Our bankruptcy laws were always based on the principal that people who screw up financially deserve a chance to go through some pain and then be rewarded with a clean slate. We believed that America was more enlightened than the England of Charles Dickens where debtors would live a diminished life of perpetual servitude or imprisonment.

But the explosive growth of the credit industry changed this. How could huge and powerful financial companies offer boundless credit to almost everybody if those people had a way out of paying. So they put their financial muscle to work and they got a lot of laws passed.

So now they can market home loans, credit cards, lines of credit, student loans and credit accounts to pretty much everybody. Wages are flat and the perceived needs of modern life grow ever more expensive. Advertising propaganda pushes the goods and the money is there to borrow so most people just buy and borrow. It's the new American way. End result is that most American's are gradually drifting into a permanent state of debt servitude.

This is exactly how the financial industry wants things. They gain enormously when most people are struggling to service a crushing debt.

So don't expect anything to change. There is too much at stake. Our current spinless and corporate beholden congress will never pass any bill that changes anything major. Their financial masters may sign off on a couple of misleading bits of legislation with fancy titles but nothing major will change. Too many politicians and corporate insiders are feeding too well at the trough of american indebtedness.

Kicker,

Current housing values, by and large, should not be supported - perhaps in areas where median prices and incomes have not gotten wholly out of line that is not the case - but a major part of the resolution of the problem is for housing prices to return to supportable levels, to wit ballpark 2.5x-3x income levels (or incomes could rise, but that seems the less likely route to balance).

Thanks Tanta, this helped me understand the process of the forclosure the property I am currently in. My landlord just went to BK court and the stay was lifted so it now proceed into foreclosure. For some reason I thought the lender just sent a letter of default and then proceeded with foreclosure. Now is the lift of stay required only for recourse loans?

The MBA is breathtakingly short-sighted on this issue.

Our current spinless and corporate beholden congress will never pass any bill that changes anything major. Their financial masters may sign off on a couple of misleading bits of legislation with fancy titles but nothing major will change. Too many politicians and corporate insiders are feeding too well at the trough of american indebtedness.

Yes, that's obviously the assessment the banksters have made -- which is why they feel empowered to court disaster. Wait'll they see Plan B:
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I weep over the potential abuse of mortgage bankers and hedge funds by greedy and nefarious home owners.

Nice, dryfly.

Didja ever wonder why laws made (or changed) to combat those grifting, crafty poor people wind up linining by geometric proportions the pockets of the grifting, crafty rich --who tend to whine like hell when you point that out?

(forgive if you saw double on this post - halo is hating me)

In fact, I have some sympathy with the view that mortgage lenders "perform a valuable social service through their loans." That's why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I'm here to tell you that you will certainly not "forget" to model negative HPA in your ratings models, and will probably pay more than a few seconds' attention to your appraisals.

My father used to say that truck drivers should be required by law to have dynamite strapped to the bottom of their seats... with the plunger attached to their bumpers... That way if a truck driver runs over some poor hapless secretary in a Ford Festiva on the Eisenhower then they both get blown to hell (instead of just the secretary). Think of it as 'Interstate Cram Down'.

Moral hazard works best when it works both ways.

This is absolutely one of your best posts! (In my book, at any rate.)

I second.

City [London] 'to lose 6,500 jobs' in 2008

BBC NEWS | Business | City 'to lose 6,500 jobs' in 2008

Fort Worth Star Telegram -
A thankless job, evictions are increasingly common

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A truly wonderful post, Tanta. I hope some of the staffers who will advise our Congress-people on this topic read it and spread the word.

BTW FCs in VenCo are up 768% y-o-y.

Come on Bob, you know as well as anyone you get big percentages like that when you start at 'zero'. It hasn't been 'zero' in rust belt - the market never recovered much from 'the last recession' there. VC might catch up with Indianapolis and Cleveland and Detroit in total dollars involved but last I saw rust belt still owns the records for number of cases.

BK judges should have the power to dig through the facts and rule according to the differences. Hopeless cases go straight to FC as always while those able and willing (need to prove both) go to workout. In the Midwest, due to the cheapness of housing, a LOT of folks could successfully workout if the 'predatory practices' are reigned in. Probably not the case in VC.

Great post Tanta, with very informative follow-up by Uncle Festus.

Nothing but time and pain will ultimately solve the credit/real estate mess, but cram-downs sound like a positive and practical measure that would help some people.

But as long as Wall Street owns the cojones of both parties, I just don't know what the odds are for making this tool available for principle residences. Unless things get a lot worse. Which they might.

Tanta, before it was a joke, but now you've pushed me over the edge. I will indeed sit down and write my Congress Critters this week recommending the Blogger Known as Tanta for the position of Mortgage Tsarina. All week long I read the lunatic ravings of delusional financial engineers, and then I arrive at the Oasis of Sanity at Calculated Risk.

