Case for Cramdowns

Economists at the Federal Reserve Bank of Cleveland have weighed in on the long-running debate over whether to let bankruptcy judges modify home mortgages, saying evidence suggests the strategy helped stem farm foreclosures in the 1980s.

During that crisis, which the economists Thomas J. Fitzpatrick 4th and James B. Thomson called "a typical boom-bust scenario," farmers faced a predicament similar to that facing many homeowners today: the outstanding balance on their mortgages exceeded the current market value of their property.

Not unlike today, foreclosure moratoriums proved to be ineffectual, the economists wrote in an Aug. 3 research paper.

So Congress passed legislation to allow what was then known as a stripdown (and is now commonly referred to as a cramdown) for farm loans. The balance of the mortgage was reduced to the current market value of the farm, and the remaining balance was converted to an unsecured claim that received the same treatment as other unsecured debts in the bankruptcy.

Opponents of stripdowns in the 1980s made arguments similar to those made more recently, Fitzpatrick and Thomson said — namely that such a change would flood the courts with bankruptcy petitions and could lead to higher interest rates on mortgages.

But "the effects of that stripdown provision, in place for more than two decades, on the availability and terms of agricultural credit suggest that there has been little if any economically significant impact on the cost and availability of that credit," the economists said.

Data also suggests that the legislation "worked without working," the economists said, in the sense that it actually led to an increase in private loan modifications.

Of course, the whole discussion may be academic.

A bill introduced by Sen. Dick Durbin, a Democrat from Illinois, proposing such a change has been held up in Congress since the beginning of last year.

Durbin's three previous attempts to pass this type of reform have failed in the face of opposition from the mortgage industry and Republicans.

Party's Over

Wells Fargo & Co.'s infamous "party house" in Malibu, Calif., has been sold — at a steep discount.

The home, which the San Francisco bank seized after the previous owners were ensnared in Bernard Madoff's Ponzi scheme and ran into financial trouble, sold for nearly $15 million, The Wall Street Journal reported on its website this week.

That's about 30% less than the original $21.5 million price tag, the Journal said, and 17% less than the recent asking price of $18 million.

The house garnered attention last fall when Cheronda Guyton, a Wells senior vice president in charge of foreclosed commercial properties, was accused of throwing extravagant parties at the house. Wells Fargo later fired her for violating company policies.

The Other Buyback Problem

As banks fight loan-repurchase requests from Fannie Mae and Freddie Mac, a similar liability risk lurks on the horizon.

Chris Gamaitoni, an analyst at Compass Point Research & Trading LLC, wrote in a 13-page report published Tuesday that increased litigation by investors in private label residential mortgage-backed securities means originators and underwriters of securitization deals have added liability risk that he estimates at 5% to 15% of their tangible book value.

Investors trying to claw back loan losses include the Federal Home Loan Banks of Pittsburgh, Seattle, and San Francisco, requesting rescission on about $25.6 billion of MBS purchases, and a large investor syndicate with $500 billion in residential securities that is requesting trustees enforce servicing breaches for improperly-originated loans.

Gaining access to loan files could be "the smoking gun," Gamaitoni wrote.

He estimates total liability for rescission on alternative-A loans to be $67.9 billion with JPMorgan Chase & Co. topping the list with $13.1 billion of estimated losses due to its acquisition of Bear Stearns, a former lead underwriter. Deutsche Bank is second with $10.3 billion of estimated losses and Bank of America Corp. third with $10.2 billion of losses.

Quotable …

"Frankly, I don't want the tax credits to be re-enacted or be re-created or extended. We want to get back to a normalized market. It is a lot easier to run a business based upon designing your business with the current demand as opposed to having any kind of stimuluses or incentives to create abnormal demand."

Donald Tomnitz, the chairman and chief executive officer of the home builder D.R. Horton, answering an analyst's question about the expired federal homebuyer tax credit, on an Aug. 3 conference call.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.