With bank seizures of foreclosed homes at record levels, the Obama administration continues to treat bankruptcy court as the proverbial elephant in the room. As this New York Times editorial observes, the administration’s Pollyanna-ish belief in the willingness of banks to voluntarily modify principal balances for homeowners facing foreclosure has led to a standoff between primary and secondary mortgage holders:

Investors, including pension funds and mutual funds, often hold the first mortgages. Banks often hold home-equity loans and other second mortgages. Investors reasonably believe that second liens should be reduced before the primary mortgage is modified, but banks balk at that because it would prompt write-offs they don’t want.

Fortunately, investors are getting tired of this foot-dragging:

Some investors, notably the powerhouse group BlackRock, have called for a special bankruptcy process to resolve the standoff. The court would seek to reduce bankrupt borrowers’ total debt to affordable levels, starting with unsecured debt like credit cards, then undersecured debt, like second mortgages, and then, if necessary, the primary mortgage debt.

Giving bankruptcy judges permission to modify the terms of mortgage loans–isn’t that what we’ve been saying for years? Maybe this time the message will get through to Congress and the administration.

Having trouble modifying your mortgage?  You’re not alone.  The New York Times recently reported that mortgage servicing companies have little interest in helping troubled homeowners lower their monthly payments because of the “lucrative fees” they can collect on delinquent loans. 

According to the Times article, the Obama administration’s foreclosure program, which provides a $1,000 incentive to servicers for each loan they modify (plus $1,000 a year for the next three years) is no match for the revenue generated from delinquencies and foreclosures:

“For many subprime servicers, late fees alone constitute a significant fraction of their total income and profit,” said Diane E. Thompson, a lawyer for the National Consumer Law Center, in testimony to the Senate Banking Committee this month.  “Servicers thus have an incentive to push homeowners into late payments and keep them there: if the loan pays late, the servicer is more likely to profit.”

What’s more, the article reports, some mortgage companies (Ocwen, for example) have established their own title companies in order to keep more of the revenue from foreclosures. 

Scary stuff, but kudos to the Times for shedding light on these dark dealings.

(Please don’t let this post stop you from trying to get a modification…many people have successfully lowered their mortgage payments! The loan modification and forbearance section of our website can help you get started.)

Maybe so, according to Bloomberg (via the P-I‘s real estate blog):

House Financial Services Committee Chairman Barney Frank threatened to revive the mortgage “cram- down” bill that stalled in Congress this year, saying lenders aren’t being aggressive enough in modifying troubled home loans.

Cram-downs let federal judges lengthen terms, cut interest rates and reduce mortgage balances of bankrupt homeowners, even if the lender objects. Congress gave the mortgage industry every legislative tool it requested to allow them to more easily modify loans for those facing foreclosure, and the results have been below expectations, Frank said in a statement today.

“People in the servicing industry and in the broader financial industry must understand that if this last effort to produce significant modifications fails, the argument for reviving the bankruptcy option will be extremely strong, and I think there is a substantial chance that the outcome will be different,” Frank, a Massachusetts Democrat, said.

Great news, if it happens. Meanwhile, last night’s Daily Show brought us the story of one particular man who might want to take advantage of such an option:

Via Yves Smith at Naked Capitalism, here’s another reason why passing cramdown now is important: the existing loan modifications aren’t working.

Mortgages modified in the third quarter failed at a faster pace than those revised in the first, and the delinquency rate on the least risky loans doubled, signs of deteriorating credit quality, U.S. regulators said.

Loans modified in the first quarter to help borrowers keep their homes fell delinquent 41 percent of the time after eight months, and second-quarter loans had a 46 percent default rate, the Office of the Comptroller of the Currency and Office of Thrift Supervision said in a report today. Third-quarter trends “are worsening,” the agencies said.

Yves notes that most of the mods that lenders are offering today involve interest rate reductions and lengthening maturities, which aren’t as successful as mods that reduce the principal owed. Unfortunately, principal reduction is rarely offered due to the way most mortgages today are securitized (i.e., cut up into pieces and sold to far-flung investors). The only thing that is likely to reverse this trend of increasing modification failures is if bankruptcy judges are given the power to rewrite loan terms.

The cramdown bill passes the House, 234-191. All of our Western Washington representatives voted for the bill except for Dave Reichert, the only Republican in the bunch.

The U.S. House of Representatives is scheduled to vote within the next couple of hours on H.R. 1106, the Helping Families Save Their Homes Act of 2009, which would allow bankruptcy judges to modify the terms of a mortgage to help prevent foreclosures. Please call or fax your representative’s office and tell them you support the bill.

Phone numbers for Seattle-area representatives:

This is pretty huge:

For the first time since the housing crisis began, a major mortgage lender agreed Thursday that courts should be allowed to order reductions in the principal of “underwater” loans for some troubled borrowers, cracking what had been fierce and unified industry opposition.

The agreement struck between congressional Democrats and Citigroup Inc. would permit bankruptcy judges to change the terms of mortgages as part of court-ordered debt restructuring. Democrats hope to include the provision in the upcoming economic rescue legislation under negotiation between Congress and the incoming Obama administration.