Kicker wrote: here will be no chance that the secondary market for structured mortgage products is going to recover with the added uncertainty of mortgage cram-downs.

Absolutely untrue. If the underlying asset has depreciated this much in value, all this procedure would do is recover some of the overhang and avoid the costs of foreclosure and carrying REO. It is far cheaper to pay the costs of the appraisal and show up in bankruptcy court than to carry and try to flog some of these dogs. In many cases, it will be the cheapest option for the lienholders. In my experience, this is what actual real live lenders are seeking to accomplish with modifications. There is no way that the proposal will destroy the market any more than it has been destroyed already.

It is true that such a procedure will alter the risk/reward pic a bit going forward for the insane lenders who are still offering bizarre mortgage terms. How is that a bad thing? The market is what has toasted those lenders. It's got nothing to do with some bankruptcy judge.

Allowing cram downs could give homeowners stuck with bizarre loan terms and depreciating loans a purpose to hold on for a while, actually. The longer they continue to pay, the longer the value of their home depreciates and the better their chances of a significant debt reduction in bankruptcy court.

There's another beneficial aspect of this proposal. The explosion of REO on markets hurts the collateral values of all the lenders who didn't write ridiculous loans with ridiculous terms and the property values of all the home buyers who didn't borrow ridiculous amounts of money in relation to their incomes. It is better for everyone if people who are genuinely underwater but have some chance of actually paying on the real, underlying asset can stay in their homes.

I just have no tolerance for the idea that somehow the lenders and investors who generated all this will become helpless victims of predatory bankruptcy judges. The truth is that it is the responsible home buyers and the responsible lenders who are getting bent over by the system.

One FC in your neighborhood is worth at least five in his.

Try more like 8-10. Seriously, my guess is the typical home in Bob's hood cost 10 times the typical home in my town. Median home in my town is something like $125-150K... something like that. Median family income of about $50-55K. Over buying is NOT one of the leading causes here or in most of the Midwest...

The reason people fail here are (not in order):

1) job loss

2) medical bills

3) divorce

Homes are so cheap most folks have no problem getting conforming vanilla loans at purchase... Its what happens in their life AFTER that that makes the mess... and then like everywhere they then turn to sub-prime.

If folks can show a judge that they've straightened out their lives and have a decent shot at financial rehab then they should get a shot. Its the best option for all of us going forward IF they can show a reasonable plan.

If not FC.

But my world isn't one where failure is baked in by ridiculous housing cost... something like half of America is like me. We don't all live in or even aspire to live in Ventura County (Rob't takes big sigh of relief)...

tj: MOM, that "collateral value" was pure fantasy from the get-go and will disappear regardless.

In some places yes, in some places no. There literally are places that saw very little increase in home prices but did get hit by lala lenders, which is forcing a lot of sales now.

Personally, I experience no angst for lenders that factored years more of yearly appreciation rates of 10-20% into their deals. I'm pretty sure that no one here does. I do see the problem in places like Dryfly's that got penetrated by the predatory lenders with teaser rates.

There is nothing worse than to be a prime FTHB borrower who put down 20% and wake up one day and find out that 20% of your neighbors bought or refied with these exotics, and now are selling. OK, there's one worse thing. That's when you get the layoff notice from your company, and are forced to sell in that environment.

I have always felt that the reason why huge swathes of Texas never recovered from the meltdown in the 80's was that everyone still kept buying with those adjustables and the rollover rate stayed high.

Robert - cram downs aren't a bailout. They are a court-mediated recognition of reality. If someone borrowed 1 mil and the house can now be sold for .8 mil, that $200,000 is unsecured! What more does foreclosure offer to the lienholder? Zip. It's not like people are going to go into bankruptcy just because of this, because once they are in, they will be forced to repay even unsecured debt based on ability. It's not a pleasant experience and you really can't run up debts beforehand, because they do look at that. What some of the people are doing to escape (the ones who still have non-recourse loans), is to buy another house in a cheaper area and then walk on the first. That's actually a more attractive option.

I was reading an article about the economics of the SD area:
But based on the county's job creation, wage increases and the growth of its high-tech businesses, it is not even among the top 70 best-performing regions, according to a report issued last month by the Milken Institute, a think tank in Santa Monica.
...
Our region has gone from first place in 2002 to fifth in 2003, 16th in 2004 and 29th in 2005. Our latest ranking places us firmly between Hagerstown, Md., and Little Rock, Ark.

“It's not that the economy in San Diego is going south,” said Perry Wong, a researcher at the Milken Institute. “It's just that the momentum for creating jobs is gone. Job growth has been almost standing still.”

One of my brothers lived in SD for quite a while. The climate's great and the area is great in many ways, but he requested a transfer a couple of years ago because of these issues. It took months to schedule with movers, because so many other people were doing the same thing, I guess. I don't think the big run up in values is sustainable.

