Can a new bankruptcy law fend off foreclosure?

A couple of quickies this morning on what government might do to slow the tide of foreclosures:

The New York Times, which has been on the cutting edge of reporting and commentary about government bailout plans, awakens today to an important part of that story: Many, many Americans are strongly opposed to bailouts for struggling homeowners. "People struggle to buy homes in this city, for sure,” says Mark Ellerbrook, who manages a government homeownership program in Seattle. “And then you have what looks, on the face of it, like the city giving money to people who made bad decisions.”

The L.A. Times reports that Senate Democrats are pushing for changes in federal bankruptcy laws that would allow homeowners to renegotiate their mortages in hopes of keeping their houses: "The proposal, part of the Foreclosure Prevention Act embraced by leading Democratic lawmakers, would allow judges to ease the terms of mortgage loans during bankruptcy proceedings."

The bankruptcy change raises a number of issues, and I'd like to hear your thoughts. Say a judge does in fact reduce your mortgage. Does that constitute a sale of the house, with reduced property taxes, and a new, cheap comp in your neighborhood? How does the judge decide what the house is worth -- only what you can pay?

Much more important: How many people facing foreclosure are likely to go into bankruptcy to get a new mortgage? And what is the likelihood that, if bankruptcy laws are changed, they will make timely payments on the new, reduced mortgage in the future?

I'm reminded of the words of mortgage broker and Fed watcher Lou Barnes, who wrote recently that attempts to prevent foreclosures are a waste of time. He doesn't mince words: These are "weak financial households" that purchased homes only because of disastrous underwriting. They can't be saved.

Barnes: "The sad reality: The vast majority to suffer foreclosure today were weak financial households to begin with. ... The few households suffering temporary bad luck (job loss, health, divorce) deserve all the 'workout' help the system can provide. The inherently weak households will defy every effort. Even extraordinary re-writes will beget re-default, the poorly maintained house creating deeper loss in the ultimate foreclosure, the troubled inventory overhanging the marketplace and preventing recovery."

Thoughts? Comments? E-mail story tips to peter.viles@latimes.com

Comments

[Doug]

Many of the folks facing foreclosure used equity in their homes to finance a lifestyle that was only affordable through increased home appreciation. Allowing a judge to change the financing terms is a bad idea, It may help a few, but won't address the majority. Also, have you ever tried to get a court date?

[William Jones]

What will this proposed "reform" do to the housing finance market in the long run? It will encourage lenders to only make loans to highly qualified borrowers - ones who can put down AT LEAST 20% - maybe more, and who have a good history of handling credit.

Maybe that is a good thing. Some people got home loans who simply could not manage their personal finances well. However, we can't have it both ways - everyone can't get a home loan if after the fact a judge can arbitrarily modify it.

I cannot imagine how judges will modify mortgages with any consistency. Some might cut the balance, but others might stretch out the payments, while a third faction reduces the interest rate or increases the amortization period. It will take years for appeals to make their way through the court system in order for any consistency in the process to develop. This bill, if passed, should be known as the Bankruptcy Attorney's Full Employment Act of 2008.

If passed, this "reform" will be titled the Bankruptcy Atttorney's Full Employment Act of 2008.

[CD]

We got a phone call last night from the NDC asking for a check. Well he got his money's worth and an ear full.
-Your candidates better take care of the middle class, the back bone of this country and do not pin us down again with the banks robber barons'foolishness. I'll send a check when you guys come to your senses or I'll give my vote to Ralph Nader.- Bail out = No donation, no vote.
Ralph Nader sounds good to me these days....

[jaded]

and if a judge decides that my neighbor can only pay for a $200,000 mortgage, what happens when my home value automatically declines as a result? Does the government then give me the difference? Does it create a "save the market value" bailout for the rest of us?

[MyLessThanPrimeBeef]

It's about time we get back at them Japanese.

I mean, how often have people complained that they copy us?

This is one chance for us to imitate their 20 year long deflation.

[Rod]

Millions of middle class folks need to earn six figure incomes just to get into condos and fixer-uppers. How fair is that? Give me a break and quit with the bail-outs.

Let these homes be foreclosed, freeze the debt obsession now and give the rest of us who have been prudent the chance to own a home, too.

[mike]

we should put the people that signed up for these mortages in the frying pan and let them fry!!!!! this is not the fault of bad lending and realtor practices, this is the fault of people with no financial skills. LET THEM FRY!!!!!

[mike]

we should send these people to a criminal court for false documentation on their multiple mortgage applications. i don't know why we mess around with a civil court. we should put them on criminal trials.

[American]

Why do these dang crackhead in office insist on bailing on gamblers in the RE market???? Because of inflated RE price due to fraud in the mortgage market, many families have been displaced. People in their 20's and 30's are forever priced out of the CA housing market and end up having to move to the midwest if they want to buy a house. No longer will you have generations of family staying in cities like San Francisco because these crackhead in charge think an entry level home at $900k is a good thing for society.

