Credit Cards, Bankruptcy Laws and the Mortgage Meltdown
The role of subprime lenders in inflating the housing bubble, then bringing down the whole economy has received plenty of headlines. But there has been little attention paid to the role of credit card lending and BAPCPA in the current home foreclosure crisis.
A new paper, Bankruptcy Reform and Foreclosure, argues that the 2005 bankruptcy amendments are deepening the mortgage crisis. The article was written by David Bernstein, an economist at the U.S. Treasury who chose to post this analysis as private citizen listing only his home address and home e-mail address. Drawing on data from the Survey of Consumer Finance, he links credit card debt, access to bankruptcy, and mortgage foreclosures. If more families could use bankruptcy to deal with their credit card debts, more could avoid foreclosure on their homes.
Bernstein studies families paying more than 40% of their income on home mortgages (in the trade, known as highly leveraged). This group is 21 times more likely to default on a mortgage than homeowners below the 40% mark. He notes that relieving these high-leverage families of their credit card payment obligations would permit about 1.5 million households to bring their home mortgage payments under 40%, increasing the odds substantially that they could keep their homes. By restricting access to bankruptcy, he argues that "BAPCPA increased home foreclosures, increased the dollar value of financial assets in default, and put downward price pressure on real estate markets."
One implication of Bankruptcy Reform and Foreclosure is that more homeowners should consider bankruptcy in order to save their homes. Even if they cannot rewrite the mortgage, they may write off enough other debt so that they can still meet their payments. Whether that will work depends on the kind of mortgage payment structure they have, but it is a point that more families should think about.
The paper is a sharp reminder that bankruptcy is not simply a debtor-versus-creditor battle. One creditor's gain can be another creditor's loss. During the Bankruptcy Wars leading up to BAPCPA, I spoke with mortgage lenders about the pending legislation, urging them to weigh in against making bankruptcy tougher. The uniform response was "the bill doesn't affect us." But the bankruptcy laws favoring credit card companies did affect the mortgage lenders. Even today, as Indy Mac shuts down and Fannie and Freddie need the federal government's backing to stay alive, few people are connecting the dots that link family economic health, bankruptcy, consumer debt and mortgages.
It seems odd that mortgage lenders should have said "the bill [BAPCPA] doesn't affect us."
Years earlier, Sullivan, Warren, and Westbrook (2000) had reported the obvious ---
. . . some mortgage lenders are eager to see a troubled borrower file for Chapter 7 bankruptcy, since the other debts can be discharged and the debtor can cure the defaults on the mortgage debt and continue regular home payments. Having eliminated their other debts, the debtors are much better able to service the mortgage and maintain the property and are less likely to end up in foreclosure.
Perhaps, these "mortgage lenders" weren't lenders, at all, but only originators who had no intention of winding up holding the mortgages they wrote initially.
July 18, 2008 2:58 PM | Reply | Permalink
Debt in general has run wild in the last three decades. The middle class has been hit with credit cards that are high interest with schemes designed to extract as much money in fees as in interest.
The working class is attacked by payday loans (we used to court martial GI's for doing that back during the Vietnam era) and subprime loans for automobiles (essential to get to work) and for homes. Pawn shops have been with us forever, but in Texas they charge 1/2% per day interest (180% per year) as well as a high administrative fee for just doing the paperwork. If you renew the loan you pay a new fee.
There seem to be two differences between the middle class and the working class financially. First, the middle class tends to have regular income and stable jobs. The working class does not have stable jobs, so the income is not as predictable.
Second, the middle class has bank accounts. The working class don't. A large part of that is because if you bounce a check and don't pay it off with the high fee immediately, Telecheck is informed and you can no longer open a bank account anywhere. The chain Cash America Pawn Shops considers itself the bank to the 30% of American workers who do not have bank accounts.
Ever try to cash a paycheck with no bank account? Try it and you'll find it runs about 3% to 5% of the face value of the check. And no employer pays in cash any more.
Combine that with the unrealistically low interest rates that Greenspan created in order to reelect Bush in 2004. The current interest rates paid on savings don't even beat inflation, and the income is taxable to boot. When you hear economists, pundits and politicians complain that Americans don't save anymore, ask yourself what the incentive is to save when you lose part of every dollar you have in a savings account instead of getting a return on the money.
This low interest rate is what drove large money investors to try to find higher paying safe investments. What is safer than investing in AAA bonds backed by mortgages - the first debt most of us pay each month; Or at least that was true before bankruptcy reform. Now it's credit cards, since often more is owed on the home than it can be sold for. Little did they know that the underlying mortgages weren't really AAA grade. That was a fiction created by the Wall Street Bankers to sell these financial instruments and collect more fees.
It really looks to me like the American banking system has been conducting financial war on the American general public for at least two decades. Certainly they have since Phil Gramm got Glass-Steagall removed and made Enron exempt from SEC regulation even thought is was a financial institution.