That raises the questions from the other end. How is the rest of the country going to react when oner of my bubblicious nerighbors sucessfully games the system for an amount that could make 10 even 20 "regular folk" whole? When does protecting a roof overhead slide into lifestyle subsidy?

I don't want this to be about me or my 'hood except that I see it as an example of why I think the idea of bailouts is going to be fraught with far more public objections than are being anticipated.

Nah, I don't want it about your 'hood either. I have family out in the Bay Area and they are scrambling to make ends meet in a small two bedroom with two kids... priced somewhere north of $600k. They tell me its a classic starter but at that price it could also be an 'ender'. That price would buy him a nice hobby farm with horses around here... And for those who say it's the higher income - think again. He makes more out there but only maybe 10-20% more yet housing costs 5-10 times as much.

The thing about Tanta's proposal is that it doesn't matter on homes like that... you can't mod somebody with median income into those homes unless there is a HUGE decline in prices or they have very high income... playing around the margins isn't going to do squat for folks in Cali who are really in trouble.

Out here they don't need mods - they jobs.

As far as what would the rest of the country think? Not much IF the same standards are applied everywhere... i.e. can the homeowner make the payments under the new plan? And realize they aren't going to cut the payments 75%... mods are pretty modest. My guess is with price to income ratios > 6:1 in most of Cali I'd say most are screwed regardless - most will go to FC.

Dryfly,price to income levels were above 12-1 at the peak in Sonoma county.they are still in the neighborhood of 7 or 8 to one.Not much is selling,but inventories are growing...It is weird seeing inventory jump at this time of year...are they Anticipating a Halloween home buying binge?

Dryfly, price to income levels were above 12-1 at the peak in Sonoma county.they are still in the neighborhood of 7 or 8 to one.Not much is selling,but inventories are growing...It is weird seeing inventory jump at this time of year...

Tom - those numbers are mind boggling. Median prices at eight times median income like it was some kind of good deal... and we are wondering why homes aren't moving.

For some of us, honoring our debts and contracts is still a moral issue. I guess for us, a moral hazard is created when you put the honest guy at such a disadvantage that it becomes difficult to be moral.

I've seen a half dozen of my peers go through the bankruptcy process. They went into the bankruptcy process driving better cars and living a better life style than I was. And most times, they came out of the bankruptcy process driving better cars and living a better lifestyle than I was.

In some cases, they were "serial filers". Building up a credit history, maxing out credit, and then filing for bankruptcy again.

Credit standards have been so loose, and the spread so tight, that in many cases the bankruptcy had almost zero impact on the cost and availability of credit. The impact has been so minimal that in many cases I've wondered if it wasn't worth "selling my credit score" every couple of years.

I've even done back-of-the-envelope calculations on how much "additional income" being a serial filer would provide. It usually worked out to about a 25% bump in income. And, I still got to keep all my savings because 401K's are exempt!

Now really, how much temptation do you think I can handle?

energyecon,

Current housing values, by and large, should not be supported

I doubt there are many people today that wouldn't agree that home prices are going to need to adjust. But, they can either adjust all at once or slowly.

By adjusting all at once, you're going to lock a large number of homeowners in their homes for decades. That will reduce the overall flexibility of the workforce and the health of the economy.

Seems to me that slower adjustments over a longer period of time are a better option.

"The banking industry seems to believe they can sleep nights because they got their version of bankruptcy reform passed. Americans aren't socialized in the principals of serfdom and they aren't going to step up to have their wages garnished for the next 30 years courtesy of VISA."

I would have agreed with this five years ago. But now I'm not so sure what Americans will put up with. Apparently they are willing to accept wars of aggression and the loss of basic constitutional rights without much trouble.

So why won't they accept debt servitude? In a sense it's already here. The laws are on the books to hold people in servitude for 5 years. Like so many laws these days the Bankruptcy Reform Act passed easily despite the fact that most people opposed it. Congress no longer answers to the people - they answer to the lobbyists and the corporate moneymen.

So when they put together the next bill that pretends to help people but really helps only the credit and banking industries who is going to object? And will it matter if they do? The corporate media will spin the bill as required and it will pass.

We don't have to be called serfs to live in servitude. Habeus Corpus is dead, the right to assemble is dead, the right to be free from unreasonable search and seizure is dead, free speech is mortally wounded. The Supreme Court is not tossing out these new laws. What's the deal? Servitude is already here. We're just too distracted by the internet and all our electronic toys to fully realize it.