[sunsetbeachguy]

All stated income loan data should be automatically submitted to the IRS for immediate back taxes billing with interest & penalties.

That would stop the foolishness.

[Norm]

I think the lenders, brokers, loan officers and real astate agents, should be investigated and charged with fraudulent real estate crimes for falsifying figures in their unsuspecting clients, for their benefit they are the real criminals not the client that is maybe just trying to buy a home and making them belive they can afford it some how..with their many false promises of buying for investment purposes....now everyone is affected bye this crisis...

[bruintechie]

Giving Judges the power to modify the terms of a contract without the consent of both parties or evidence of fraud seems to undermine the rule of law. (Though, they I think maybe the burden of proof should be lowed to prove fraud.)

I think the common sense thing to do is to ward off property speculation. I'm not sure what the state law is, but to me it would make a whole lot of sense that investment properties (i.e. houses which are not primary residences) should be taxed at a higher rate.

[RW&B]

I'm tired of hearing all you people take shots at our men and women in office. They are servants of the people and have been voted into office because they have the knowledge and experience to run our country. We should not be second guessing them all the time. If you don't like the way this country is run, then get out. Simple as that. I'm all for this "bailout" if it prevents us from going into depression. USA, love it or leave it. You people may as well be with the terrorists.

[mike]

hey bruintechie....

i think you should be taxed at a higher rate. r u a renter. if we get higher taxes, i will just raise the rent that dollar amount every year...

[Robert K Lee]

Here are my comments after having practiced bankruptcy law for nearly 18 years:

1. Is allowing judges to adjust mortgages an entirely new concept ? No. Under current Chapter 13 bankruptcy law, if the value of the home falls under one of several mortgages on the home, the junior mortgage can be "stripped" and made unsecured and then treated like other unsecured creditors like credit cards. For example, if you have a 1st mortgage ($300,000) and a 2nd mortgage ($100,000) and you convince the judge (via competing testimony from appraisers) that the value is under $300,000, then the entire $100,000 can be made unsecured. If your budget only allows for paying your unsecured creditors 5 cents on the dollar, then you have essentially wiped out the entire second mortgage at the end of your 3 -5 year bankruptcy plan. The idea that bankruptcy judges will be re-writing loans is not entirely new and the proposed laws are merely an extension of those current rules.

2. How do we know people who file bankruptcy will honor the new terms ? If these were indeed "weak financial households" that purchased homes only because of disastrous underwriting, then perhaps banks should not have lent them the money in the first place. Any time you lend to people with poor credit, you run the risk of not getting paid. Let's face it, banks closed their eyes during the real estate boom and are now just waking up. Besides, if you don't pay the mortgage under the new terms, the banks can always foreclose.

3. How does a judge decide what the house is worth ? As in the example in #1 above, the judge will consider competing appraisals.

4. What is the likely (and desired) effect of these legislative changes to future lending practices ? Banks will probably be more careful when lending in the future. People with excellent credit should still get excellent terms and should not be penalized for sub-prime borrower's mistakes. Sub-prime loans are inherently risky. Banks should adjust their practices to charge appropriately for these types of loans only.

5. What is the alternative ? If you let everyone lose their homes in foreclosure, where does that leave the investors behind the mortgage backed securities ? The lenders are stuck with these homes which they will have a difficult time unloading and in the meantime will not be receiving interest payments on the loan. Will people with excellent credit magically appear out of the woodwork to buy up these foreclosed homes ? Lower interest payments are better than no interest payments.

The reality is that banks had no business lending to "weak financial households" and "weak financial households" had no business obtaining these loans. Both sides need to bear some of the loss and the proposed legislation seems to accomplish this objective.

[arroyogrande]

"You people may as well be with the terrorists."

That reminds me, keep buying things that you cannot afford, or the terrorists win.

We must have bail-outs, so that people can be tricked into continuing to spend all that they make (or more, using credit), in order to keep the "Goldilocks Economy" humming at the same level...otherwise the economy tanks and you will all lose your jobs.

I repeat...you have to keep Americans spending all that they make (and more) in order to keep the economy humming. Otherwise, the economy slows, and you lose your jobs.

Keep the party going, please let the government bring in a fresh, spiked, punch bowl. The party doesn't have to ever end, does it?

- arroyogrande

[Richard Maize]

The concepts of natural selection and survival of the fittest should apply here in the mortgage crisis too. Any type of bailout, delay or postponement of an obligation, or dependence on bankrupcy law modifications to try to change the inevitable outcome is to go against the natural order of things. It may help a few, but prolongs the economic misery for everyone. Dealing with the reality of the situation and adapting to the next cycle in the economy is about the best strategy we can employ at this time.

