Saturday, December 6, 2008

End The Housing Crisis with These Changes

Let me preface this by saying that I get into a lengthy explanation of collateralized debt obligations and commercial paper and some arcane points of bankruptcy law and I wouldn't blame you if you simply noted my righteous indignation at this point and just went back to your email.

Currently, we are trying many, many "bank-centered" ways of fixing the housing crisis. No one disputes that the price of houses in the US are in free-fall. There is a much simpler, quicker way to let home values and mortgages reach their point of equilibrium so we can begin the climb out. We must temporarily adjust the rights of homeowners in bankruptcy.

First, a quick primer on this impenetrable topic.

For at least the last decade, when most people in America got a mortgage on their home, that mortgage is bundled up with other mortgages, and sold. That bundling is called "securitization" and the resulting bundle of mortgages is called a "bond" or a "collateralized debt obligation" (CDO). Big companies and investors buy those CDOs. They pay a price to receive a certain rate of return on their investment. They buy the right to receive mortgage payments from average Americans, setting the price they pay based on the payments and interest rate they will receive. They also set the price based on the idea that not only are they getting the right to receive mortgage payments, but they are also getting a piece of collateral for the obligation - the home of an American family.

Now, what is causing the problem in these CDOs is, for the most part, NOT the failure of people to pay their mortgage. Yes, we hear a lot about foreclosures and people losing their homes. I am not minimizing this issue, but here is the point: Of the 45 million mortgages in the US, 10% are more than 30 days late or are in foreclosure. What is causing the most of the problem for banks is two other issues:

1) The value of the collateral for the obligation - the home - is difficult to know. Most houses have lost value in the last year. This means the value of the mortgages held by these banks has gone down, so the banks must reduce the amount of value they put on their balance sheets. This triggers a requirement that they reduce the amount of cash they have to lend, and increases the amount they must hold in reserve as defaults become more likely (discouraged debtors are more likely to walk away from homes that are under water).

2) The process for resolving defaults creates uncertainty as to valuation of the CDOs, and is creating logjams in how to resolve defaults. It seems simple to the outsider - homeowner can't make payments at the old amount, bank will lose more money if the house goes into foreclosure and stands empty - why not make a deal for a reduced payment amount? That seems logical.

Part of the root of both of the previous problems is the nature of corporations. The person on the phone, talking to the homeowner, or the person in accounting, trying to assess the value of the house that is collateral for the CDO, have to defend their decisions about reduced payments to receive or reduced values to put down. This requires them to EXERCISE JUDGMENT in a corporate environment. It is so much easier for these people to make no decision at all, to let the problem fester, and wait until they can simply say "It was out of my hands, it went into foreclosure."

The other part of the root of the above-described problems is the nature of securitization. These CDOs were originated by one bank (the originator), and sold to another (the investor). Then another bank bought the right to collect the money and distribute it (the servicer). The person on the phone works for the servicer. These CDOs are so intertwined that the servicer might not know who the investor is - the rights get sold over and over. The investor might not know if they own a specific loan or not. Add to that, a lot of these originators and investors bought insurance that is payable in the event of a default. Which company insures which bundle of loans?

What each of these parties knows, is that if anyone makes a decision to take a loss - the servicer, the investor or the insurer - the others are going to sue that party for making the decision. The insurer will try to say that the servicer mishandled the loan, and the insurance isn't collectible. Then the investor sues the servicer and the insurer. Or the investor sues a previous investor for selling them the bad bundle of CDOs in the first place. And so on.

Add to all that the confusion created by the fact that these CDOs are a mess. Millions of pieces of paper per CDO (all that stuff you sign at closing). Originators have gone out of business. The paper has changed hands multiple times. Servicers are going out of business. No one can keep track of who owns what, and where.

So the companies have a disincentive to make a decision. Make a decision to take a loss, and you will get sued. The people at the companies have a disincentive to make a decision. Not only is making tough decisions not rewarded in business, but here, specifically, if you make a decision to take a loss, you will be responsible for the company getting sued.

The only way to fix this is to take the decision out of these people's and companies' hands. Currently, in bankruptcy, a debtor cannot have a banktuptcy judge change the terms of their residential mortgage. That's an exception, other kinds of secured debt can be changed in bankruptcy. Debt secured by other kinds of property can be reduced to equal the new value of the collateral, and the payment can be changed to reflect the new reality of the debtor's cash flow. There's a certain amount of flexibility. Payments can be eliminated for now, and ramped up later. The debt can be reduced so that the asset can be sold. The leftover debt is treated as unsecured and a portion can be paid back over time, or discharged as part of the bankruptcy.

