The Sandbag Plan
I've been struggling to understand the real point of the Administration's headline-grabbing plan to deal with subprime mortgages. Now that I've read the plan (thanks to Bob Lawless at Creditslips), it seems to be nothing more than a guideline for when some lenders or servicers might let some borrowers extend lower interest payments for a while before the interest jumps up later. The loan on the house stays the same, even the family owes much more than the house is now worth--a circumstance that will cut off any refinancing option and any real resolution of the problem. The plan doesn't require any new laws or government intervention because no one is bound to anything. 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." 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. As people commenting on earlier posts rightly noted, 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.
While it might be good policy to remove the home owners' exception from the Bankruptcy Act and treat mortgagors more like business owners, would such an amendment be applied retroactively to debt obligations contracted before the date of enactment? Would such retroactive application which would impair contract obligations violate Article 1, Section 9* of the Constitution?
If the answer is yes (I don't know the answer), then, amending the Bankruptcy Act won't resolve the current crisis.
* "No bill of attainder or ex post facto Law shall be passed."
December 7, 2007 5:37 PM | Reply | Permalink
There's no ex post facto law problem here because that applies to criminal laws (you can't prosecute someone for an action that took place before before the law was passed). Also, as I noted elsewhere, the 2005 law also applied to debts contracted before the law was passed, and no challenge was mounted (and while creditors may have more political clout than debtors they are certainly not a specially protected class under the Constitution and have no more rights than debtors). There are also numerous examples and hence ample precedent of non-criminal laws being changed in ways that apply retroactively: tax laws being a very obvious example. Some of these sorts of changes affected very powerful entities, but there was no ex post facto challenge to them because that clause did not apply. One could perhaps argue that this represented a "taking" without due process, but I don't see that as a profitable avenue of attack since A) the a government is not taking anything and B) that argument would apply to bankruptcy in general which deprives a creditor of expected pay-back. The Constitution however very explicitly allows for Congress to make laws on bankruptcies.
December 9, 2007 5:36 AM | Reply | Permalink
So, then, lets not talk about "taking." Let's talk about Fifth Amendment rights to due process.
And since many laws which affect rights are held to be "remedial" or are said to restrict "rights" previously conferred under the law being amended (the government giveth and thus, the government may taketh away), citing an enactment generally ("the 2005 law") without pointing to the specific contract-impairing provision is not persuasive.
The creditors whose contract rights would be impaired under the suggested Bankruptcy Act revisions relied upon the law in effect when making their contracts. Further, they were not within the class of beneficiaries of the Bankruptcy Act. And finally, they are not petitioners -- that is, they have not as the prospective bankrupt may be thought to have done, traded constitutional rights for rights legislatively granted.
What about Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935)? Do you have a case under the Bankruptcy Act in which it was held that Congress may, retroactively, deny secured creditors their right to execute upon their collateral?
December 9, 2007 5:01 PM | Reply | Permalink
Re: The creditors whose contract rights would be impaired under the suggested Bankruptcy Act revisions relied upon the law in effect when making their contracts.
This is true, but it is also true that laws are subject to change and nothing in the Constitution prevents laws from being changed simply because some powerful interest group or other would prefer otherwise. Those interest groups most certainly have the right (and the ability) to participate in the political process to defend their intertests. But they don't have a constitutional leg to stand on beyond that.
And there's no such thing as an unbreakable, unalterable contract. Never has been and never will be and nothing in the constitutioin inistso otherwise.
Moreover bankruptcy by its very nature is a contract-nullifying process-- and the Constitution however specifically allows for it.
Nor in the fairly minor reform Prof Warren proposes is the government itself doing anything to actively deprive the creditor of his interests. The market itself has already eroded the value of the collateral; it's a fait accompli and the reform suggested here would be recognize the fact of it rather than pretend otherwise. Should the mortgagees foreclose they will end up having to deal with that fact as well and could hardly argue in court that they are legally entitled to receive the value they had originally counted on.
