The Onion Plan
The Onion has a pseudo-survey of what people who are trapped in subprime mortgages are planning to do. In usual Onion fashion, it is both grim and funny. But what ARE families going to do? For all their fulminations, most of the Washington crowd is focused on developing regulations to stop the next credit bubble--not to help millions who will be hurt by this one.
Bankruptcy law is the final arbiter of debtor-creditor rights, but here's an interesting asymmetry in the law: If a corporation can no longer afford the mortgage on its factory, it has powerful tools to rewrite the mortgage in bankruptcy. But if a homeowner is in exactly the same trouble following an interest rate hike, those same tools are unavailable.
More details: A company that cannot pay its mortgage can declare Chapter 11 and do two things: 1) separate the mortgage into its secured and unsecured portions (called bifurcation), and 2) pay the secured portion at current market rates under a new mortgage and discharge the unsecured portion. So, for example, a $1.2 million mortgage at 12% on a factory worth only $1 million will be bifurcated into a $1 million secured mortgage at, say, 7% interest, and the remaining $.2 million can be discharged. The economic insight behind permitting this move is that the mortgage company will get 100% of the value of the property paid over time, which is a LOT better than the much lower amount it would get in foreclosure. The second insight is that this is precisely the risk the lender took: that the property would decline in value and the debtor couldn't pay. The Chapter 11 bankruptcy forces the lender to revalue the mortgage to the actual market value of the collateral.
But notice: If a homeowner can no longer afford her mortgage, the homeowner can declare bankruptcy and get rid of the credit card debt and doctor bills, but she cannot force the lender to write down the mortgage to the value of the home or to accept payments at the current market rate. All the homeowner gets is the right to make up past-due payments--in full, with interest. So, for example, a $120,000 mortgage at 12% on a home worth only $100,000 must be paid in full at 12%. In other words, homeowners get a lot less protection in bankruptcy than do businesses.
The distinction was in the 1978 Bankruptcy Code, advanced at a time when the median first-time buyer put down 18% of the purchase price on a home and the typical mortgage was a fixed-rate 20 year loan. Moreover, the lenders were largely Savings & Loans and other heavily regulated companies. At the time, a home mortgage stabilized most family budgets. Exploding ARMs, Liar's Loans, and other exotics were unheard of.
Mortgage markets have changed, but the bankruptcy laws that balance the rights of debtors and creditors have not. For homeowners, the exit doors usually provided by bankruptcy are blocked. Does that mean the Onion Plan is all that's left?
I find this situation extremely disturbing and unless we have some broad sweeping changes in corporate political access things are not likely to improve. After all aren't many of these corporations responsible for a great deal of new legislation passed? And isn't a great deal of that legislation very corporate friendly and consumer/citizen unfriendly? In their eyes people in default are shady and immoral characters trying to exploit "the system". Conversely corporations in default are simply victims of either unfair trade practices or perturbations in the market. In short, people are evil and corporations are victims. It's enough to make you choke. This is especially true when you consider the amount of damage one shady person can cause opposed to that of a shady corporation. And the number of shady corporations over the last decade have been historic in size, number of employees and investors hurt and the amount of money swindled.
But I've had a problem for quite some time with how this entire system was supposed to sustain itself. I suppose that's why we've been hearing more and more buzz about the expanding world economy and world markets. The American people have no more blood to draw but there are still people out there around the world that do. Our citizens in our market simply have no real money left to spend. All they've really been spending for well over a decade has been credit. If they have jobs they make less with little or no benefits (which further strains their personal finances). And at this point many are so far in debt that a crisis seemed inevitable to me. And businesses seem to have been surviving using similar tactics so why wouldn't a single spark set the whole forest ablaze?
August 17, 2007 11:07 AM | Reply | Permalink
Krugman argues that its market failure, because a properly functioning market would lead to negotiations such that the lender gets some money and doesn't have to write off the whole shebang, the borrower would get out of a burden, and the ripple wouldn't propagate. But with loans consolidated under third parties, no one's responsible.
Another example of markets moving toward consolidation and ineffiency. He says the solution is appropriate regulation. One can always hope.
John
http://www.haberarts.com/
August 17, 2007 11:55 AM | Reply | Permalink
"Exploding ARMs, Liar's Loans, and other exotics were unheard of."
Apparently this is not exactly true. The last time these kinds goofy "alternative financial products" were popular was right before the Great Depression of 1929... See: Financing the American Dream: A Cultural History of Consumer Credit by Lendol Calder
It isn't true that no one saw this coming--many did--it was just that the most of the people that were being hurt were low-income borrowers and it wasn't until 'big' money was being lost that anyone took notice. Just like the student loan scams--what is being ignored there is how lenders make HUGE loans to students--loans they will never be able to repay--but MUST because they are exempt from bankruptcy--they make these loans on "what the hell" lending criteria because they know they will be paid back. I was looking at a website where you can make personal appeals for money--and the 100 or so I looked at probably 50% were pleas to help pay off student debt.
