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Constructive suggestions about foreclosures
Francisco Torralba writes:
First of all, settle on a bankruptcy text and stick to it. The latest overhaul of the Bankruptcy Code took place as recently as 2005. Regulatory uncertainty inhibits lenders.
Second, lawmakers should give the two parties in a contract more leeway to renegotiate their loans. I applaud the congressmen’s proposals to allow modifications of the terms of the original loans, but they could go further. For example, they should allow converting 30-year adjustable rate mortgages (ARM) into 50-year fixed-rate mortgages.
The modifications could be proposed by the court, but then they should require consent from both mortgagee and lender. Two of the bills under consideration -- the ones by Senator Durbin (D-IL) and Representative Miller (D-NC) -- allow the bankruptcy court to modify the terms of the loan without restrictions, not even agreement in writing between the parties. Giving such power to the court has at least two effects. First, it tilts the balance towards the consumer -- in a free negotiation between mortgagee and bank, the latter would have the upper hand. Second, it increases the uncertainty of the bank's payoffs. Both effects reduce the supply of debt.
Congress should also modify the Code so that the least creditworthy borrowers have more incentives to file for Chapter 7 instead of Chapter 13.
Going beyond the current problems, better ex ante disclosure would be welcome. Most borrowers don’t understand 95 percent of the legal mumbo jumbo on their contracts. Mortgage applicants should be given worst-case scenario simulations of their monthly payments.
We could also set a floor on “teaser” introductory mortgage payments. Hybrid ARM's, for example, start out carrying a low, fixed rate. Two to five years later the interest rate resets to a higher, floating level. Option ARM's let the borrower initially make interest-only payments, minimum payments (often below the interest accrued), or fixed, low-rate payments, also until the first reset date. Any of those schemes make mortgages affordable, but only for the first few years. Legislation could provide, for example, that initial monthly payments never be below 80 percent of the expected payment after the first reset date.
Here is Francisco's blog, if you don't already know it.
Posted by Tyler Cowen on November 29, 2007 at 06:47 AM in Economics | Permalink
Comments
As I've said before, in today's environment, loan modifications are not that simple. It's not just between a lender and a borrower. There are third-party investors who own most of the loans. If you allow loan mods, then you redistribute cash flows to investors. The whole securities market in mortgages would have to adapt. You would create a mess.
Posted by: Arnold Kling at Nov 29, 2007 7:19:34 AM
"...that initial monthly payments never be below 80 percent of the expected payment..."
The problem with this is that it gives too much weight to the computation of expectations, which in turn will incentivize the lender to issue on the part of the curve that is already most overpriced and also invite creative computations of what is "expected". It would be simpler, and probably therefore better, to require an absolute cap on payments at some multiple (i.e., 2 or 2.5) of the teaser rate. This would make lenders of such products short vol (even more than normal), disincentivizing but not forbidding such loans.
Posted by: sammler at Nov 29, 2007 8:12:25 AM
Arnold's point that 3rd parties own the loans actually works against his argument. Mortgage cramdowns aren't allowed in personal bankruptcy (unlike in business or farm bankruptcy) largely because when the previous bankruptcy reform was passed in 1978 this was not the case and banks and individuals found it relatively easy to negotiate when a homeowner was approaching foreclosure. I'm not sure allowing cramdowns (where a judget decides the value of the house and also picks an interest rate) is an answer, but if we see foreclosures increase it will be the logical legislative option.
And we've only made ONE significant change to the bankruptcy code in 30 years--the original post's complaint that we keep tinkering with the code is nonsensical.
Posted by: ike brannon at Nov 29, 2007 10:35:19 AM
I think 2 to 2.5 times is already very high. I find it hard to think of a realistic situation where someone is at first unable to pay more than a given amount, but already knows he will be able to pay double that amount in a few years more. College students come to mind, but do they really need mortgages?
Given that, I suspect the only reason to offer a mortgage whose rates are going to double is to lure people who do not understand the fine print.
Posted by: GreatZamfir at Nov 29, 2007 10:45:02 AM
How much does stretching a 30-year fixed to 50-year
fixed really help? A mortgage calculator online says
monthly payments go from $600 to $526 on $100k at 6%.
Not exactly save-the-day.
Posted by: Lou at Nov 29, 2007 11:18:28 AM
Am I the only one who thinks that making "mortgages" essentially unsecured will screw up the mortgage market massively?
-dk
Posted by: Dick King at Nov 29, 2007 1:47:53 PM
"allow the bankruptcy court to modify the terms of the loan without restrictions, not even agreement in writing between the parties...Both effects reduce the supply of debt"
Of course it will reduce the supply of debt. Lenders are not stupid. If something like this is passed, they would just charge more and we would go back to the good old days of 20% down. Housing prices will really tumble then. As mentioned before, for lenders that portfolio their loans, no big deal. For those that securitize, some major changes would have to take place. No investor would go for it in its current form.
"Most borrowers don’t understand 95 percent of the legal mumbo jumbo on their contracts. Mortgage applicants should be given worst-case scenario simulations of their monthly payments."
Even though this is sad and true, it is mind boggling. This is probably the biggest financial decision people make in their lives. Read the $#@! contract! It is not that hard and guess what, you can always ask questions. Maybe more summary pages and worse case scenarios would help.
Posted by: Patinator at Nov 29, 2007 4:06:02 PM
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