The exclusion of real estate owned by individuals from collateral revaluation in bankruptcy proceedings is the exception not the rule as other forms of personal property, and all business holdings including real estate, are valued at current market pricing during bankruptcy no matter what their original worth.
This is not a radical reform; it's realistic one.
December 10, 2007 3:33 PM | Reply | Permalink
. . . nothing in the Constitution prevents laws from being changed . . . .
Actually, the Fifth Amendment's been doing a pretty good job of doing just that for well over 200 years.
May I assume that you haven't been able to locate a court case which supports your argument -- an argument which seems to avoid, at all costs, the constitutional issues which are the subject of my question?
December 10, 2007 4:45 PM | Reply | Permalink
Seems to me that sandbagging is the strategy for the whole ball of wax. Our Federal Reserve Bank Chairman's whole job seems to be to attempt to manipulate the markets to delay the inevitable consequences of our endless and increasing borrowing habits. Printing more money by increasing lending to prop up the economy (the effect of lowering interest rates), while sweeping the real problem under the rug with bank bailouts. I bet this is leading to a repeat of the S&L crisis.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 7, 2007 5:47 PM | Reply | Permalink
Sub-prime and proud.
New From the front lines of the sub primeloan owners.
In order to make my sub-prime loan payment I have done the following:
1.I will not buy a new car, this year, next year or the next. Though I need one. I am currently recycling a 1984 beemer. It is paid for and it runs and it is ugly.
2.I don't eat out.
3.I will not buy a new HD flat screen TV.
4.I will not buy a new computer, for me, my daughters or my wife.
5.I will not buy the new version of Microsoft soft ware
6.I only buy clothes on sale or on clearance.
7.I do my own remodeling: plumbing, electrical, drywall, Tile work, hardwood flooring , paying cash for materials that are on sale or deeply discounted.
8.I will not do the oral surgery I need until I can save the $600.00 deductible.
9.I mow my own lawn and do my own fertilizing rather than hiring a service.
10.I don't go to or rent Movies
11.I disconnected the cable or satellite TV.
12.I don't buy anything that is advertised on TV or radio
13.I won't go on vacation and stay in a Motel, Hotel or Timeshare.
14.I won't go to Disney land, Knots berry Farm, or Magic Mountain or any theme park
Trickle UP Economics!
If there are more people like me then our entire American way of life would be threatened.
Further Consequences: I spend more time with my friends and family, read more, write more, do more artistic activities, and do more volunteer work and have a heck of a lot less stress.
December 8, 2007 12:01 PM | Reply | Permalink
That makes sense. The wealth that would have supported the economy instead goes to the mortgage lenders. The economic effect of interest is to siphon wealth out of the economy, and give to the lender. Mortgage interest is usually 90% or more of a mortgage payment.
It is not a really good long range plan, because you likey find yourself working longer hours as things get tougher from inflation and your wages don't keep up with inflation. That is why we have two-income families now that are still broke, working their tails off to pay off a mortgage that got them a home in a neighborhood with a highly sought after school district. In the long run, this increased willingness to lend by mortgage banks is destroying the family. We teach our children to borrow as much as possible to buy a home, which makes the problem worse.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 8, 2007 3:36 PM | Reply | Permalink
I have done a lot of the above plus I cut out my monthly checks to that TV preacher who says he's fightin' to save our way of life from the sinister influence of liberal conspiracies like SpongeBob. I still have my Rush/24/7 subscription but that may have to go too.
December 10, 2007 7:52 AM | Reply | Permalink
We have fallen in amoung the "money lenders". Is Huckabee going to prattle on about throwing them out of the temple?
December 8, 2007 9:06 PM | Reply | Permalink
Re: Would such retroactive application which would impair contract obligations violate Article 1, Section 9*
Since the bankruptcy "reform" of 2005 applied to debts contracted before its enactment without constitutional issue, I don't see why this proposal would trigger an ex post facto clause challenge either.
