This entire affair is pure lunacy. An economy requires above all things consistency. Even bad policy if far preferable to chaotic policy. Why would anyone want to stick there neck out right now when you don't know the rules? All the Keynesian stimulus in the world will fail when with the other had our government is preaching doom and pell-mell trying to run the economy by the Frank/Dodd/Pelosi whim of the day. I don't think its a stretch to say these aren't the brightest of bulbs. Go youtube one of our congressional leaders talking about the economy and tell me you feel comfortable with them grabbing the rudder of our economy.

They really are dumb, as well as ignorant. Just on its face- think of what is happening here. Congress shoehorned lenders into making risky loans, elbow nudged regulators to allow it, and now when it all blows up they are not only blaming the markets and banks but they are trying to force the lenders on the one hand to keep digging by continuing to lend, while on the other hand promising they are going to prevent them from ever recouping bad loans. Honestly, it's insane.

When someone is bankrupt, it means they can't meet their obligations. So the issue is whether there is some reason mortgages should be treated specially or whether the BK master can modify the terms, as he can with other contracts. Indeed, existing law allows for a "cramdown" of the mortgage on everything other than a primary residence.

The existing special treatment of mortgages is more of a political matter than anything economic. Why it would be good to change that, by the late Tanta of Calculated Risk.

(Mortgage modification is even more difficult now than historically, because there is no longer a corner bank involved that might re-evaluate the situation itself, rather a slew of anonymous holders of CDOs, CDOs built on CDOs, etc. This would seem to be an argument in favor of allowing judicial modifications, since there is no way to set up a bargaining situation between the bankrupt and the creditors.)

I don't remember the WSJ crying this river when corporations, e.g. Continental Airlines, used BK to change, forcibly and unilaterally, the terms of their labor contracts. And now, of course, unions have to consider the possibility the corporation will use BK when planning their own demands, etc. All of these arguments would work in two directions, except for the slant of the WSJ.

“Back in the 19th Century, there were a lot of steep crashes, guys got wiped out, and the economy came back quickly.”

Here's Herbert Hoover's couldn't-be-harsher view of:

the “leave it alone liquidationists” headed by [my] Secretary of the Treasury Mellon, who felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people”...

Milton Friedman likes--alas! liked--to quote R.G. Hawtrey of the British Treasury, who said that Mellon and the others who thought in 1930-1933 that the big danger was excessive inflation were "crying 'Fire! Fire!' in Noah's Flood." A nationwide banking panic is altogether a bad thing. In this dismissal of Mellon's economic policy Friedman was in complete agreement with John Maynard Keynes:

Everywhere else it's recognized that one of the components of a recession is that money gets hoarded instead of invested, and that the pump-priming is exactly to pry this money loose. That it didn't happen in the first 24 hours since the stimulus package is not a very strong argument.

First- is it a fact that we are talking about people in bankruptcy here, as opposed to just defaulting on their mortgages? I don't believe so.

Second- despite the illusion presented by the Democrats, there are just as many economists worried that not only will this spending fail to stimulate spending in a timely fashion (because its too back loaded, as well as unsettling the market by frightening everyone with unparalleled levels of public dept just when entitlements are set to explode) but that all this borrowing and spending is crowding out private investment and potentially risking the viability of the dollar. Partner that up with Congress making up rules as they go along, and it is a far more frightening world to do business in than it did before these measures were taken.

"still, years behind, trying to set up an American rentier class, free of taxes, free of laws, free of regulations,"

I thought you were talking about our Congressional leadership there for a second. Lot of nerve for Chris Dodd and Nancy Pelosi to be lecturing business leaders about sweetheart deals and private jets. Lot of nerve for the President to frighten everyone into voting for a bill before even 48 hours could be taken for it to be read... and then taking a long vacation before flying to Colorado for no reason to sign it.

When someone is bankrupt, it means they can't meet their obligations.

No, it doesn't. Look at the first part of the Tanta article. The homeowners have too much income to file Chapter 7, so they are forced into Chapter 13, for a workout of difficult loan payments. Their workout payments would be easier if they could assume that the $400,000 home they bought was really a $200,000 home in retrospect.

I don't want to see anybody without a place to live. I think slowing the devaluation of the housing market makes sense. But these are all public goods. The banks shouldn't be paying for them.