I also agree that the "world market" had better watch out. Will this be our downfall? That we've stopped producing goods and make our wealth exploiting financial markets? Hasn't that happened to other civilizations?
August 17, 2007 1:17 PM | Reply | Permalink
I'm sorry. I have little to no sypathy for these pathetic borrowers. When does personal responsibility come into the equation? I understand that there are some who have unforseen circumstances that put them in a bad place financially. That is unfortunate. However, most of these people facing forclosure bought more house than they could afford, further contributing to the ridiculous price increases OR they have lived beyond their means.
The simple solution for these people would have been to RENT!!! For christs sakes, i would love to buy a home but here in Suffolk County, Long Island starter homes are over 400k and avg. salaries are about 33k!!!!!!! Do the goddamn math before you buy!
I would love to buy a home and some of my coworkers have spent over 400k on their first homes. They have monthly expenses approaching 4k! (our real estate taxes are second highest nationwide)
They are choking on mortgages to pay for a depreciating asset. BUT NO ONE TWISTED THEIR ARMS TO DO IT!
Im on the sidelines waiting for prices to come down... renting and living responsibly. Why should I as a taxpayer bail out these ass-hats?
liz
August 17, 2007 2:02 PM | Reply | Permalink
Personal responsibility certainly has a place in the conversation but I think you might be placing far too much weight on that while giving the lenders and market a bit of a free pass. People were being offered sweet deals (at the time) involving one of the cornerstones of the American Dream (tm), a home. The credit-oil salesmen have been duping citizens for years into burying themselves deeper in the abyss and many of them still are. Yes a person should know better but there's far more to the story than that. We either have a nation chock full of idiots (I'm willing to accept that argument) and you are one of the few "smart ones" or the entire system needs to be examined much more closely. I'd like to think that the later is more accurate than the former.
Incidentally, not all of the people in danger right now just ran out and bought themselves a shiny new home they could not afford. Many people refinanced their homes to get money to put back into them for repair or to improve their value for sale. Are these people idiots or are they victims of the current economic and market climate? There are myriad of reasons why so many people's situations are so dire and writing it off as over zealous and irresponsible buyers strikes me as a pretty inaccurate and unfair generalization.
August 17, 2007 2:19 PM | Reply | Permalink
Why should I as a taxpayer bail out these ass-hats?
I was just curious about how you feel about our seeming decennial bailout of one or more airlines that continues to be embarrassingly run? Or about our pumping billions into banks recently to help stave off this whole panic the big boys in the market have found themselves in? Or the limitless number of pork projects our taxes get siphoned into every year?
There's an almost endless list of examples of our tax dollars being given to corporate interests or other nations at our expense. There's nothing in it for us and in some cases it hurts us. But I'll tell you one thing, I'd be much happier if my tax dollars saved a few family's homes then I currently feel having it line the pockets of someone like Ted Stevens and all his buddies.
August 17, 2007 2:27 PM | Reply | Permalink
We could afford to argue over the moral responsibility of buyers, for all the deceptive practices of the lenders and the possibility that they will get bailed out or at least capitalize on their mistakes. That is, we could afford this if the same "your on your own" economic policy didn't threaten to tank others involved with housing or the economy, which is to say all of us.
John
http://www.haberarts.com/
August 17, 2007 2:29 PM | Reply | Permalink
To me this story is very surprising. The mortgage lender is free of all hazard? After the poor homeowner is foreclosed, evicted, declares bankruptcy and is living in their car, are they still obligated to spend all their spare time foraging for returnable bottles to pay off their morgage debt?
No wonder loans were tendered with essentially no money down and no real investigation of salary or creditworthiness.
The Onion cartoon left out one other funding source for mortgage debt- arson. Boston has seen waves of arson for profit in the past. I suspect arson out of desperation might gain in popularity. Setting fire to one's car if the payments are impossible is already an urban self-help scheme.
If my arson prediction is correct, the insurance companies may also take a tumble.
August 17, 2007 2:40 PM | Reply | Permalink
The government is not interested in helping the individual homeowner out. Any help would really just enable them pay back their loans, helping banks and corporate america.
As long as they can keep this idiotic housing/credit bubble going, the better to feed the corporate/banking machine.
