Home Mortgage Modification

I will be covering the topics of “Chapter 13: Vehicle and Mortgage Complications” and “Formulating a Confirmable Chapter 13 Plan” at the “Complex Bankruptcy Issues” seminar for the National Business Institute on May 2, 2012 in Orange, California.  This presentation will cover such thorny issues as 910 car claims, rescission and second mortgages,  detail how

I.          Loan Modifications:  The New Scam On America

In the January 20, 2012 issue of the Wall Street Journal’s Market Watch, Lew Sichelman shared a few of the many letters he received from homeowners detailing their nightmarish experiences in trying – unsuccessfully – to modify their mortgages.  Take a look at the stories and know that they are being repeated thousands of time a day all over the country.

Those of you familiar with this blog know that I have written posts about loan modification before.  My take on the process has been quite cynical because of what I’ve seen in my bankruptcy practice.

Apparently, the problems I’ve seen in the Central District of California are mirrored throughout the nation.  
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I.          The Growth Of Government-Held Debt

The managing director of Economics1, a nonpartisan policy-research institute, reports:

In reviewing the latest Fed data, Investor’s Business Daily noticed that the total amount of government-financed consumer credit (the vast majority of which is mortgages) stood at $6.3 trillion, just slightly below the private sector’s total, $6.5 trillion.  As recently as 2006, the private sector far outpaced the government:  $8.5 trillion to $4.4 trillion.

Christopher Papagianis, House of Doubt, NATIONAL REVIEW, Aug. 15, 2011, at 21.

In addition, the various bailouts that have not been repaid mean that the government holds a great deal of non-consumer debt.  For example, Mark Modica of the New York Post observes:

Taxpayers still own about 26 percent of GM, and it looks increasingly unlikely that they’ll ever get their money back:  The share price would have to rise to more than $54, and it’s stuck in the low thirties.

Most important is the enormous debt the feds owe foreign countries who hold American debt – most notably, China.  Moreover, the recent battle over raising the debt ceiling led to the downgrading of American debt, and the subsequent current scramble to lower the federal deficit, suggests we may be nearing the point at which the feds will no longer be able to fund any more bailouts.

With the reliability of the banks in question, is it any wonder that the loan modification has failed to produce the hoped for results?

II.        The Bankruptcy Option

Bankruptcy is a federal law option that is administered by the federal government through the bankruptcy courts and the U.S. Trustee’s Office.  Therefore, the cost is already part of the funding of the judiciary and the Justice Department, so there is no need for large subsidies or bailouts.  Moreover, unlike the programs I discussed in the previous post, there is no doubt about the constitutionality of the bankruptcy system:  it is explicitly authorized in article I, section 8, of the U.S. Constitution.

How does bankruptcy help a homeowner deal with mortgage problems?
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In my last post I focused on housing because I think it’s the most important factor in the current mess.  This post discusses the programs set up to address the mortgage meltdown.  The feds also view housing as the linchpin.

I.          HAMP, HAUP, HAFA, HARP

These stand for “Home Affordable Modification Program”, “Home Affordable Unemployment Program”, “Home Affordable Foreclosure Alternatives Program”, and “Home Affordable Refinance Program”.

            A.        HAMP

Freddie Mac states:

HAMP is a loan modification program designed to reduce delinquent and at-risk borrowers’ monthly mortgage payments.  HAMP is effective for mortgages originated on or prior to January 1, 2009, and will expire on December 31, 2012.

Contractually the borrower agrees to repay the loan with interest according to the contract’s terms.  In modifying the loan, what is the borrower trying to do?  Some combination of:  lower the balance, lower the monthly payments, lower the interest rate.  The common theme:  the borrower wants free money. 

If a bank gives away free money it dies.  For example, if a bank has 100,000 mortgages and lowers the principal balances by $10,000, it loses one billion dollars.  If it lowers the payments by $500 each, it loses fifty million dollars a month.  The $500 figure is the Treasury Department’s standard HAMP monthly mortgage reduction.

Banks have an incentive to modify mortgages:

Servicers will receive $1,000-$1,500 for each eligible modification they establish, and a “Pay for Success” incentive of up to $1,000 each year for three years as long as the borrower does not become 90-days or more delinquent.

But this puny incentive won’t coax a bank into giving a borrower $10,000, or $500 per month, in free money. 
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I. The Classical Home Loan

At one time – sounds like a reference to the “olden days”, but it wasn’t so long ago – a borrower was expected to put 20% down as part of borrowing 80% of the purchase price of a home. The fixed monthly payment had two components: interest and principal. The interest was calculated as one-twelfth of the annual interest rate times the current principal balance. The principal was the difference between the monthly payment and the interest. Pretty simple. After thirty years of making the payments you owned the house. Things were a bit more complicated if the monthly payment included homeowner’s insurance and property taxes, but this was a minor adjustment to the basic idea.

II. The Community Reinvestment Act

The CRA was enacted in 1977. However, aggressive enforcement beginning in the mid-1990s sowed the seeds for the current financial problems. Why? It helps to know what the CRA requires. Yaron Brook of Forbes observed:

The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound. Under the CRA, banks must convince a set of bureaucracies that they are not engaging in discrimination, a charge that the act encourages any CRA-recognized community group to bring forward. Otherwise, any merger or expansion the banks attempt will likely be denied. But what counts as discrimination? According to one enforcement agency, “discrimination exists when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.” Note that these “arbitrary or outdated criteria” include most of the essentials of responsible lending: income level, income verification, credit history and savings history – the very factors lenders are now being criticized for ignoring.

Once the traditional lending criteria were jettisoned, banks started issuing mortgages to people who couldn’t put 20% down. These borrowers – we’ll call them CRA borrowers – had to borrow more than 80% of the purchase price. The larger loan meant a larger monthly payment, which was also a problem. The solution: option ARMs.
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