Banks On Foreclosure Fixes In Bankruptcy

In a January 9, 2008 press release, the American Bankers Association’s chief lobbyist came out strongly against proposed changes to the Bankruptcy Code that would let judges lower principal and interest rates on residential mortgages–what is called a “strip-off” or “cramdown”.

Floyd E. Stoner said that, “Such proposals would bring additional risk and uncertainty to an already volatile mortgage market and would make home loans more expensive and less available for consumers.”

The only problem with this position? It’s dead wrong.

The principal argument is that allowing strip-offs of residential mortgages would increase interest rates. A recent study concludes that this argument, repeatedly dragged out when this issue is raised, is wrong.

Adam J. Levitin, a professor at Georgetown University Law Center, recently published a study that examined the potential impact of modification of home mortgages on interest rates and concluded that “permitting unlimited strip-down would have no or little effect overall on mortgage interest rates.” Adam J. Levitin & Joshua Goodman, “The Effect of Bankruptcy Strip-Down on Mortgage Interest Rates,” Georgetown University Law Center, Business, Economics and Regulatory Policy Working Paper Series, Research Paper No. 1087816 (Feb. 6, 2008) at 41. Their abstract states:

Using data from the 1980s and 1990s, we explore whether mortgage interest rates and origination rates changed as a result of federal judicial rulings on residential mortgage strip-down¿the bifurcation of an undersecured mortgage lender’s claim into a secured claim for the value of the collateral property and a general unsecured claim for the deficiency.

Our initial results suggest that permitting strip-down has no effect on origination rates and increases mortgage interest rates by only 10-15 basis points, though the latter result is statistically distinguishable from zero only in some specifications. We do, however, find some evidence that allowing strip-down has a larger impact on interest rates in states where Chapter 13 filing is more common. These findings are consistent with current pricing in the primary and secondary mortgage and private mortgage insurance markets, and suggest that permitting bankruptcy modification of mortgages would have no or little impact on mortgage interest rates.

It isn’t only Professor Levitin who thinks that allowing strip-offs would have little impact on mortgage rates. The originator of mortgage securitization, Lewis Ranieri, said that such relief is the only way to break through the problem posed by second mortgages. For this reason, even though he was the one “who wrote the bankruptcy exemption for first mortgages,” he “finally gave up” and now publicly supports letting bankruptcy courts modify home mortgages.

Jack Kemp, a former Republican secretary of Housing and Urban Development, perhaps summed it up best in a January 18, 2008 LA Times editorial: “Bankruptcy law is wildly off-kilter in how it treats homeownership. Under current law, courts can lower unreasonably high interest rates on secured loans, reschedule secured loan payments to make them more affordable and adjust the secured portion of loans down to the fair market value of the underlying property–all secured loans, that is, except those secured by the debtor’s home. This gaping loophole threatens the most vulnerable with the loss of their most valuable assets–their homes–and leaves untouched their largest liabilities–their mortgages.”

Related posts:

1. Chapter 13 Bankruptcy Home Mortgage Strip-Down Would Stop Foreclosures
2. Mortgage Bankers Want Your Home, Not Your Money
3. Chapter 13 Bankruptcy Mortgage Modification Win-Win