To be fair, I didn't like the bankruptcy reform act of 2005 and I think there is an argument that people who entered into substantial debt arrangements prior to 2005 have the same claim to "change of rules" issues as the banks may have today. But I think a lot of the housing bubble issues are post 2005.

And where do the lenders go to complain that the $500,000 they shelled out for somebody's house should have only been $250?

And what incentive do i have to keep paying my current mortgage if the government is going to refi me for free, and lower my principle?

And what incentive do i have to keep paying my current mortgage if the government is going to refi me for free, and lower my principle?

You can obtain the short-term benefit of filing bankruptcy to reduce your principle payments, but you may never get a loan again. Your credit score will take a huge hit; you won't be able to file bankruptcy for seven years even if worse things begin to happen to you; interest rates will skyrocket; and lenders will be more responsible in the future (which is Tanta's primary stated goal).

And where do the lenders go to complain that the $500,000 they shelled out for somebody's house should have only been $250?

And what incentive do i have to keep paying my current mortgage if the government is going to refi me for free, and lower my principle?

PD--would you be happier if I said BK means the debtor can't meet his obligations as currently structured? Doesn't seem important to me.

The core of the "Calculated Risk" argument cited by AJL:

"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. You might even decide that, if a loan does get into trouble, you're better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you'll accept.

....I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.

Is it possible for this to be correct, and for Tim to be correct? That is to say, the ability of courts to restructure mortgages in bankruptcy will create more reasonable caution among banks (policy good), but also have the effect of removing much of the non-bank financing from the mortgage market (accelerated housing crisis)?

"You can obtain the short-term benefit of filing bankruptcy to reduce your principle payments, but you may never get a loan again."

Or for 7 years anyway... which considering i could be getting a house at half price might be worth considering.

AJL: Has far as I know there is no means test for filing Chapter 13. This is important, at least from a traditional liberal point of view, because the state is giving benefits to people who may not need it.

The main vehicle for limiting bankruptcy "abuse" is that it harms the debtor. I think we should think very carefully about using that process to "help" debtors.

JoeK: Is it possible for this to be correct, and for Tim to be correct?

I think it's possible that both foresee the same outcome, one thinks its a bad thing (banks won't lend to anybody below Joe the Plummer salary range), and the other thinks its a good thing (banks won't lend to Joe the Plummer any more).

PD: BK also involves a "best efforts" test. If you can meet your existing payments, as determined by the formula, I don't think you can declare BK at all. (IANAL.)

So now 'rentier' means you actually expect the government not to unilaterally abrogate contracts, rather than enforcing them? And here I thought it referred to exploiting ownership of natural resources

I guess from a certain leftist point of view, the funds committed to support a mortgage are a 'natural resource', since they work hard to ignore the actual source. But if this kind of talking point represents the level of sophistication in analysis in the current ruling party, those 'natural resources' are fully justified in taking a hike. Why would any rational investor want to play this game, directly or indirectly?

It's rather difficult to imagine even a feeble public policy argument for this kind of interference, considering that not so long ago it was 'public policy' to encourage - nay, coerce - the granting of loans of doubtful value. But rather than suck it up and let both sides of the market, lenders and borrowers, deal with the fallout - and come clean on the causes - instead we've got to ignore causes and pump in more bogus money to stave off reality.

Contemptible.

For me, there's a bit of a quandary. Having judges or the government randomly rewriting contracts is an awful idea. If you're an investor, the government becomes a sort of random thing like a natural disaster, although one that you can't insure against. You still may be willing to do loans, but only at much higher interest rates and/or with much stricter qualification rules to avoid government capriciousness.

That said, mass foreclosure can destroy neighborhoods and blocks of cities, especially if the city isn't growing for other reasons. A bunch of abandoned houses is not a good thing for all sorts of reasons.

My crazy idea for dealing with this sort of thing would be "in-place foreclosure", where the property is foreclosed on, but the person is "invited" to rent it for a time. If they rent it and make payments for a period of time, they can buy the house back later at a market price, possibly with some credit from their rent payments applied to the down payment to incent them. But if they default on their rent payments, they'll be tossed in the street. The landholder in this case would be some sort of RTC-style entity, who would buy the property upon foreclosure at a market price. If the note holder takes a haircut on its note - which it will in the vast majority of cases - so be it. (And non-first-position note holders will be wiped out as they should and as they expect.)