December 8, 2007 10:27 PM | Reply | Permalink
I'm not dead sure, but I don't think that interpretation is accurate.
The 2005 amendments affected the rights of those who "choose" to file for bankruptcy, not the bankrupt's creditors.
As to whether the proposal of Warren et alia "would trigger an ex post facto challenge," I think we can be pretty confident that it most definitely would. The question I posed is whether that challenge would be successful. I tend to think it would, but as I said, I'm no expert.
Of course Warren -- one of our regular driveby pundits -- won't be answering.
December 8, 2007 11:01 PM | Reply | Permalink
The Bush administration couldn't sandbag legislation if we had an opposition party.
December 9, 2007 2:05 PM | Reply | Permalink
Doing nothing would be better than this. The real estate bubble madness we experienced 2 years ago had all kinds of warning signs and anyone who bought was taking the same risk as those who bought stocks in Oct when the DOW was 14,300.
The reversal is squeezing all the speculators and flippers out and correcting the market back to basics. The only way this could have been avoided is if the government had stepped in and cooled the bubble years ago, when prices were clearly getting out of control.
December 9, 2007 2:14 PM | Reply | Permalink
I do have sympathy for people who were genuinely duped by a mortgage company. But it's hard to think that there should be relief for people/firms that purchased/sold mortgages that clearly made no sense.
Exotic mortgages drove the housing bubble in some markets.
December 9, 2007 2:25 PM | Reply | Permalink
people who think that this is just a matter of squeezing out the speculators and flippers are kidding themselves.
These things expand, and steps taken to control the damage will help those who made good mortgage decisions as well as those who made poor ones.
December 9, 2007 3:48 PM | Reply | Permalink
are you saying people who locked in a fixed rate are still going to get hurt? I don't see how that will happen.
December 10, 2007 5:41 PM | Reply | Permalink
Pretty easily, actually. You're locked into a fixed rate, wondering how those fools could have messed up. Then you have another baby and when you try to sell your house to move into something a bit larger you discover that the value has dropped by 30% and nothing is selling. Then somebody steals the copper pipe out of the foreclosed house next door and drug addicts start using it as a place to hang out. Two of your neighbors (whose houses are already paid off) get sick of the hassle, put their houses up for sale and one sells for half of what you thought it was worth. Whoops, you're in a mortgage on something that's worth half of what you owe on it.
Or, you need to move to be closer to your aging mom but you can't sell your house. You end up with a house payment on your old place and a rent payment in the new location. Or you live with your mom. You rent your old place out but the renters trash it and steal all the stuff you left in the garage.
The crash of 1929 didn't just clean out the speculators, it chilled the whole economy. Not out of the question here.
This holiday season's sales will tell us a lot about how far up the food chain this particular chill will go.
December 10, 2007 9:53 PM | Reply | Permalink
we've seen steady appreciation for over 10 years in almost every national market, so a year or two for prices to pull back is going to help more couples looking for homes than hurt those trying to sell. The reason for this is that anyone who had a fixed rate and 5 years of payments should still be in the black, despite the depreciation.
With a projected population of 500 million by 2050, this could be one of the last good buying ops for real estate we will see in a while. My money is in home building stocks and a few good REITS. Once the inventory draws down, prices will rebound to the ridiculous again.
December 11, 2007 7:56 PM | Reply | Permalink
Sounds reasonable, however, you have to take into account that a lot of people refinanced to pull equity out of their home to get cash to get them through the economic challenges that resulted in 2001 from the turmoil then. The FRB lowering interest rates made refinancing attractive, and encouraged it. They now have higher payments, and though they may have recovered jobwise, they are more fragile than ever. Another job loss could cause a real problem, since they can't just pull equity out as easy now. The interest rate game played by the FRB in 2001 that gave the real estate market a boost, will come at a price. It is a microcosm of the problem with the whole economy and how our current fiat based currency has caused it. We are simply delaying the inevitable, and making it bigger.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 12, 2007 11:58 AM | Reply | Permalink
I'm sure that on the macro side, there will be an eventual recovery. I just don't like it that it will happen on the backs of huge numbers of homeowners who will lose their homes and their credit ratings. That's an awful lot of demographic chaos, kind of the equivalent of opening an artery and going "hey, no worries, it'll clot eventually."