As long as they can keep people using debt to pay for ever increasing assets and necessities, corporate america (the gov'ts. main concern) IS OFF THE HOOK FOR PAYING LIVING WAGES! Bernanke admits that there has been NO REAL wage growth since 2000 but corporate earnings are up and that is, he is quick to admit, his only concern.
People need to learn how to live within budgets that allow them to exist without so much debt. If americans did this, houses would have never skyrocketed so high. We need to get back to traditional lending standards to do this. Americans are so spoiled and greedy that they are unwilling to make sacrifices to do this.
Artificially helping to keep house prices ridiculously high will not help. There must be a purging of the insanity and americans must stop playing the debt game.
People need to get back to basics and stop being consumers, breeding new little consumers.
August 17, 2007 3:07 PM | Reply | Permalink
To clarify- the homeowner is paying off the mortgage minus the proceeds of the foreclosure sale.
If you pay attention to real estate in the bubble markets, prices are falling month by month, but more significantly, nobody is buying.
The real estate market values, at least on the coasts, are a bubble, like the dot com boom. Values won't dissolve; remember pet.com? But there will be a readjustment.
The struggle will be whether the banks and investors, the homeowners, or the US government picks up the tab.
August 17, 2007 3:11 PM | Reply | Permalink
I'm in full agreement that this nation needs to get off the consumer express and I've felt that way for years. I'm with you 100%.
But it's just not that simple. The entire system is rigged to make you spend more then you have or to go into debt. Some examples that come to mind -
1. Don't buy, rent. I live in Los Angeles. Rent is cheaper than a mortgage but it's still pretty damned expensive. $1200+ a month for a one bedroom and often well on the + side of things. If I want to pay less I need to move further away from my office and so does everybody else. Soon we've all moved 30 or more miles away, spend 4 to 6 hours a day commuting which pays us zero dollars and pollutes like mad. Oh and after about 6 months of all of those people's exodus to the land 30 miles or more away - the rent goes up there too.
2. You have a job and live on a shoe-string budget. You mind all your P's and Q's and somehow have miraculously managed to stay out of any sort of debt. You have some lame-o health insurance but hell it's more than many people have. You have a medical emergency and that lame-o insurance doesn't come close to covering it. You may or may not be out of work a while. Your bills start rolling in. Fade to black. Roll credits.....
3. You want an education. Colleges now charge obscene amounts of money for questionable educations at best. We tell people they need an education to get anywhere in life. And then we force them into an outrageous amount of debt just to get it. And even if you pick up a few little side jobs so you can eat while studying you will certainly end up using credit cards occasionally and going further in debt. All before you even get that job you'll need to live the "American Dream".
I'm sure there are plenty more example like these that do not represent the "buy-buy-buy, more-more-more" part of our society. These examples show how dismal it is for people that don't necessarily want anything than to simply survive modestly. It's just not fair to say it's all about greedy citizen/consumers and ignore the greedy country and life we've all built for ourselves to live in.
August 17, 2007 3:37 PM | Reply | Permalink
I misunderstood.
Once the homeowner is foreclosed, they are released from their mortgage debt.
They might be living in their car, but their spare time is their own.
August 18, 2007 8:50 AM | Reply | Permalink
same misunderstanding
August 18, 2007 8:52 AM | Reply | Permalink
The world according to smudge:
I'm sorry. I have little to no sypathy for these pathetic pre-teen sluts. When does personal responsibility come into the equation? I understand that there are some who have unforseen circumstances that put them in a bad place emotionally. That is unfortunate. However, most of these children allegedly molested actually put themselves in that position, getting into cars, taking candy from strangers, trusting their uncles OR being so foolish as to fall prey to seductive emotional games. Clearly they lived beyond their means.
The simple solution for these pre-teen sluts would have been to JUST SAY NO!!! For christs sakes, i would love to have a sugar daddy but here in Suffolk County, Long Island, well endowed sugar daddies are in short supply. salaries are about 33k!!!!!!! Do the goddamn math before you spread your legs!
I would love to have had a thirty or forty year old man spend over 40k on my sexual or financial needs. They have monthly expenses approaching 4k! (our law enforcement taxes are second highest nationwide)
They are choking on male organs to pay for a depreciating asset. BUT NO ONE TWISTED THEIR ARMS TO DO IT!
Im on the sidelines waiting for suitably young poon to come down... renting and living responsibly. Why should I as a taxpayer pay for police and social workers bail out these child sluts?
August 18, 2007 9:30 AM | Reply | Permalink
Are these people idiots or are they victims of the current economic and market climate?
yes, because they assume that the next buyer wants to foot the bill for all those things and even the initial price that they buyer paid for the house!
I'd rather retire 10 years earlier than take on the burden of someone else's bad deals.