The amount of the rent would be determined by local market rates.

This would get rid of much of the contract hazard problems, and would allow the people to rebuild their lives and avoid much of the neighborhood disruption of mass foreclosure. There's still some moral hazard and other "icky issues", but these can't be completely avoided by any scheme.

Foobar - I can see something like that as a logical outcome. I can see the govt. predefining such contract terms so they don't have to be renegotiated uniquely for each situation, and even helping to support the transition. I also agree that the lenders on the bum loans (or equivalent MBS tranches) should be wiped out, and it will have a salutary effect on this happening again. What I can't see if having the government change from an enforcer of contracts to an arbitrary breaker of them.

That much said, I suspect something like what you suggest may happen de facto. Suppose you actually wanted to invest in US real estate, but are going to stay clear of bank deposits or stocks or any sort of mortgage backed securities, for the reasons I cite or others. How to do it?

It was suggested (on another thread I think) that a rational outcome of the current mess is that homeownership is going to retreat to the historical 60% or so from its artificially inflated rate. If an investor agrees (I do) the logical path is to wait for home prices to start to form a bottom (or average in), buy foreclosed properties outright (no long term time contract to be interfered with), and turn them into rentals. Avoid any place that's rent controlled like the plague, given the risk of future inflation. And yeah, anyone less solvent than Joe the Plumber can kiss off ownership.

One thing that was also interesting was I heard an interview yesterday with a CEO whose company buys dead car loans from banks for a few cents on the dollar. Apparently, a dead car loan is a total loss due to the various hassles involved with repossessing the car and selling it, so the banks were quite happy to get this bit of money and get the loans off their books.

His company then offered various note compromises to the car owner to let them keep their car, including writing off big chunks of the "face value". The company is apparently doing very well - even if the note is written off by 50% or more, his company still makes a lot of money.

The interviewer asked him why the bank itself couldn't do the stuff he was doing. In addition to his company having expertise in this sort of thing, he said banks have all sorts of legal and regulatory constraints that his company doesn't have, so banks pretty much have to repossess.

I suspect something similar could work in the mortgage world, but since everyone's expecting the government to "take over the mess", it won't happen.

a person who lives on income from property or securities

I'd say that's just whom a lot of GOP economic policy is tailored towards. Do you want to deny that, or celebrate it?

I am certainly not in favor of futile attempts to reflate the housing market, but I find your entire approach confusing. Performing a cramdown on a mortgage is an admission that the property (and the mortgage on it) are worth less than the value the mortgage indicated. I can't see what aspect of that judicial function (which, as I mentioned before, is performed on all sort of assets in BK except a primary residence has to do with pumping more money into the system, more like the opposite. A cramdown is probably the best way by which the borrower and lender will take their medicine.

I would also appreciate a little more recognition from you of the impact securitization and leverage had on this mess. People have been unable to pay mortgages since they were first invented. What's new was the need for the Masters of the Universe to concoct CDOs and CDO-squareds and CDO-cubeds for the purpose of moving way out on the risk/reward curve, for which they, at least, were handsomely rewarded. Far from being a government creation, the toxic credit default swap casino operated, by bipartisan agreement, free of meaningful regulation.

An official for Fannie/Freddie was on CNBC this morning, critical of the cramdowns, but mainly tooting the new foreclosure prevention program. What struck me was that he said that the new refi program would probably have a 40% failure rate. Yikes. And we're talking about people who are no more than very modestly under water. People with $700,000 houses?

But I imagine (since nothing was said) that the hostility to the cramdowns was because he doesn't think it's good idea for the overall economy to "realize" housing prices at the moment.

AJL: The reason home mortgages are treated differently is because all debts are treated differently. Secured, unsecured, priority, long-term, short term. If you want to treat all debt the same, then shouldn't we get rid of the homestead exemption?

One of my problems with the cram-down is that it benefits unsecured creditors like credit card companies. Credit card companies operate on revolving credit lines, which allow them to boost interest rates as the risk of default increases. Mortgage lenders don't have that option (or do we want them to?) But one of the results of the cram-down would be to free up income to pay off credit card debt that would not have otherwise existed.

