ClydeR
02-18-2009, 09:45 PM
Speaking in Phoenix today, Obama said bankruptcy courts should be able to reduce the loan principal for upside down mortgages (mortgages where the loan amount is greater than the current value of the home), if the debtor complies with bankruptcy rules.
And my administration will continue to support reforming our bankruptcy rules so that we allow judges to reduce home mortgages on primary residences to their fair market value -- as long as borrowers pay their debts under court-ordered plans. (Applause.) I just want everybody to understand, that's the rule for investors who own two, three, and four homes. So it should be the rule for folks who just own one home -- (applause) -- as an alternative to foreclosure.
More... (http://www.whitehouse.gov/the_press_office/Remarks-by-the-President-on-the-mortgage-crisis/)
I've spent some time thinking about it, but I can't figure out whether or not Obama has the right plan.
Bankruptcy judges already have the authority to reduce the principal amount of upside down commercial loans, including mortgage loans for residential property other than first mortgages on the debtor's principal residence. When a bankruptcy judge reduces the principal amount of a loan to the value of the collateral, despite the objection of the creditor, it's called a "cram down." Cram downs for residential mortgages were allowed prior to 1978, but cram downs were very rare at that time because of the high rates of inflation and the resulting rarity of upside down loans. (Don't even get me started on the financial windfall enjoyed by Baby Boomers because of that spurt of inflation.)
On the teevee tonight I've seen several Republicans -- most Republicans oppose cram downs for residential loans -- say that allowing cram downs for primary residence mortgages would result in higher mortgage costs for all homeowners, because lenders would factor the estimated costs of cram downs into their loan offers.
Besides that, several states (like Texas) have what's called "nonrecourse" laws that protect homeowners with upside down loans. Those laws say that if a lender forecloses on a house and the house is worth less than the balance of the loan, then the lender is out of luck because the lender has no other recourse than taking the foreclosed upon home.
But most states (like New Mexico) don't have nonrecourse laws. In those states, if the lender forecloses on an upside down loan, the lender can sue the homeowner for the balance due on the loan (after deducting the value of the foreclosed home). Once the home is foreclosed on, the remaining balance of the loan loses its special status as a residential loan and is subject to adjustment by a bankruptcy court. If the homeowner cannot pay the remaining balance when sued, then the homeowner may be forced to seek bankruptcy protection, and then a bankruptcy judge would have the authority to reduce or wipe out the balance owed to the lender.
What it boils down to is that an upside down borrower in a nonrecourse state can walk away from the home and the loan without the necessity of filing bankruptcy (but with possible negative tax consequences). An upside down borrower in a recourse state can walk away from the loan only by filing bankruptcy and losing his home. But a bankruptcy court, regardless of the state, cannot reduce the principal (cram down) the loan while allowing the homeowner to stay in the home.
That's where I get confused when I try to figure out if it would be a good idea to allow cram downs. Why is the lender better off owning a foreclosed home with a reduced fair market value than the lender would be owning a loan with a reduced principal amount? And what is the economic difference to the lender between such a result and a cram down? There has to be a good argument that I just can't think of.
And my administration will continue to support reforming our bankruptcy rules so that we allow judges to reduce home mortgages on primary residences to their fair market value -- as long as borrowers pay their debts under court-ordered plans. (Applause.) I just want everybody to understand, that's the rule for investors who own two, three, and four homes. So it should be the rule for folks who just own one home -- (applause) -- as an alternative to foreclosure.
More... (http://www.whitehouse.gov/the_press_office/Remarks-by-the-President-on-the-mortgage-crisis/)
I've spent some time thinking about it, but I can't figure out whether or not Obama has the right plan.
Bankruptcy judges already have the authority to reduce the principal amount of upside down commercial loans, including mortgage loans for residential property other than first mortgages on the debtor's principal residence. When a bankruptcy judge reduces the principal amount of a loan to the value of the collateral, despite the objection of the creditor, it's called a "cram down." Cram downs for residential mortgages were allowed prior to 1978, but cram downs were very rare at that time because of the high rates of inflation and the resulting rarity of upside down loans. (Don't even get me started on the financial windfall enjoyed by Baby Boomers because of that spurt of inflation.)
On the teevee tonight I've seen several Republicans -- most Republicans oppose cram downs for residential loans -- say that allowing cram downs for primary residence mortgages would result in higher mortgage costs for all homeowners, because lenders would factor the estimated costs of cram downs into their loan offers.
Besides that, several states (like Texas) have what's called "nonrecourse" laws that protect homeowners with upside down loans. Those laws say that if a lender forecloses on a house and the house is worth less than the balance of the loan, then the lender is out of luck because the lender has no other recourse than taking the foreclosed upon home.
But most states (like New Mexico) don't have nonrecourse laws. In those states, if the lender forecloses on an upside down loan, the lender can sue the homeowner for the balance due on the loan (after deducting the value of the foreclosed home). Once the home is foreclosed on, the remaining balance of the loan loses its special status as a residential loan and is subject to adjustment by a bankruptcy court. If the homeowner cannot pay the remaining balance when sued, then the homeowner may be forced to seek bankruptcy protection, and then a bankruptcy judge would have the authority to reduce or wipe out the balance owed to the lender.
What it boils down to is that an upside down borrower in a nonrecourse state can walk away from the home and the loan without the necessity of filing bankruptcy (but with possible negative tax consequences). An upside down borrower in a recourse state can walk away from the loan only by filing bankruptcy and losing his home. But a bankruptcy court, regardless of the state, cannot reduce the principal (cram down) the loan while allowing the homeowner to stay in the home.
That's where I get confused when I try to figure out if it would be a good idea to allow cram downs. Why is the lender better off owning a foreclosed home with a reduced fair market value than the lender would be owning a loan with a reduced principal amount? And what is the economic difference to the lender between such a result and a cram down? There has to be a good argument that I just can't think of.