To boldly go...
August 18, 2007 12:45 PM | Reply | Permalink
I posted a link to this on another thread;
From Cold War to Class War: Interview with financial economist and historian, Dr. Michael Hudson.
American homeowners are killing America and Dr. Michael Hudson, I think, rightly notes that "because the cost of living in the US is so high, companies can't make money there and go abroad!"
Thus, because of this-- and other things, a bailout won't help. Of course, John "there's a simple solution to poverty" Edwards claims otherwise.
Housing might have to crash to bring jobs back! Or, alternatively, the value of the dollar needs to plumit.
To boldly go...
August 18, 2007 12:54 PM | Reply | Permalink
you life out "everybody in america." the cost will be socialized over the entire popuation by making the dollar worth less or something else.
I remember reading that housing is 75% of america's wealth so a drop isn't easy to ignore.
To boldly go...
August 18, 2007 12:58 PM | Reply | Permalink
I earlier commented that I wouldn't argue against the many here who wished to dump the personal responsibility onto the borrower. After all, I reasoned, there were plenty of other grounds that the arguers here were ignoring for seeking to help these people, whether on grounds of our usual concern for society's losers, on getting the balance of bail-outs between individuals and corporate lenders halfway close to other than another Bush handout to the rich, or on what this means to me, which has me scared stiff.
But I have to say, Warren's details and those of other columnists have chastened me, and I think now that the predominant doubters here are dead wrong on that ground alone, whether it matters or not. These details speak of people who unknowingly assume debt and fees from the moment their credit access begins, as well as other related scams.
Now ask yourself. Have you never clicked on "I agree" at a Web site? Did you read the fine print on the agreement that came with your credit card? Are you sure you're competent enough in law to do so without injury to yourself?
John
http://www.haberarts.com/
August 19, 2007 6:01 PM | Reply | Permalink
Whether a person foreclosed is held to pay for the losses a bank has in foreclosure depends on the state law and the procedures followed in the bankruptcy. Some states have a very short statute of limitations on this, too. Anyone looking at foreclosure needs to talk to a lawyer.
August 20, 2007 6:38 AM | Reply | Permalink
the problem with your point is that if people stop believing in contracts, society starts to deteriorate.
CITI sent me an offer to "transfer CC balances" and in their letter, they "offered me" a 3.99% interest rate for the first year if I paid a 3% transfer fee-- so the real interest rate was 7%?; and, if I made a late payment on any CITI account (universal default), CITI would no longer honor the 3.99% rate and, the worst part: "we apply payments to lower APR debt first!"
As long as the reader "respects his/her money," there were too many bombshells in the CITI offter to take it seriously.
The problem was that the 3.99% interest rate and the phrase "enjoy fewer bills" were bolded. the rest of the details were in a normal font mixed in with marketing hype that downplayed them and CITI didn't even hint at what the interest rate would be if "you paid late" or what the late fees would be.
However, regardless of these tricks, notes like this show why literacy is important.
I think that congress should promote "good faith credit contracts" such as "we won't charge you more than $1.50 in interest and fees for each dollar borrowed." i.e. credit card companies would have to set and advertise a maximum effective interest rate. that way, no matter what the details-- transfer fees, late fees, accrued interest, etc..., the borrower would know what their "worst liability" would be.
And, you have to remember: "Ms. Warren is a lawyer and lawyers are predatory!" They "get work" to craft agreements and enforce them in court but they also make money defending the rights of the people who suffer because of them-- what a dysfunctional system. There's no incentive for simplicity and fairness! The devil is literally "in the details."
To boldly go...
August 20, 2007 7:55 AM | Reply | Permalink
Professor Warren's analogy to corporate bankruptcy law is very odd and not at all successful or valid. A corporation is just a piece of paper in a file. It can be liquidated. A person should not be liquidated. Corporate bankruptcy law allows, and often leads to, liqudation, but surely Professor Warren does not want to adopt that part of the analogy!
A corporation does not need a place to sleep, to cook, to bathe. Thus, management of a corporation could sell the factory she uses as an example and put the proceeds into a pile of gold ingots. The corporation does not care. It has no needs. A homeowner can't do that with a home.
So, too, through a bankruptcy, the ownership of a corporation might change as part of the "restructuring" she describes. Its creditors might take it over from the old stockholders. But the corporation does not care who its shareholders are. It is a piece of paper.
What is a better analogy to an individual or couple that owns a home? The corporation's shareholder(s) are a better analogy. They start the business and put the assets they want to use in the business into a form called a corporation. They hold the equity in their corporation just like homeowners hold the equity of a home. That's why we use " equity" interchangeably in each case: the "equity markets" for securities and "home equity" loans - same concept.
