said, was hopeful that he'd get another crack at it before too long. Miller said Durbin may now get that chance because he banks were given an opportunity to reform and they haven't lived up to their end of the deal.

"Barney's really angry that we've done all this stuff, that the industry helped draft, and they said, 'If you do it this way, and you hold your mouth, and you stand on just your left leg, if you do all that, we'll have lots of modifications.' And nothing - nothing - has happened," Miller said.

For a history of mortgage Cram Downs, and why they are needed, see Tanta's Just Say Yes To Cram Downs .

Just Say Yes To Cram Downs
by Tanta on Calculated Risk
10/07/2007 11:09:00 AM

A lot of people have raised questions in the comments regarding proposed changes to federal bankruptcy law to accommodate modifications of mortgage loans.

Here's the issue, in a nutshell. Until the 2005 bankruptcy reform, insolvent homeowners could choose Chapter 7 (liquidation) or Chapter 13 (repayment plan) bankruptcy. After the reform bill, for practical purposes most homeowners are limited to Chapter 13.

Chapter 7 filings usually do not result in borrowers keeping their homes, although they can (if the borrower reaffirms the mortgage debt, the court accepts the reaffirmation, and the borrower has the financial capacity to continue to make mortgage payments). In most cases, the BK stay is lifted and the loan is foreclosed.

You can think of Chapter 13 as itself a kind of loan modification: the court establishes a 3-5 year repayment plan for all the borrower's debts, with the unpaid remainder discharged at the end of the repayment plan period. In Chapter 13, the debtor can keep a mortgaged home, as long as he continues to make mortgage payments throughout the plan period, and makes up any past-due amounts (including fees) during the repayment period as determined by the repayment plan. If the borrower does not or cannot continue to pay the mortgage, the stay is lifted and the lender can foreclose.

However, secured debts can be restructured or modified in a Chapter 13 bankruptcy, and secured creditors, except the mortgage lender on a principal residence, can be subject to what is called a "cram down." This happens when the amount of the debt is greater than the value of the collateral securing it; the court reduces the value of the secured debt to the market value of the collateral, with the remainder being treated as unsecured (and subject to the same repayment plan/discharge terms as any other unsecured debt). The prohibition of court-ordered modifications for mortgages on principal residences was created in 1978; between 1978 and 1993 most bankruptcy courts interpreted the law to mean that while interest-rate reduction or term-extension modifications were not allowed, home mortgages could still be crammed down.

In 1993, with Nobleman v. American Savings Bank, the Supreme Court held that the prohibition on modifications of principal-residence mortgage loans also included cram downs. The result is that borrowers who are upside down and who have toxic, high-rate mortgages are simply, in practical terms, unable to maintain their homes in Chapter 13.

According to the Center for Responsible Lending:

The language we seek to change was enacted in 1978, a time when virtually all home mortgages were fixed-interest rate instruments with low loan-to-value ratios. The loans were rarely the source of a family’s financial distress. As originally introduced, the House legislation permitted a plan to modify any secured indebtedness, including that represented by a home mortgage.21 During Senate hearings on the proposed legislation, advocates for secured lenders suggested that home-mortgage lenders were “performing a valuable social service through their loans,” and “needed special protection against modification.” At their urging, the original proposal was subsequently amended to insert the exception for mortgages on primary residences. 22 This claim likely succeeded through effective lobbying since, as described below in section III, the merits of the argument are groundless. Whatever the merits of this claim in 1978, however, when home mortgage loans were responsibly underwritten thirty-year fixed rate loans, it plainly does not apply to the practices of subprime mortgage lenders during the last decade.

As far as I'm concerned, if you believe that prior to 1978, when modifications of home mortgages were unrestricted, and in the period of 1978-1993, when term modifications were restricted but cram downs were widely practiced, mortgage lenders offered higher-rate (relative to prevailing market), higher-LTV mortgage terms than they have in the post-1993 period, when they are safe from any restructurings, I would like to discuss a bridge purchase with you. Nonetheless, that reliable source of comic relief, the Mortgage Bankers Association, wants you to think that allowing cram downs or other kinds of loan restructuring would, um, ruin the party:

“Giving judges free rein to rewrite the terms of a mortgage would further destabilize the mortgage backed securities market and will exacerbate the serious credit crunch that is currently hindering the ability of thousands of Americans to get an affordable mortgage,” said Kurt Pfotenhauer, Senior Vice President for Government Affairs and Public Policy for MBA. “The current legislation gives no guidance as to the proper parameters for judges to modify existing loan contracts.”

By allowing judges to rewrite loan contracts and provide whatever relief they individually deem appropriate, HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured. As a result, lenders and investors would likely demand a higher premium for offering these loans. This premium could come in the form of higher fees, a higher interest rate or the requirement for a larger downpayment, all of which would serve to make the American dream of homeownership less attainable for many Americans.

In other words, the MBA implicitly admits that in the post-1993 era lenders have made low- or no-down loans at interest rates that, while high enough in terms of the blood they extract from strapped borrowers, are still lower than what they would have been if the lenders had had a healthy fear of BK court restructurings. Of course it's beyond ludicrous to argue that being forced to take what they can reasonably get by a BK judge is the "destabilizing" factor here, but you can count on the mortgage industry be ludicrous when dollars are on the table.

In fact, I have some sympathy with the view that mortgage lenders "perform a valuable social service through their loans." That's why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I'm here to tell you that you will certainly not "forget" to model negative HPA in your ratings models, and will probably pay more than a few seconds' attention to your appraisals. You might even decide that, if a loan does get into trouble, you're better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you'll accept. That would be a major bummer, right?

But I think my favorite part of the MBA lament is this: "HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured." Translation: lenders mark to model, but if you let them, BK judges will mark to market.

Is it possible that BK judges would use the lowest plausible "distressed liquidation value" to determine the secured part of the mortgage loan? Sure it is. BK judges don't have parts of their job descriptions that refer to supporting home values or keeping those comps up or controlling "price discovery." The cram down is, precisely, the "mark to market" you don't want to get, which is why the risk of it used to function as a brake on lender stupidity.

I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.

Big banks getting bigger

Economic Policy Institute

Economic Snapshot for September 9, 2009

by Nancy Cleeland

Total assets held by the nation’s banks have grown dramatically in recent years, from $8.4 trillion at the end of 2002 to $13.3 trillion as of the end of June 2009. Within that rapidly expanding universe, a handful of mega-banks have grown even faster, taking an ever-larger share of the total. As of this summer, the four largest bank holding companies—Bank of America Corp., JPMorgan Chase & Co, Citigroup Inc., and Wells Fargo & Co.—accounted for nearly half of all bank assets held in the United States. That’s significantly higher than in late 2002, when their share was a mere 27%.

[Figure: Big Banks Getting Bigger: December 2002 to June 2009]

With some 8,000 small to mid-sized banks, the U.S. financial sector remains far more diverse than those of most European countries, where a few large banks have long dominated the financial sector. But at the upper levels of finance, the trend toward consolidation is clear. It was made possible by a series of regulatory changes in the 1990s that eliminated geographic restrictions and the separation of commercial and industrial banking, in the hope of achieving greater efficiencies and competitive advantages in a global environment. Today, that philosophy is being reevaluated and policy makers are looking at a variety of approaches to keep the big banks at a more manageable size.

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