We wrote earlier this week that the subprime relief deal orchestrated by the Administration was an effort to forestall a bill sponsored by Democrats that would, among other things, give judges the ability to change some mortgage terms in consumer bankruptcies.
Elizabeth Warren at Credit Slips confirms this view in her assessment of the subprime plan. Warren discussed in an earlier post how lenders recognize the so-called “hostage value” of the house borrowers live in, and will be willing (if they can) to pay more than it’s worth. Remember, the plan focuses only on borrowers that have less than 3% equity in their residence, which effectively means they have no equity or negative equity.
Even though Warren is proponent of the bankruptcy bill, and we agree that it is a better solution than either the status quo or the Bush plan, it’s important to recognize it is the best of not-so-hot options. Declaring bankruptcy is stressful, costly, disruptive, and leaves the consumer with access only to expensive credit until the bankruptcy rolls off his credit record seven years later. The flip side is that those factors mean the system is unlikely to be abused despite Republican dogma to the contrary.
From Credit Slips:
I’ve been struggling to understand the real point of the Administration’s headline-grabbing plan to deal with subprime mortgages. …..I can’t quite figure out what the plan accomplishes that the lenders couldn’t do without the plan–if they were in a mood to deal fairly with borrowers, acknowledge their losses, and start cleaning up the mess before it takes down the whole economy. So why trumpet a plan that doesn’t do anything? CongressDaily (no link) found the answer: “‘Totally will sandbag the bankruptcy stuff,’ one lobbyist said of the White House announcement.” So that’s what the plan is designed to accomplish–kill off the bankruptcy proposal to deal with home mortgages.
In a piece entitled, “Bankers Hope Bush Subprime Plan Will Scuttle House Bill,” CongressDaily reports that “the mortgage industry hopes a White House plan designed to aid subprime borrowers at risk of losing their houses will help scuttle congressional efforts to refashion mortgages through the bankruptcy code. . . The announcement comes as Congress moves ahead with plans to make it easier for bankruptcy judges to refashion home mortgages that are on the verge of foreclosure — legislation bitterly opposed by the housing industry. Bankers said they hope to use the White House approach as a prime example of why the bankruptcy legislation should not move forward, emphasizing that a voluntary effort can cover many of the estimated 2 million subprime loans that are scheduled to reset to higher rates over the next two years.”
Bankers evidently dislike the bankruptcy proposals because they give borrowers some real power: they can write down the mortgage to the value of the property, and they can rewrite the mortgage into a fixed instrument. “Voluntary,” according to the banks, is much better.
Of course, if the bankruptcy laws changed, the negotiations outside bankruptcy would change too. If families had the option to declare bankruptcy and cut the mortgage down to the size of the property, some mortgage servicers might start returning homeowner’s phone calls and talking over other options.
Bankruptcy can’t fix the whole subprime problem, and it is not a perfect solution even for those who would be helped. Families have to be in really bad shape to go bankrupt, and many will resist either because of the stigma or because they won’t qualify for relief. But bankruptcy could help some of the families hit hardest. It would also move this crisis through the system faster. If a bankruptcy court determines that the family can’t afford the home even with a decent mortgage, then they will have to give it up. A bankruptcy amendment will not put off the day of reckoning. It will help move toward a more stable (and more realistic) housing market faster.
So the administration’s subprime mortgage plan is the bank lobby’s dream. “Totally will sandbag the bankruptcy stuff.” And totally sandbag American homeowners and would be homeowners.