December 14, 2007 9:16 AM | Reply | Permalink
What you're thinking about is the boom-bust cycle exaggerated by the Fed when they started trying to manipulate the market when they were created in 1913. They have made this cycle worse than it ever has been in history. It is a side effect of a fiat currency and a central banking system. The wealth is redistributed to bankers, despite the "losses" they claim, during the down cycle.
Jim Anderson
The Truth About Credit
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Ministry WebsiteDecember 14, 2007 3:42 PM | Reply | Permalink
An unnamed source mentioned that the plan included FHA protection to these loans. Wouldn't mean federal mortgage insurance for the lender? That would be huge windfall.
December 9, 2007 2:53 PM | Reply | Permalink
If the courts can cancel a collective bargaining agreement when a company is facing bankruptcy, why not a mortgage structure?
After Bush came out with his plan to save homeowners I said to a friend;
"Here's the pattern; a crisis occurs, Bush comes on TV and announces a grand (compassionate?) federal program to help victims. Ten days later, after the plan has been analyzed, we find the Bush plan helps Corporate America and his wealthy constituency, not so much the victims."
December 9, 2007 3:27 PM | Reply | Permalink
When our president was asked why he supported the recent "bankruptcy reform" act, he said that our country has a history of individuals "paying their debts". I thought his comment was unusually insensitive. He was born with a silver spoon in his mouth and all he knows about paying his debts is that one must take ones check book out and write out a check. He must think that is an easy enough thing for anyone to do.
December 9, 2007 3:42 PM | Reply | Permalink
I believe the record shows that Businessman George W. Bush consistently used /someone else's/ checkbook to pay his debts.
sPh
December 9, 2007 5:05 PM | Reply | Permalink
If the courts can cancel a collective bargaining agreement when a company is facing bankruptcy, why not a mortgage structure? JohnW1141
Because the Bankruptcy Act provides for one but not the other? The law could be changed by the Congress to grant home mortgagors rights similar to those enjoyed by businesses.
But could the Congress apply that amendment retroactively -- that is, could Congress, without violating the Constitution, impair the preexisting rights of creditors to execute on their security? Unless the Congress has that power, such an amendment would have no effect upon the current crisis.
December 9, 2007 5:08 PM | Reply | Permalink
I said that I would keep interested folks updated on efforts to rescue my own loan gone bad, on a duplex I purchased in what was a recovering neighborhood just a few years ago. (Just a couple of years later, housing values are down by 35% and nearly every property on the block north of me is near, in or through foreclosure.)
My first call was to Citibank, to talk about the demographic forces that had led to missed payments and work out a plan, possibly including a re-valuing of the property, an extension of the teaser rate and a rental revenue sharing arrangement as a gesture of good faith until things get straightened out.
They acted like I was green and had three heads. At this point the only plan they are interested in is the one where I pay them a bunch of money right now and stop bothering them with this think-tank stuff.
Maybe I talked to the wrong person.
December 9, 2007 4:00 PM | Reply | Permalink
The fact that it is voluntary is a signature of Bush proposals.
Some thirty or more years ago, Texas passed clean air and water legislation, but grandfathered in existing industrial organizations with the statement that instead of retrofitting their operations with scrubbers and other air and water cleaners, they would voluntarily do so over the next few years as part of their normal maintenance.
Not a one of the businesses grandfathered in took an action at all to clean up their waste.
