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March 7th, 2009

Judges won’t “run wild” on cramdowns?

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Reuters finds a couple of bankruptcy judges who share their thoughts on the cramdown bill working its way through Congress:

Mortgage bankers are in knots over proposed U.S. legislation that allows loan contracts to be broken up in bankruptcy court, fearing it will taint the core of their business and raise interest rates.

But their fight against the bill gaining momentum in Congress is an overreaction, or a red herring to prevent the industry from realizing inevitable losses, some judges said.

“Judges aren’t just going to run wild,” said Judge Keith Lundin, of U.S. bankruptcy court in Nashville, Tennessee.

That reassurance, however, is negated to an extent by his further thoughts:

Bankers are merely putting off the realities of the ailing housing market, Judge Lundin said.

“If these guys are worried about value, it’s about what they did, not because of what I’m going to do,” said Lundin, speaking of bankers’ roles in offering risky loans. “They don’t want someone with authority telling them what their securities are worth, that’s what they’re afraid of.”

Judges in the mid-1980s used Chapter 12 of the bankruptcy code to rewrite farmland values, aiding farmers who were also faced with falling commodity prices. After a year or two, the real estate market adjusted, Lundin said.

“I guarantee you, that is exactly what will happen if you allow home mortgages into Chapter 13″ bankruptcy, he said.

One can reasonably expect a bankruptcy judge to make a ruling based on the facts, so one would hope that Judge Lundin wouldn’t automatically assume, as his comment suggests, that a homeowner’s bankruptcy is due to “what [the bankers] did.” That argument is the true red herring, since it implies that the lender either made the loan fraudulently or somehow forced the borrower to take a loan he couldn’t afford. If that’s the case, the borrower can sue, and most likely prevail, under any number of consumer-protection laws.

Bankruptcy can be the result of many scenarios, most of which are outside of the lender’s control, including unemployment, extended illness, or some other financial catastrophe. Or, just maybe, it might be because the borrower fudged some of the facts on his loan application — or because, like many homeowners, repeatedly tapped his home’s spiralling equity for spending on… whatever.

Moreover, Judge Lundin’s suggestion that he would repeat his experience of the mid-1980s — “aiding farmers who were also faced with falling commodity prices” by imposing losses on the banks which lent the farmers money — won’t reassure first-mortgage lenders in his district, either.

The article also quotes Judge Sam Bufford of the Los Angeles bankruptcy court, who seems to have an imperfect understanding of how the bailout works:

What’s more, the legislation would put the costs of reworking mortgages entirely on the private sector, quelling a rising tide of anger among Americans watching the government throw taxpayer dollars at banks and consumers, he said.

“There is not a penny of government money needed to do it at the time when Congress is wondering where is the bottom of this pit, of pumping billions into the economy,” he said.

While the judge acknowledges that cramdowns impose losses on the private sector, he seems blissfully unaware of the purpose of the hundreds of billions in “government money” (which is, of course, taxpayer money) being poured in the “pit:” to prevent their losses from pulling them under.

The judges may have inadvertently provided more ammunition to opponents of cramdowns than to their supporters.

UPDATE: A post on the Mortgage Insider blog also notes the Reuters article, but there’s a good back-and-forth regarding cramdowns in the comments.

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One Response to “Judges won’t “run wild” on cramdowns?”

  1. Esko Kiuru Says: March 8th, 2009 at 1:48 pm

    The private sector, banks, made some poor decisions that are now biting them where it hurts. Why should the taxpayer reward them for that? The reasonable road to mortgage and real estate industry recovery is to bring the housing prices down to where the marketplace says they belong and start over. If the banks don’t want to do it, then someone else has to do it.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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