Getting the rest of the lending industry on board with the Durbin cramdown bill won’t be easy, but Citigroup’s support might make it politically more difficult for congressional Republicans to filibuster or otherwise block the legislation, if they’re of a mind to do so.

Sen. Durbin’s bill is S.61, if you’d like to track its progress.

Update: See this post by Tanta at Calculated Risk for a good primer on the cramdown situation.

The One Hundredth Eleventh Congress is starting off on the right foot:

Legislation designed to stem foreclosures by allowing bankruptcy judges to erase some mortgage debt will be introduced by Congressional Democrats on Tuesday, and hopes are high that it will pass after a similar plan failed last year.

Democrats in both the U.S. House of Representatives and Senate plan to introduce the legislation.

If it passes, this legislation will allow bankruptcy judges to rewrite the terms of mortgages held by bankruptcy filers, potentially preventing thousands of people from losing their homes. The bill is being shepherded forward by Rep. Brad Miller (D-N.C.) in the House and Sen. Dick Durbin (D-Ill.) in the Senate. President-elect Obama supported the legislation last year and can be expected to sign the bill if it passes this year.

Major news from Massachusetts this week, with the state’s Supreme Judicial Court upholding an injunction forbidding Fremont Investment & Loan from foreclosing on borrowers to whom it had issued what the court judged to be predatory loans. As Adam Levitin observes at Credit Slips (emphasis mine):

The Massachusetts Attorney General had argued that “a lender’s failure to reasonably assess a borrower’s ability to repay his loan and the use of loan features that predictably lead to foreclosure is unfair and deceptive and in violation of Massachusetts law.” More precisely, a consumer loan that is not intended to be repaid, but intended to be refinanced (a process that can only work if property values rise indefinitely) is inherently predatory. By upholding the preliminary injunction, the SJC endorsed this view and imposed a serious good faith workout effort on Fremont.

The decision by the court to recognize as inherently predatory a class of loans that are designed to be all but impossible for the borrower to pay off as structured can’t be emphasized enough. It’s beyond reasonable doubt at this point that the final years of the housing bubble were powered by increasing numbers of teaser-rate mortgages, especially in the option ARM or “pick-a-payment” space, that were never intended to be repayable by the borrower after the reset period. Even borrowers who aren’t currently upside down on such loans may encounter difficulty refinancing their way out if credit remains as tight as it has recently; those that can’t refinance often find their monthly payments doubling or worse. If the Massachusetts SJC’s interpretation of what constitutes an inherently predatory loan catches on in other states it could mean relief for thousands of distressed homeowners.

“The first wave of Americans to default on their home mortgages appears to be cresting,” writes Vikas Bajaj in this morning’s New York Times, “but a second, far larger one is quickly building.”

Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults.

The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time.

What’s especially interesting is how closely the scenario outlined in the Times article matches up with this chart, published last year by the International Monetary fund using data from Credit Suisse, showing the value of mortgage rate resets due to happen each month between 2007 and 2015. (A reset is when the repayment terms of a loan change—invariably by increasing—according to a schedule determined by the loan contract.)

Earlier this decade, as the ballooning housing market pushed the affordability index past the point where the average first-time homebuyer could afford a typical home in many areas, the real-estate industry kept the boom going by offering “teaser-rate” mortgages. These loans had artificially low annual percentage rates that were only good for the first few years of the contract, after which they would reset to a much higher APRs that the buyers in many cases would not be able to afford. As long as housing prices kept going up, the story went, buyers would be able to use the increased equity in their homes to refinance into more affordable loans. Then housing prices stopped going up.

As the IMF graph shows, the problem began a couple of years ago with a huge wave of resets in the subprime market, giving rise to talk about the so-called “subprime crisis.” It has been the failure of these loans that has been responsible for much of the turmoil in the housing market over the past couple of years. By early 2009, however, most of the subprime resets will be over and done with. Then, beginning in early 2010 and continuing for a couple of years, there will be another big wave of resets, this time in alt-A and option ARMs.

As this scarily prophetic Business Week article from nearly two years ago puts it, option adjustable rate mortgages — the so-called “pick-a-payment” mortgages — “might be the riskiest and most complicated home loan product ever created.” Option ARMs offer several payment choices each month, typically differing by thousands of dollars. The least expensive option doesn’t even cover the full amount of the interest due on the loan, so the leftover interest gets added to the principle (a situation called negative amortization). Option ARMs sold like hotcakes during the boom, accounting for 9 percent of the volume of all mortgages sold in the US in 2006, and significantly more in boom states like California and Florida.
According to Standard & Poor’s, more than 75 percent of option ARM holders were making only the minimum monthly payment in 2007.

Those attractive payment options come to an end when the mortgage resets. Faced with a monthly payment that’s nearly double what they’ve been making, a debt that’s tens of thousands of dollars bigger than it was when they took it out, and a home that may be worth less than their outstanding debt by a wide margin, many homeowners will be forced to default or to seek protection in bankruptcy court.

Option ARMs, it can’t be pointed out often enough, are prime loans, not subprime. As today’s Times article notes, prime and alt-A loans make up a much bigger percentage of most banks’ mortgage portfolios than subprime loans do, raising the specter of a new wave of defaults that may dwarf the troubles we’ve already seen:

“Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.”