Countrywide, 81 banks of the 8,611 Bauer rates are considered problematic or troubled, earning Bauer's rating of one star, a step above its lowest rating of zero. That's an increase from 73 in the first quarter of the year.
West Palm Beach Business: News, stock quotes, financial, Real Money, health care, real estate | The Palm Beach Post

Robert, you mean the scam-artist Serin facing federal charges and lawsuits - doesn't sound comfortable to me- and doesn't sound like he's getting a pass (he's facing federal charges now). And his other 'ventures' don't seem to have worked out (but pls chime in with said evidence of 'comfort' and how this 'venture' is going to work (below is wikisummary -so feel free to disupte at will, but i couldn't find any evidence to contrary):

Alexa web searches revealed a joint venture agreement between Casey Serin and Marty Stewart, an internet marketer. Their joint venture agreement along with a series of audio files was found within Google cache.[38] The self-published book, named The Foreclosure Code: My Bubble Burst! How I Purchased and Lost $2.2 MILLION in Real Estate, is scheduled for release in Fall 2007.[39] According to the book's website Foreclosure Code Book | Casey Serin's Story of IamFacingForeclosure.com | ForeclosureCode.com Serin's numerous violations of the joint venture agreement nullify his rights to the work.

[edit] Other scams
Serin's scamming history started at an early age. At age 15 Serin distributed a letter titled "$$FAST-N-EASEY CASH$$ NO risk, NOT a scam!!". [40] [41] Serin also tried to scam friends/acquaintances when he ran in financial trouble with his homes, by offering a fixed 24% return on investment in real estate. Serin later apologized for this attempt. [42]

[edit] Legal Trouble
According to Sacramento County Courthouse documents available online, Casey Serin was sued on July 3rd, 2007 by Mark Villaseñor, a loss mitigation professional doing business as Queuetrac Information Systems, who recently had a business relationship with Serin.[43]

P.S. - Kicker, would love you to spell out how your magic 'formula' works -- and info on exactly how these successful scammers did it- evidence?

completely OT:

Downtown DC's vacancy rate: 3.6% including sublets. for buildings built after 1985: 1.9%

WOW

Kicker, would love you to spell out how your magic 'formula' works -- and info on exactly how these successful scammers did it- evidence?

In my state, it was a common tactic to delay the bankruptcy process by asking for extensions to file your debt repayment plan. Once it was no longer possible to delay the process any more most would re-file under a Chp 7.

I never knew anybody to file bankruptcy with a single dollar of credit left on their cards. Most needed a vacation prior to bankruptcy because of the amount of stress in their lives.

I'm not really sure where the money that should have been going to the mortgage or credit card payments went during that time.

They would typically be allowed to keep their cars and they usually had plenty of free income after bankruptcy to continue the car payments. Usually, nobody ever bothered to repossess the furniture.

They had to give up the house, but they were usually upside down on it. It's not to hard to find a appraiser that's willing to "hit the numbers" for a loan officer.

After the filing, they would take a distribution from their 401K and get a secured credit card at a local credit union. The secured card would be quickly followed by a unsecured card. After about two or three years they would be back in a house ready to repeat the cycle again.

For some reason, a lot of times the spouse would quit working through the bankruptcy. I could never figure that one out.

It usually worked out to about 60-100K in debt that was discharged. Not a bad boost in incomes when you consider it was tax free.

sorry "debt-riddled under water guy"

Actually the info on CA. AG's potential charges came from Serin's own lawyer, who I'm sure would be trumpeting to the heavens if he managed to get the AG off Serin's back.

Alo,

Maybe we're talking about different things. What do you mean by "scammers"?

My point is, that you can't have a system with easy credit and painless bankruptcy laws without creating a moral hazard. It's like having a credit line in a casino that allows mulligans.

Personally, I think it's better for the economy as a whole if we have easy access to credit and a bankruptcy process that leaves you with a fresh slate. No assets, no debts.

If you think that keeping people in as much of their lifesytle that their income can afford, fine. Just make sure that people can never borrow enough to put them under water as far as net worth.

Of course, forgive me if I'm not really happy about changing the rules in the middle of the game.

Anon, I don't understand your point. You are saying that people who are foreclosed upon will be better consumers and those who get workouts of this kind will not?

How so? Foreclosed folks walk away with ruined credit and lost equity. These people are a much greater burdern than those staying in their homes, retaining their mortage tax deduction and paying their taxes.

Also how about a rule here that when you post things about how well off most distresssed buyers or folks in bankruptcy are, you give some info to back that up.

Here I'll start - an analysis of who is going bankrupt and why (and it's not because they are gaming the system):

Mish's Global Economic Trend Analysis: Bankruptcy Trends: A Perfect Storm of Debt

[If the choice is between foreclosure or cramdown, why wouldn't the lender choose cramdown? They are going to get less money on the house either way. At least this way the lender doesn't have the hassel of re-selling nor expenses involved with upkeep before the property is re- sold.]

The inherent assumption here is that BK is the end of the story... more often than not, it isn't.

So, the servicer goes through all this nonsense, agrees to the cramdown, and the borrower eventually loses the house anyway.