Good morning, and welcome to the second day of this online forum on the foreclosure epidemic and legislation that Linda Sanchez and I introduced to allow bankruptcy courts to modify home mortgages. Matt Stoller, who blogs at Open Left asked me to participate and I roped Linda in. The Sunlight Foundation organized the forums.
We had a good discussion yesterday at TPMCafe with a pretty impressive cast. I’m not sure who will be back today. DailyKos’ chief economist, Bonddad, will probably join us, although I hope for his sake that he occasionally has to work for clients, since he’s now trying to eke out a living as a lawyer.
The foreclosure rate is already the worst it’s been in twenty-five years, and soon will be the worst it’s been since the Great Depression. According to Lehman Brothers, about 30 percent of the subprime loans made last year will end in foreclosure. Probably more than two million American families will lose their homes to foreclosure in the next couple of years, and with their homes, they will lose their membership in the middle class, probably forever.
None of this should come as a surprise. Here’s what’s happened in mortgage lending in the last couple of years, based on a summary of industry statistics by the Center for Responsible Lending:
Approximately 28 percent of all mortgage loans made last year were subprime, compared to eight percent in 2003. About 90 percent of the subprime mortgages made in 2005 and 2006 had adjustable rates with an adjustment after just two or three years. The typical adjustment in the interest rate was from about seven percent to 12 percent, resulting in an increase in monthly mortgage payment of 30 to 50 percent. There is no reason to believe that more than a tiny fraction of those borrowers would enjoy substantially more prosperous circumstances in two or three years. About 70 percent of subprime loans have prepayment penalties, 75 percent have no escrow for taxes and insurance, and almost half (CRL estimates between 43 and 50 percent) were "without fully documented income." The vast, vast majority of Americans can easily document their income by payroll records, employer verification, bank statements or income tax returns, and the interest rates on loans with less than full documentation are substantially higher.
The mortgages were designed to become unaffordable, so the borrower would have to refinance again, paying up front costs and fees for the next mortgage and a prepayment penalty to get out of the last mortgage. As long as the home values kept appreciating, it all worked exactly as intended—the various players in mortgage lending ended up with the increased value, not the middle class families who owned the homes.
But when home value stopped appreciating, the music stopped.
No, the people with subprime mortgages aren’t just people with "problem" credit. According to the Wall Street Journal, 55 percent of subprime borrowers qualified for prime loans. And no, the loans were not "innovative mortgage products" that lenders offered to encourage home ownership. Only about one subprime mortgage in ten is to purchase a first home, and 72 percent of subprime mortgages are refinances. Professor Elizabeth Warren has written about how the mortgage market steers homeowners into predatory loans, and so have I.
I’ve worked in Congress for five years on legislation to reform mortgage lending, but we have a more immediate problem: what can we do to help the families now facing foreclosure?
In turns out we’ve been here before. The Great Depression began on the farm before it began in the factory. Millions of family farmers borrowed against their farms to try to ride out the depression. When farm prices didn’t improve, they had no way to pay their mortgages.
Woody Guthrie was writing about family farmers losing their homes to foreclosure in the lyrics to "Pretty Boy Floyd":
Now as through this I ramble
I see lots of funny men
Some will rob you with a six gun
And some with a fountain pen.
But as through life you travel
As through your life you roam
You won’t never see an outlaw
Drive a family from their home.
Congress first passed bankruptcy legislation in 1934 to help family farmers avoid losing their farms and their homes to foreclosure. The legislation was temporary, and after the Democratic Congress extended the legislation a couple of times, the Republican Congress elected in 1946 let it expire. But after another epidemic of family farm foreclosures, Congress enacted legislation in 1986 that is now a permanent part of the bankruptcy law.
When I asked around early this year about what Congress could do about the foreclosure epidemic, a couple of bankruptcy judges suggested that Congress could just let bankruptcy courts modify home mortgages the same way bankruptcy courts can modify mortgages on family farms. In fact, home mortgages are the only form of secured debt that is exempt from modification in bankruptcy. A bankruptcy court can modify a mortgage on investment property, a car loan, or a loan secured by a washer and drier, but not a home mortgage. Does that make sense to you? No, it doesn’t make any sense to me either.
So Linda and I introduced a bill that would eliminate the exemption of home mortgages from modification by a bankruptcy court. There’s a well established body of law on how a bankruptcy court can modify a secured debt: If the debt exceeds the value of the collateral, the court can limit the debt secured by the collateral to the value of the collateral and treat the rest as unsecured, which goes to the back of the line for payment. And the court can then set a term of up to thirty years and an interest rate of prime plus a couple of points, because someone in bankruptcy is a greater risk than the typical debtor.
In other words, the lender will end up with the mortgage the lender should have made in the first place—a subprime mortgage, but not a predatory mortgage.
According the CRL, 600,000 or so families to save their homes from foreclosure under this legislation. The chief economist for Moody’s thinks that’s an exaggeration—probably only 500,000 families would save their homes.
The legislation obviously doesn’t help every family facing a mortgage adjustment that they can’t afford or even every family facing foreclosure. If you don’t have the income to pay a mortgage on the full value of your home at an interest rate of a couple of points above prime, you’ll still lose your home. You can’t seek bankruptcy relief unless you meet a financial requirement—in other words, unless you’re bankrupt. And going through bankruptcy is no treat.
Okay, so let’s get started.