Cramdowns, Redux

The debate over whether to let bankruptcy judges modify residential mortgages is heating up again — at least between the Cleveland Federal Reserve and the American Bankers Association.

John Blanchfield, senior vice president of agricultural and rural banking for the ABA, sent a letter Aug. 26 to two Cleveland Fed economists in response to an Aug. 3 research report that supported the idea, which is commonly known as a loan cramdown.

The economists, Thomas J. Fitzpatrick 4th and James B. Thomson, looked at how the 1980s farm foreclosure crisis was abated in part by legislation that gave judges the authority to modify farmers' mortgages.

That law, which created Chapter 12 in the bankruptcy code, "is perhaps one of the least valuable legacies from that period," Blanchfield countered.

"The realities of the 1980s were far more complicated than the paper's narrow retelling of history, and in fact, Chapter 12 bankruptcy was only a narrow piece of how the farm debt crisis of the 1980s played out," he wrote. "Federal court action, Congressional legislation, and the need to recapitalize the government-sponsored Farm Credit System had more to do with farm debt writedowns than Chapter 12."

What's more, the loan modifications done in the 1980s "were not 'cramdowns' in the same sense as the mortgage principal reduction proposals that are being discussed today," Blanchfield said, which "would not entitle the lender to future gains in market value."

Though it's unlikely legislation allowing mortgage cramdowns will pass anytime soon (several attempts at passing such reform have failed), Blanchfield said the ABA is motivated to get out in front of the issue.

"When the Fed comes out and says something did a lot of good, it gets people's attention and it gives it a 'Good Housekeeping' seal of approval," he said. "But this is a narrow retelling of what happened."

Fannie in Florida

Fannie Mae is catching up with changes in Florida late last year that mandate all foreclosure cases first go through mediation.

The government-sponsored enterprise notified servicers Tuesday that they now must assign approved attorneys to delinquent borrowers to help them through mediation before foreclosure proceedings. That means servicers will have additional responsibilities for mortgaged properties in Florida than for loans in other states, Fannie said.

The change comes as the GSE pushes servicers to stop dragging their feet on foreclosures around the country when there is no valid reason for delay. (See related story.)

The mediation program aims to help borrowers in earlier stages of delinquency and hasten the foreclosure process in instances where mediation either is not accepted by the borrower or does not lead to a workout.

The Florida Supreme Court ruled in December that once a foreclosure is filed, mediation must be offered in an effort to ease the backlog of court proceedings. Fannie Mae's new policy, which must be implemented by Jan. 1, goes a step further, requiring servicers to offer mediation to delinquent borrowers in Florida before they file for foreclosure.

Northern Light

Canada has not suffered a housing market bust quite like its neighbor to the south, despite similar homeownership rates and the dominance of government-backed mortgage lending.

A new report from the Center for American Progress, a Washington think tank, credits the difference in outcomes to the rise of the private securitization market in the United States.

The author of the report, David Min, writes that "Canada did not become enthralled with the laissez-faire ideology that dominated U.S. economic policy making in the 2000s, and thus did not allow major gaps in its regulation of housing finance to develop."

Undoubtedly, the housing market in Canada is vastly smaller than in the U.S.; Canada has a population of about 34 million, smaller than California, and total residential mortgage debt of around $1 trillion, versus more than $14 trillion in the U.S. So, the report cautions against "drawing overly strong conclusions from the Canadian experience."

However, a stark difference in the financing of the housing markets in the two countries sheds some light on why Canada averted the credit crisis, the report said.

"During the 2000s, Canada experienced very limited amounts of lending financed by private securitization (and its alphabet soup of ABS, asset-backed securities; CMOs, collateralized mortgage obligations; CDS, credit-default swaps; SIVs, structured investment vehicles, and the like), whereas that lending channel grew to immense heights in the United States," Min wrote.

In Canada, there were few incentives for private securitization, quite the opposite from the situation in the U.S. "Regulated lenders in the United States seeking to reduce their capital levels and raise their return on equity had strong incentives to avoid regulation and to sell their loans to securitization conduits," Min wrote.

"The key lesson Canada appears to teach us is that regulated, government-supported mortgage finance leads to greater sustainability and stability than its unregulated, purely private counterpart."

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