So when Bush became Governor in 1994 the legislature readdressed the issue. But Bush used his veto pen to force the Lege to make the improvements voluntary.
To this day, none of the businesses have done a damned thing to clean up their waste, especially after the Republicans took control of the Texas House in 2002 (financed by Tom DeLay's illegal money laundered through the Republican National Committee.)
That is the fate of any voluntary plan that has to be followed by all businesses, because the mortgage companies that agree to renegotiate the loans will find themselves competing with those who refuse or stall, and the renegotiaters will end up with less revenue than those who don't bother.
So any "plan" to renegotiate is a farce as long as it is voluntary. But it will still give the politicians political cover to avoid giving the issue to the bankruptcy judges.
Correcting that boondoggle will need to be one of the first actions by the Democratic President and the stronger control by Democrats of the House - and we can hope - the Senate currently requiring 60 votes to pass real legislation. I wonder how many people will find themselves homeless between now and 2009?
December 9, 2007 5:02 PM | Reply | Permalink
. . . the renegotiaters will end up with less revenue than those who don't bother.
Not necessarily. The alternative to renegotiation may well be foreclosures, and in a falling market foreclosures frequently yield fifty cents on the dollar. If lenders can induce borrowers to keep up their payments -- even at the initial interest rate -- and the housing market recovers in 3-5 years, the "renegotiators" will be in fine shape -- much better shape than lenders who didn't or couldn't renegotiate.
Paulson and his Wall Street friends ain't dummies!
December 9, 2007 5:18 PM | Reply | Permalink
But the foreclosures will be further down the trail. Foreclosures take time.
The guys who start early in renegotiating will lock in their losses, while the ones that don't renegotiate will be depending on the government to bail them out because so very many people will be effected. The political pressure to bail them out will grow as their numbers grow.
Like all free marketers, they want their profits totally, but depend on the government to cover their losses.
December 9, 2007 5:38 PM | Reply | Permalink
It's as if when the internet bubble peaked back in 2000/2001, the stock holders colluded and said they were going to hold onto their stock and not sell it until the market rebounded (through other means) at which time they could sell it without taking too bad a loss. It's no different here. Except instead of stock holders we're talking mortgage bond investors. Basically, all the big players are holding a lot of bad debt. If any one of the players decides to unload, all the other players will have no choice but to follow suit, and there'll be the proverbial blood in the streets (which is when Warren Buffet usually arrives on the scene to buy low). So the players are looking for anything to forestall that. One of the options was a superconduit, http://www.econbrowser.com/archives/2007/10/superconduit.html, which seems to be a way for truly distressed players to park some of these bad debts without actually unloading them in the marketplace. Another option is to prop up the housing market, which is what the Treasury department cooked up (and Bush is touting), the plan being to forestall foreclosures. Another option is to stimulate inflation, which will in turn stimulate demand for high-yield debts, in turn lowering the value of low-yield debts, allowing investors to cycle through that and replace one with the other. Home-owners can do the same if they have any play money to work with, but this is unlikely, especially if they're sub-prime, and the rates keep indexing up to stay ahead of inflation.
The thing to keep in mind is that the housing bubble was stimulated to help the economy recover from the bursting of the internet bubble back in 2000/2001. This time, there doesn't seem to be an alternate bubble that can be stimulated to compensate for the bursting of the housing bubble. Maybe the chinese stock-market could serve as that, but that already has signs of peaking out. Basically, there's a lot of money out there trying to find something worth investing in, and there's a lot of bad debt out there trying to find buyers.
December 9, 2007 6:08 PM | Reply | Permalink
Mark to market, and all that "money out there" will vanish in a bookkeeping entry -- "Poof!"
December 9, 2007 6:33 PM | Reply | Permalink
Re: This time, there doesn't seem to be an alternate bubble that can be stimulated to compensate for the bursting of the housing bubble.
Two words: alternative energy.
December 10, 2007 3:43 PM | Reply | Permalink