Yesterday, Senate Republicans (pushed by the banking and mortgage loan industries) refused to pass the most important measure to assist struggling homeowners who deserve assistance--a bankruptcy reform that would permit bankruptcy judges to modify mortgage loans on primary residences. See David Herszenhorn, Senate Rejects a Proposal to Allow Bankruptcy Judges to Alter Home Mortgages, NY Times (Apr. 4, 2008). The bill they are working on is the Foreclosure Prevention Act of 2008, offered by Sen. Chris Dodd as an amendment (S.A. 4387) to H.R. 3221. The CBO's estimates in connection with the bill are at this link.
Couples who try hard to make their mortgage payments are suffering. See, e.g., this story in the Boston Globe (Feb. 18, 2008). The banks have argued that it wouldn't be a good idea, because it would mean everybody's costs for mortgage loans would go up, but they haven't offered any real evidence to support this assertion. See this story by Marcie Geffner, Fox Business.
I suspect that argument is not accurate but rather one of those lobbying positions that tries to win by dividing and conquering. If even some of the public can be convinced that helping people in dire need of help will cost others later, they won't be as likely to be supportive of a reform that they themselves might need someday. Consumer protection groups arguing for permitting modification in bankruptcy have done studies that show very small rate increases related to this, at most. Note that Geffner cites various academic studies that have shown that the Bank's stories of woe are woefully exaggerated, at best. There's simply no reason to expect the grief they claim from the bankruptcy revision. See also this 2007 report from the Center for Responsible Lending.
After all, foreclosures are extraordinarily expensive--banks are generally better off avoiding them, just as homeowners are. It's the law firms and other agencies that feed on foreclosure activity that make lots of money out of that tragic event. The fact is, banks like to control the timing of when they have to recognize the loss--if it is up to them to decide when to foreclose, they have that control. If a judge in a bankruptcy close can cause a mortgage loan to be written down, banks lose control. One byproduct could be worse looking financial statements than the banks want to admit to at the moment. Finally, loans on vacation homes, family farms, investment properties, yachts and even credit cards can be modified in bankruptcy; why shouldn't loans on primary residences be modifiable?
Let's remind ourselves that this mortgage loan industry is not a saintly enterprise out to help the ordinary person buy a home or out to help cities create more livable environments. Mortgage brokers made all kinds of fast money out of shoving people into more expensive loans than they needed to be in. I'm a fairly sophisticated homebuyer, yet I was astounded last year when I bought a home (not for the first time) at all the fees and service charges that the brokers and banks have added to mortgage loans and sales deals to squeeze the last penny out of buyers that they can. They charge for services that they don't actually provide or that cost them pennies on the dollar of the fee the charge. (I asked about one such charge, and was told "It's a standard charge; it doesn't matter whether we actually have to do it or not.") They do it because they can get away with it because the mortgage lending industry and broker industry is underregulated. They have cozy relationships with appraisers and they sock the fee to the buyer (making money on it, too) to pay for an appraisal the result of which is set before the appraiser does a thing. They expect from the beginning that they will sell the loan to a securitization vehicle and, maybe, still service it and make more fees off that but bear no risk of loss if the loan goes bad. They charge "administrative fees" of several hundred dollars that cover no particular "service" but are just another way to make money on the loan. And they tack several hundred basis points onto the interest rate of the loan as their "commission" for "helping" the buyer get a mortgage loan. It's a racket, and nothing less. It's time for Congress to step in and regulate it and end the unconscionable fees being charged to ordinary people who are merely trying to use lending services. Between the realtors who work together to increase the amount of an offer and the brokers who lie about prevailing mortgage interest rates, it is a major problem. The fact that black homebuyers were steered into subprime loans when their credit was just as good as white homebuyers who were given regular (cheaper) loans demonstrates the perverse market incentives that have been allowed to hold sway. See the Atlanta Journal last November: "Among black homebuyers making more than $100,000 a year, more than 41% got a subprime mortgage, compared to 7% of whites in the same income category."
Changing the law to permit modifications in bankruptcy would have a positive effect in many ways. It would keep families in their homes and prevent more families from becoming casualties of the banks' risky lending practices. It would reduce the problem of multiple foreclosure properties blighting neighborhoods. It would have a positive impact on home housing markets. It would protect urban areas, in particular, that are the most likely to suffer from the housing crisis. It would force the lenders who made so much money off the housing boom to bear some of the cost of their reckless financing arrangements and their use of even riskier financial bets (credit default swaps) to make even more money.
Allowing modification of loans in bankruptcy doesn't raise moral hazard issues, because it is within the very framework that we have developed to deal with individuals who have gotten themselves on a financial deadend street and require the assistance of the bankruptcy laws to get out. Hopefully, the House will have the gumption that the Senate didn't have to face down the powerful financial institution lobbies with a resounding "get out of the nation's business" and pass a bankrupcty reform that will treat home mortgage loans like every other debt --modifiable in bankruptcy, according to the discretion of bankruptcy judges. Those judges are not fools, and they don't offer modifications of debt lightly. The mortgage industry should not have more sway over Congress than the little guy that has been eaten alive by the same industry.
What did the Senate think worthy of passage, if not real protection for ordinary people who face financial ruin and just want to stay in their homes and pay off their mortgages at some more reasonable rate? Regrettably, the Senate thought it would be more important to enact another big and costly tax break for businesses. This break will translate into more money in the pockets of construction business owners and their investors, but it won't do a thing to help the workers who have been laid off and are struggling to put food on the table. There's a $15-20 billion giveaway to contruction companies (which supposedly will reverse in later years and so not cost quite so much over the long term), in the form of a new provision permitting them to carry back losses from this bad time to their rollicking good times up to four years ago and get a refund of the taxes that they paid on their huge incomes then.