And what happens to "equity holders" in a corporate bankruptcy? They get wiped out most of the time.
Can the equity owner of a business work out the kind of restructuring she describes AND hold on to all the equity? Theoretically (Prof Warren is an academic after all) but it is very hard in practice. If the assets of the corporation are worth less than the mortgage on them, as she hypothesizes, it is nearly impossible unless the shareholder puts in more money. In most such cases, the mortgagee winds up with the property, or, in the next most likely outcome, the OTHER CREDITORS wind up becoming the new owners of the corporation.
For the 'equity" holder(s) to wind up with the equity in that case, they have to (1) propose a plan to pay back all the creditors in full over time with a fair rate of interest, (2) pay all the expenses of the bankruptcy, (3) convince at least one group of creditors to vote for that plan by a significant margin and (4) convince the court that plan is (a) feasible and not just a hope, and (b) better for the creditors than an outright liquidation. If the assets are worth less than the mortgage and you've been in default for a while, plus you add in the other debts and expenses a company has, the need to prove feasiblity usually boils down to equity owners putting in more money or getting wiped out. While someone like a Paul Allen might be able to do that, most "equity" owners usually get wiped out.
That "discharge" for the 0.2 million debt Professor Warren describes, that she makes it seem so easy and so unfair? It happens only some of the time (most business bankruptcies wind up as liquidations) and the rest of the time it usually involves wiping out the original "equity" in the business. It does the equity owners no good to know that the corporation continues to own the factory when the other creditors own the equity of the reorganized company.
So if you applied the corporate bankruptcy paradigm to homeowners in an intellectually honest way - i.e., to the "equity" owners of the bankrupt business, as opposed to the piece of paper called a corporation, the paradigm would result in as bad a result for individual "home equity" owners as current law.
The analogy and thus the argument are both invalid. Though I am sure the intention is good.
August 20, 2007 10:00 AM | Reply | Permalink
It is true in California that a homeowner could be liable for the unpaid balance of a mortgage loan after foreclosure. However, from what I understand, if it is the purchase money loan this won't happen. It only happens on refinanced mortgages.
The real estate is only collateral for the loan. I think the law to prevent collection of the balance on a purchase money loan is meant to prevent banks from lending too agressively to homebuyers. However, at the same time, they seem to be encouraged to refinance mortgages. I guess that is why it is so hard to get a loan to buy a home, but easy as pie to refinance.
Jim Anderson
The Truth About Credit
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Ministry WebsiteAugust 20, 2007 9:09 PM | Reply | Permalink
I'm with you, Liz. As a fellow renter, I know full well that politicians are more likely to listen to frantic homeowners--or, more likely, frantic bankers, homebuilders, and real estate agents--than they are prospective home buyers.
Out here in middle America, we could afford a house. But, I respect my landlord more than I do most home sellers. At least my landlord isn't trying to sucker me and calling it "The American Dream." I get what I pay for, which is all I want. Plus, my wife can work from home part time. I telework for an East Coast firm. We get to raise our son. Plenty of disposable income. No debt. Retirement savings.
First Step to Financial Self-Determination: You gotta get out of the major metro areas.
--
Empire of Liberty
August 21, 2007 6:18 AM | Reply | Permalink
So, one stupid bailout deserves another, huh? Don't fool yourself. If there's a bailout it won't be for the benefit of homeowners. It'll be for the bankers, homebuilders, and real estate agents--three of the most stalwart anti-progressive interests in the country. But, Democratic members of Congress will rationalize as follows: "Sure, these guys are Republicans and will support the next GOP candidate for President, but I'll pick up a few one-time votes and contributions from them back in my district."
--
Empire of Liberty
August 21, 2007 6:24 AM | Reply | Permalink
Yes, the game is rigged. If you don't play you're going to pay. My boyfriend and I talk about this all the time! Bernanke's main worry right now is that americans will START saving money, keeping it out of the system, directly affecting corporate america's bottom line. When the most powerful man in the United States says this is his main concern, you better believe the game is rigged to keep you playing and paying.
That is why there is NO return for people who depend on fixed income. They want your money in play. Whether its being used by banks through mortgages or stocks which make wall street rich. Even our 401k's have been pimped out. I work for a MAJOR corporation and I have NO control over how i can allocate my 401k money AND the funds we have to choose from are UNDERPERFORMING even by todays standards.
Why arent Americans allowed to choose CD's in our 401k's? WHY? because they cant make money off of that.
ok... done with my current rant! have a super day! liz
August 22, 2007 7:56 AM | Reply | Permalink