Why Did Cramdown Fail? Insurance and Principal.

[Joanne98]

Published by Bankruptcy Law Network.

On April 30, the US Senate voted against S. 61, a bill that would let judges modify home mortgages in bankruptcy. Karen Oakes wrote an excellent article, “Congress Votes Against Consumers Modifying Home Mortgages In Bankruptcy” discussing the vote.

But some might wonder why the banking industry would fight so hard, and spend so much money, lobbying against a bill that would seem to save it money. After all, saving lenders the costs and expenses of foreclosure, maintenance of the property after foreclosure (including property taxes, maintenance, HOA and condo fees) and the lower price it will receive when the property is finally sold, and changing the loan into one that pays interest would seem to a good thing for them.

So, what’s the problem?The problem is insurance. Mortgage insurance, to be precise. It gives lenders a very strong incentive not to write down principal, and gives them more money if they foreclose, even where the property is sold at a significant loss, than to work to make the loan performing.

Many are familiar with PMI, or Private Mortgage Insurance, that is part of the mortgage payment. This insurance doesn’t protect you; it protects your lender from loss if the property goes into foreclosure and the lender loses money. But PMI isn’t the only source of insurance. The Federal Housing Agency (FHA) issues government-backed mortgage insurance to lenders as well.

So what typically happens in a foreclosure? The lender sells the property at auction, tallies up the costs of sale, credits the money received when the property is eventually sold, and submits a claim to the mortgage insurer for the difference. This may result in a loss for the lender, but the loss is far smaller than that which would exist without the insurance. And from the lender’s perspective it doesn’t matter how much the loss is, since that loss is paid by insurance.

Now look at what happens if the loan is crammed down in a Chapter 13. The PMI and FHA insurance typically exclude from coverage losses due to bankruptcy cramdowns…so the lender can’t make a claim and eats 100% of its losses. Is it any wonder why the lenders have been fighting so hard against S. 61?

There has been virtually no discussion of this vital issue, and no indication that the negotiations between the lenders and Congress have touched upon it. Interestingly enough, one would expect that the PMI insurers would support cramdown legislation, since it would seem to reduce the loss they would have to pay; a crammed down mortgage will still be higher than the eventual price that would be received in a post-foreclosure REO sale, thus lowering their payment. The problem is that the three major PMI insurers, MGIC, RMIC and Genworth, are in such financial straits that they currently have little leverage, particularly as compared with the banks.

One option to allow this necessary piece of legislation to pass would be to require the coverage of bankruptcy losses by PMI and FHA insurance, removing the fiscal incentive lenders have to foreclose, allowing them to reduce principal and letting bankruptcy fix things where the lenders won’t.

http://pdamerica.org/articles/news/2009-05-11-13-09-00-news.php

[w4rma]

1. This is highly useful information. (nt)

[Froward69]

2. The letter I recieved

from my congressman...

Dear XXXX:

Thank you for contacting me regarding homeowner assistance legislation. I appreciate hearing from you.

America’s homeowners continue to struggle, as foreclosures increased by 9 percent in the first quarter of 2009. Every day, more and more Coloradans fall behind in their mortgage payments, and hundreds call the Colorado Foreclosure Hotline for mortgage counseling and help. This news comes after a deeply troubling last year: 39,307 foreclosure filings in Colorado, of which 21,301 families eventually lost their homes. We need bold action to address the housing crisis and help keep families in their homes.

As you may know, on May 6, 2009, the Senate passed the Helping Families Save Their Homes Act of 2009 (S.896) by a vote of 91 to 5. The legislation does much to prevent foreclosures by expanding the tools available to homeowners and the lending community. Key provisions in the bill would:

* expand the ability of the Federal Housing Administration (FHA) and the Department of Agriculture’s Rural Housing office to modify loans;
* improve access to the FHA’s HOPE for Homeowners (H4H) Program, which helps those at risk of foreclosure refinance into more affordable loans;
* provide a safe harbor for servicers that either modify a loan through President Obama’s Making Home Affordable Refinancing program or refinance a borrower into a H4H loan;
* create enforcement tools for FHA to eliminate bad lenders;
* authorize an additional $127.5 million for foreclosure prevention activities;
* extend the $250,000 deposit insurance level for four years; and
* increase the borrowing authority for both the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Association (NCUA).


I strongly support this bill. I am pleased that the Senate came together to craft legislation that will help tens of thousands of working families across Colorado and America keep their homes.

As you may also know, Senator Durbin of Illinois introduced an amendment to S.896 that would allow bankruptcy court judges to modify the terms of a mortgage for borrowers participating in bankruptcy proceedings, a process often referred to as “cramdown.” The amendment, which needed 60 votes to pass, failed by a vote of 45-51. I voted against the amendment because, though well intentioned, it was far too broad and not sufficiently focused on the middle class. The amendment posed the risk of unfairly punishing small lenders and local bankers who have been making a good faith effort to provide credit to their communities. In addition, it very likely would have had the unintended consequences of raising interest rates for all homeowners, potentially delaying real housing recovery.

Passing S.896 in the Senate was an important step in a comprehensive effort to help stem the tide of our current housing crisis. I was proud to support the legislation. As Congress considers further homeowner assistance legislation, rest assured I will keep your thoughts in mind.

Again, thank you for contacting me.


Sincerely,

Michael Bennet(D?)
United States Senator

I knew it was Bullshit when I read it...