The objection to making this change has always been that if you make it so residential mortgage debt can be changed this way, then making the loans will be more risky, risk equals more price, and everyone's home loans will be more expensive.

That's compelling, so let's not do that. Instead, let's identify a period of years, say 2005 to 2007. If your loan was originated during that time, you have the right to adjust the loan in bankruptcy. You can write the loan down to the current value of the house, change the payment terms to reflect the reality of yoru situation at home. We can broaden that period if need be, or tighten itup. The idea is that we will identify all the so-called "toxic assets" and allow a bankruptcy court to adjust them on an as-needed basis. We give people the right to do this for the next 36 months. Or 24, or whatever we think works.

This will solve several problems. Banks can stop guessing at write-downs - either the loan has been written down or it hasn't. The originator, servicer, investor and insurer can stop jockeying for position to sue each other based upon a decision to take loss, as all the decision making takes place within the already established confines of the bankruptcy court. The person on the phone at the bank that doesn't want to make a decision doesn't have to - they can just throw up their hands and say "It went into bankruptcy, it was out of my hands." This allows things to get fixed without people in organizations having to take direct responsibility for making decisions. It is the only way out.

Some may argue that bankruptcy causes a blemish on people's records, making their credit bad for 10 years. Fine, we can pass a law that it can't for this set of extenuating circumstances.

To those that complain that this will cause banks to have to take losses and the government will have to bail out those losses and that this is will be expensive, I say wake up, we are already doing that. We're already giving the banks billions to reward them for this risk-taking. The difference between this plan and what we're currently doing is that in my plan the market will reach equilibrium faster, we'll deal with bad loans faster and we'll help actual American taxpayers stay in their homes.

This is extreme and not ideal, but I am not hearing anything better coming along. And I'm an attorney that just signed myself up to file personal bankruptcies for people.

If they did this, then we could all believe that the bailout is really about regular Americans, and not about bailing out Hank Paulson's banking buddies from over on the Street.

Monday, December 1, 2008

Joe Biden Redeem Yourself

Joe Biden is currently being marginalized by the Obama Administration. I can't help but wonder if it is because they are concerned that he doesn't really share their values. (Or that he'll open his mouth). Joe Biden, you need to prove that you really and truly care about average working people. Take steps NOW to undo the damage you did to the rights of average working people everywhere. Rollback the mean-spirited, cumbersome and expensive "reforms" to the Bankruptcy Code that you helped put in place in 2005. Help people that are suffering get a fresh start, and take back the giveaways to credit card issuers. As Vice President-elect, and as a former proponent of these changes, no one is better positioned than you to lead the charge.

In 2005, the purported representatives of this country passed the Bankruptcy Abuse Prevention and Consumer Protection Act. The financial wing of the corporate oligarchy that actually runs this country lobbied hard for this change. It made it harder to discharge one’s debts, made it harder for businesses to reorganize, and much, much easier, for credit card companies located in Delaware to collect money from consumers, and to sell bundles of debt to investors, domestic and foreign. The stated benefit was that money would be cheaper for all of us “responsible” citizens and this would promote “personal responsibility.” And interest rates would of course go down. No doubt anyone looking at a credit card statement since passage of the bill is shocked at how low their rate is now.

As a bankruptcy attorney, my anecdotal experience, and one borne out by COUNTLESS reputable studies and opinions is that people struggle to avoid filing bankruptcy. People want to pay their debts back. But people get hurt, and run up medical bills and can’t work or lose their jobs and get behind despite their best efforts, and they sit, all grown up in my office and cry because they’ve let “everyone” down.

Or they get unlucky. Like Joe Biden’s dad, a businessman that went from playing polo to selling pennants at fairs.

Joe Biden, a Democrat with blue collar roots SPEARHEADED the insultingly titled Bankruptcy Abuse Prevention and Consumer Protection Act. MBNA, the credit card issuer from Delaware enlisted Senator Biden’s eager assistance with pulling the wool over the eyes of American citizens. Actually stood on the Senate floor and gave speeches about how this bill helped average Americans, and combated the deadbeat dad problem. Joe Biden is perhaps the best example of how the government no longer represents the people. Joe Biden was the only Democratic Presidential candidate that voted for that thing. Joe Biden’s 38-year-old son has received “consulting” payments from Bank of America (purchased MBNA) for his assistance with they-aren't saying.

(Paul Wellstone, the Minnesota senator who heroically and single-handedly filibustered this monstrosity, is now dead after an airplane “accident.")

Joe, the only other thing you could do to help keep people out of bankruptcy is fix health care, and they aren't going to let you anywhere near that.