But yes, I think home mortgages deserve different treatment, at least non-palatial ones.

I didn't ask the credit card companies to lobby to "reform" BK law to make it harder to discharge credit card debt. Maybe the mortgage division and the credit card division of the banks should have had a little chat.

Generally speaking, the banks don't bring very clean hands. As another counterexample to the idea that community lending requirements are a major part of the problem, equity-stripping refis of existing mortgages don't make a bank's community lending numbers any better, and are a good example of a type of mortgage likely to be nonperforming now.

But let's make one thing clear. If we are going to mark all these deflated houses to market, then the choice in many cases is between repossession or (if the law changes) cramdown. I'm not sure what Tim is hoping for. Is he following the Mellon liquidation principle? If so, does he understand why Herbert Hoover(!) found it too extreme?

Look, there are two critical points here:

1. There is no way to seperate the guys that overbought overpriced houses assuming they would flip them and make a mint before their arm came due from the people who overbought overpriced houses because they didn't ask or understand what an arm was.

To paraphrase Robert Di Nero in Casino, either they didnt know they were being scammed, in which case they are too dumb to own a house, or they were in out it. Either way, they're out. Otherwise, the rest of us end up paying for a house that either a sucker bought and couldn't afford, or a greedy fool bought and broke bad on.

2. If lenders are required to eat this, what exactly do you think these struggling companies are going to do to compensate their bottom line? They WILL raise interest rates on the rest of their business. That's a brilliant thing to have happen when the housing market is in the toilet.

The unintended consequence of bailing out the suckers and the stooges will be to dump us further into a recession and punish the people who can read a contract.

I would also appreciate a little more recognition from you of the impact securitization and leverage had on this mess.

Huh? That would be the "securitized mortgages" in the OP, or the MBS (mortgage backed securities) in my comment just above? Am I missing something?

Securitization was and is a huge part of the problem. As I've commented elsewhere here, the whole mess is a complex failure chain. Once you had less-than-prime loans justified or forced via CRA, there was no way to turn away other not-so-qualified borrowers (per MB just above). And to keep the market liquid, Freddie and Fannie bought, packaged and resold the not-so-great loans. And since it looked profitable, they were joined by plenty of other repackagers and originators in keeping the bubble growing. And then we've got swaps to create an even larger derivative market that seemingly got totally detached from reality.

But you don't get back to reality with another dose of government funny money and mandates. Unwind the whole thing back to where people who can actually afford loans get them. Those who made bum loans or bought them in the secondary market should get burned. So should those who took them in bad faith or without adequate means. And turn the FBI loose on both the ratings agencies and the congress critters that enabled the Fannie and Freddie mess - something smells.

The private money for mortgages will dry up because of this fickle attempt to protect mortgages.

If you were worried about nationalizing the banks just think how the government will hide the dissapearance of private money - force the government banks to issue mortgages and pump more of our money money into the banks.

Next to go - well run local banks who cannot compete against the government owned banks using our money.

At my worst moments I'm starting to believe what Hunter S. Thompson said (or at least Bill Murray in Where the Buffalo Roam) - there are two kinds of people, the screwheads, and the doomed.

"And the poor doomed, the young, and the silly, the honest, the weak, the Italians... they're doomed, they're lost, they're helpless, they're somebody else's meal, they're like pigs in the wilderness."
"Candidate: Come here Harris, come here. *&#% the doomed!"

Forecast is for bad craziness.

Re: Tim Oren's mention in #22 of the 1977 Community Reinvestment Act, here is Steve Sailer's useful backgrounder on how this and similar legislation and regulations contributed to the Housing Bubble.

CRA Commitments in 2003-04 = $2,350,000,000,000

I don't see why the total CRA pledges would be significant, without knowing if these mortgages were more or less likely to be in default. The last time this issue came up on this blog, the answer appeared to be less likely.

This makes a certain amount of sense. Some of the practices associated with CRA loans have proven to be (in general) problematic: unverified income, high LTV, etc. On the other hand, HELOCs, equity-stripping refis, and very large exurban McMansion mortgages, also (in general) problematic, would not be an issue.