The Finance Committee explained that by allowing corporations to apply excess net operating losses for 2008 and 2009 to tax returns from four prior profitable years--instead of the two currently allowed by law--will increase cash flow for businesses and allow them to write off losses over a longer period of time. BNA Daily Tax Report, Apr. 4, 2008, G-7.
I think this kind of special interest legislation is extraordinarily short-sighted. It doesn't use the money to provide unemployment compensation to laid off workers. It doesn't address the needs of ordinary people--those 80% of households that earn less than $100,000 a year. It doesn't do much even to boost the general economy. This will provide money in the pocket of the owners of the construction firms and, for the bigger firms, their investors. It won't lead them to hire more workers or even avoid laying off their construction workers. It's doubtful that it will lead to new investment. It may, perhaps, stave off some of the lower-priced sales of excess inventory (which the Finance Committee seemed to see as a problem). But the builders have too much inventory because they overbuilt--the problem won't be over until there ceases to be excess inventory. Helping the builders sustain higher prices for their excessive inventory does not appear to be a reasonable intervention by the government. It's about as token a gesture as those checks coming out in May, to the extent they go to people with incomes above the median who will just use them to pay off the latest credit card splurge.
[This paragraph is corrected from its original statement.] The Senate also included a $7000 tax credit for people who buy foreclosed homes. Apparently this will be only for purchases of foreclosed homes as principal residences, and the taxpayers who receive the credit will have to use the home as their principal residence for the two years over which the credit is taken. See Section 603 of HR 3221, the Foreclosure Prevention Act of 2007 (available on BNA). So my original concern that it would be a taxpayer-subsidized boon for real estate developers and real estate businesses that will swoop in like vultures to buy the best properties anyway was incorrect. However, I still don't think it is a reasonable use of taxpayer money--the taxpayer who happens to need to buy now gets a $7000 break but others don't (and the tax break is probably susceptible to easy cheating, as well.) The break isn't based on the purchaser's need but merely on the type of property purchased (that it be in foreclosure). Even million dollar homes can be foreclosed, and quite well-off purchasers could just happen to want to take advantage of the $7000 credit. (This isn't a deduction, remember, but a dollar for dollar reduction in tax liabilities due.) This is basically unfair to all those taxpayers who have struggled to buy their homes without that federal subsidy, which is a one-year-only deal. When the homeowner sells the house, say right after the end of the two-year period, there is no requirement that the homeowner repay the government, since gain on a principal residence is not taxed, under current law. It would be much more reasonable to take the same revenue otherwise going to that tax break and provide it to cities to use to purchase foreclosed properties. Let the cities then resell them at market prices. That would help restore the housing markets, at below bubble prices, get people into foreclosed homes, AND provide revenues from the resales to help blighted areas in the city. A much fairer proposition all around.
There's another very strange provision in the Senate bill--a property tax deduction ($1000) for taxpayers who do not itemize. Since the standard deduction is the provision that is already intended to cover that issue (e.g., taxpayers who don't itemize do not do so because the standard deduction is already MORE than their actually deductible amounts, such as their property taxes), one has to wonder what the rationale is here. Again, this is not really going to do anything about the foreclosure problem or the fact that many people have mortgage loans that exceed the value of their homes. The Senate could address that issue, but chose not to. It is instead applying a very ill-fitting bandaid to the problem.
The property tax deduction for non-itemizers also carries an onerous restriction--property taxes won't be deductible if the municipality raises its taxes! Now, folks, given the hard times currently hitting many cities and the fact that property taxes are the only means most cities have for paying for schools and police and fire departments, that seems like a Republican "starve the beast" strategy, since everyone knows cities already have trouble getting their residents to support increased taxes. At the least, this draconian restriction should be eliminated--it makes no sense at all and it is simply unworkable, since it requires an individualized determination by the IRS to verify the legitimacy of the deduction (which there aren't enough IRS resources to support). See the CBPP's analysis, here. (I'd personally, though, prefer eliminating the entire idea of providing a special deduction for non-itemizers for a tax that is already included in their standard deduction.)
In the House, Barney Frank's proposal to create a fund to guarantee refinanced mortgages sounds like a much more workable idea. Lenders and loan service companies would have to cut the principal of the loans and take a loss. That's only fair, since their greedy high risk loans are one of the primary sources of the problem. Homeowners would be enabled to stay in their houses, but they would still have to pay the full fair market value of the home.
CORRECTED 4/5/08
Excellent sentiment and analysis.
My observations were similiar to yours, but I had not considered that real estate speculators would be exercising the $7,000 tax credit. Having not read the details of the legislation, shouldn't there be a requirement that the family must live in the home for at least two years as their primary residence? With all the Florida condos on the market, I can foresee a number of SnowBirds "buying" now with the intent on selling their traditional home over the next few years.
Always enjoy reading your commentaries --- keep it up.
If you are interested, here is a link to my commentary on the subject http://minnesotacentral.blogspot.com/2008/04/coleman-senate-foreclosure-bill-another.html"
Posted by: Minnesota Central | April 05, 2008 at 05:45 AM
Hi,
I have been reading this blog for some time now but never bothered to comment until today. Wanted to let you know that I am a fan and enjoy your work.
Thanks,
RoorseCruilug
Posted by: roorseCruilug | August 02, 2008 at 10:50 PM