Temporary Bankruptcy Instead of Loan Mods?
May 20, 2010
Source: Robert Freedman, REALTORŪ Magazine
The federal government's program for helping hard-hit home owners avoid foreclosure could be having the unintended effect of encouraging people to make strategic defaults.
The program needs to be replaced with a new way for judges to modify mortgages in bankruptcy court, one of the country's largest financial asset management companies suggested to REALTORSŪ this week.
Barbara Novick, vice chair of New York-based BlackRock, an investment risk management firm, on Wednesday shared with NAR's Conventional Finance and Lending Committee her company's proposal for ditching the federal Home Affordable Modification Program.
Fewer than 2 million mortgages have been modified under HAMP since its inception about two years ago. That's a small percentage of troubled home owners that need help, Novick said. What's more, many of those modified mortgages are destined to fail - and many already have - because the program suffers from a fundamental flaw, in her company's view.
Novick: Why HAMP Won't Work
HAMP modifications are based on making the home owner's first lien debt affordable, at 31 percent of income. The modifications don't take into account the borrowers' other debt, including second liens, student loans, credit card debt, and car loans. It's not unusual for home owners to go into the program with a debt-to-income ratio of more than 60 percent, Novick said, making any modification limited to the first mortgage loan inadequate for helping many home owners reach a sustainable financial position.
One outcome of this systemic weakness in the program is that home owners in some cases are choosing to default on their first mortgage to qualify for assistance while continuing to pay their other debts.
Novick says these strategic defaults turn investors' contract rights upside down, because first-lien holders are supposed to be the most protected class of investors. But under HAMP, they're the only ones being asked to accept lower returns in a modification.
An Interesting Proposal
The BlackRock proposal envisions a temporary bankruptcy procedure that recognizes the unique problems presented by the mortgage meltdown. Under the procedure, bankruptcy judges would look at which debts to write down and by how much, but their discretion would be curtailed relative to other so-called cram-down proposals Congress has looked at to deal with the mortgage meltdown.
Under the proposal, creditors' rights would be recognized and adhered to; and judges would be prohibited from expanding debtors' rights in cases in which consumer protection statutes or the Truth in Lending Act are violated. (Under some proposals in Congress, some debtors' rights would be added onto the restructuring if the judge found the lender's practice in violation of those consumer protection laws.)
But Will It Work?
NAR's Conventional Finance Committee said it would look at BlackRock's proposal. But the proposal raised a number of concerns among the members, not least of which is the heavy burden placed on home owners who would have to go through bankruptcy court rather than the far more targeted approach offered by HAMP.
Novick said the proposal is aimed at helping the public in general by reducing the hit to the federal government and the secondary mortgage market companies Fannie Mae and Freddie Mac, which are bearing the brunt of the first mortgage write-downs.