[sfvrealestate]

Today's L.A. Times' headline is about this, too. Yes, the devil is in the details, but here are a few points. First: I expect a bankruptcy judge would have a court-appointed appraiser determine value. That's how it is done in probate court.
Second: this isn't a bailout. The government isn't giving anybody money any more than it is by making gambling losses tax deductible.
Third: At the risk of stating the obvious, if somebody is already in bankruptcy court, their house would already be going back to the bank to turn it around and sell it at a loss anyway. The net effect is the same -- the bank is going to take a loss, regardless of the method. This is similar to a short sale. You people should be happy that bankrupt folks can -- perhaps -- have a roof over their heads, rather than just have a foreclosed house end up in the hands of us evil, blood-sucking Realtors.
Fifth, yes, if a house is reassessed at a lower value, that usually lowers the value of surrounding properties. But if it is going to be foreclosed anyway, what's the difference?
Fifth, and this is a general point, because it seems that many on this post don't know this. If you are an independent contractor and/or are 1099'd rather than W-2'd by your employer, most lenders won't give you a a full-document loan and you must have a stated income loan. Yes, even with your last two years' tax returns.

[Michael Snyder]

RW&B
I glad to see their are still a few patriots left. Quite a few actually and we're exercising not only our right to dissent but our patriotic duty to hold our elected representatives responsible for their actions. Clearly the actions taken and proposed by Congress are not in the best interest of the vast majority of the electorate. Proof of this is in the results. Have you bought gas or groceries lately? How about visited an emergency room?
Add to that the embarrassing number of Congresspersons under indictment or in jail and you might see where that "my country right or wrong" thing isn't flying in this venue.
As to knowledge and experience; the actions or lack of by our current representatives has led us to the brink of a depression and ripened the chances for a world war beyond anything since the Bay of Pigs. It's clear what they're doing isn't working So instead of accepting input from the grass roots, they listen to the lobbyist that comes calling with a "contribution" in hand and do whatever they please. Typically more of the same bad ideas.
Your remark accusing the patriots here of treason is the type of statement I'm sure you wouldn't be inclined to make to this cowboy's face. Perhaps you might want to limit your remarks to those you would make with the listeners in the same room.
I hope you can get out from under that bad loan, but don't expect me to pay for it.

[P J Evans]

You lose your job, and can't find a new one because there's a recession (or you're not young). You fall behind in your mortgage. Does that mean you shouldn't have bought a house when you had a job and a regular income?

Why are people assuming only sub-prime borrowers are the ones defaulting? There are people who are still trying to get out of holes from the last recession, and they're hurting again.

[fastball]

Sunsetbeachguy - Your suggestion regarding stated income loans misses the target. SI loans are for consumers, particularly business owners, who have a difficult time documenting their income. The use of a SI loan does not exempt the consumer from underwriting standards. I used a SI loan and had to provide tax documents, bank statements, etc. My rate was bumped to boot. I know of several brokers that fudged W-2s, paystubs, etc in order to get their clients financed. What is the liability of those brokers? How about the liability of the infomercial speculators and house flippers?

I don't know why the NYT waste ink on discussions of a bailout plan for individuals - it ain't going to happen! Things work top down in a Republican administration and banks will likely be praying for (and get) a federal bailout come June. Bad loans and good loans gone bad have made it so that banks have no idea of their liability. Everyone knows that the unknown and Wall St don't mix. This is gonna get ugly.

[Michael Snyder]

PJ,
I have a friend who had an accident and lost almost a year of work back in the ninetys. Without insurance to cover his living expenses he used credit cards. Eventually he went BK and lost his home in spite of his best efforts to save his investment. Bad things happen to good people.
The vast majority of loans that are in default were ill advised under the best of circumstances. Your situation may be the exception that proves the rule, but your solution should come from negotiations with your creditors, not government intervention.

[Landless]

Remember the article about the $400,000 starter home? Banks made bad loans; people got in over their heads. The Fed helped promote speculation. Foreclosures will punish the banks who profited earlier by fees; homes will come down in price; the individuals who could not afford homes and lost them through foreclousre will benefit (eventually!) from lower home prices. Those who tried to save when savings account interests were also sub-prime will be able to purchase homes at affordable rates.

An individual who got into an overpriced home with no down-payment was just renting. Stop the sentiment. Why all the hysteria over foreclosure? It's not jail, death, or disability. It is a setback. People are supposed to handle those with some grace.

[Bruin_Bry]

I absolutely agree with Barnes!

I, as well as millions of responsible Americans, want to own a home. I purchased what I was able to afford. I researched and understood the terms of my loan and made sure I didn't stretch my finances too far. If they bail these people out, then I should've gotten the million dollar home instead so the government can bail me out as well!

[sunsetbeachguy]

There is only one legitimate use of stated income loans.

TO CHEAT ON YOUR TAXES!

What are you afraid of fastball?

Tanta at Calculated Risk has gone over this numerous times. Every imaginable scenario has a corresponding Fannie & Freddie form to capture the slightly more difficult to documented income.

Only tax cheats should fear my proposal.