My next door neighbor was a middle aged single Black woman who bought the house about four years ago. This is Texas, so she paid $58,000 for a three bedroom one bath with about 1300 sq ft. But her mortgage broker got her into an ARM. Last Summer her mortgage jumped from $650 a month to over $1000. She simply had no way to pay that, and the mortgage lender from out of state refused to even try to work with her. It got $38,000 on the court house steps in foreclosure. Several people have looked at it in the last four months but none of them can get a loan because the lenders want perfect credit and big money down. The investor who paid the $38,000 thought they got a good deal, but now they can't sell it. Yet Dallas-Fort Worth is the best real estate market in the U.S., second only to Charlotte, NC.
The small farmers I used to know a few decades ago were right. Bankers are lying scum out to cheat everyone they can, and they have declared war on most Americans. If you look at a picture of Phil Gramm in a candid photo, you will see the face of the American (and Swiss) banker.
July 18, 2008 4:21 PM | Reply | Permalink
Wow. I don't know what insurance and taxes cost over there, and I certainly don't expect you to go quiz your neighbor. But something, between the interest rate and the escrow payments, is pretty exorbitant about that loan:
Rate 30y P%I Escrow Total
4% $276.90 $373.10
6% $347.74 $302.26
8% $425.58 $224.42 $650
10% $508.99 $141.01
12% $596.60 $53.40
Doesn't sound like the bank was doing her any favors.
July 19, 2008 1:31 PM | Reply | Permalink
The mortgage broker who did that to her collected a commission, probably augmented because she got an ARM instead of fixed rate 30 year mortgage. From what I know of the neighborhood, the taxes and insurance would have run roughly $200 a month.
The bank also got a commission and resold it to an investor as part of a package of loans. The investor took a bath. They got back $38,000 of the $58,000 loaned four years earlier.
My understanding is that when the bank resells the mortgages into the after market, they normally include a guarantee that is the mortgage defaults they will replace it with another of like characteristics. In theory the originating bank retains the risk of default when selling the package of loans. (I worked as a temporary accountant at a local mortgage bank for a short time in 2002 auditing a couple of those loan packages the mortgage bank had resold to investors. Neither party knew what was in those packages. The packages were entirely computerized, and I never learned who, if anyone, retained the original documentation.)
I haven't heard that banks are being hit with these guarantees, but that is something only they and the regulators would know - assuming that the regulators have audited. That $20,000 loss the lender took on the foreclosed mortgage comes right off the top of the bank's net assets and sharply reduces the bank's ability to make more loans of any kind. Assuming they kept a 5% reserve of net assets on each loan, that $20,000 loss would reduce the bank's ability to lend by $400,000.
That's where the increase in bank failures this year has come from, and there should be more soon.
The other thing that intrigues me and I don't know the answer to - the owner of the loan refused to work with my neighbor to try to rescue the loan. I think that means the investor wouldn't work the loan out. They let it go to foreclosure and stuck it to the bank that made the original loan. Why? Too many bad loans? Investors who simply don't know what they are doing?
This is a growing set of problems, not one that anyone has contained yet. Every block around me has three or more "For Sale" signs in the yard, and the ones that say "By Owner" with an empty house means it was already foreclosed and the investor is trying to flip it. And I am talking about Dallas-Fort Worth, the second best real estate market in the U.S. The American problem is big enough already to be severely effecting the entire world banking system. (Hooray for globalized finance!!) On top of that, the inflation is only just starting. Anyone who says things will start getting better any time soon is a fool trying to sell "Happy Talk."
July 19, 2008 3:18 PM | Reply | Permalink
For a discussion of the complicated area of mortgage repurchase and warranty agreements, see Tanta, here.
But what happens when the mortgage originator is -- when the s**t hits the fan -- out of business?
July 19, 2008 4:40 PM | Reply | Permalink
That one's easy. When the organization offering the warranty goes out of business, the buyer is simply S**t out of luck.
I'd like to see the rating agencies sued, myself. But the problem there was the unregulated system in which the sellers paid the rating agencies for the ratings the buyers used. The market didn't work because no one was responsible for the overall condition of the market. Each participant was allowed to pursue his own self-interest.
And thanks to the reference to Tanta.
July 19, 2008 5:37 PM | Reply | Permalink
Your welcome.
For a back office bank-lending übernerd (her self-description) she's definitely got her s**t together -- and with style.
July 19, 2008 8:25 PM | Reply | Permalink
Paying $650 a month for 4 years, your neighbor must've paid the bank at least $20,000 worth of P&I. They probably lost a couple thousand at most, when you figure the foreclosure and resale costs.
Good point about bank losses decreasing their reserves, and making less money available for new loans. I wonder if that has a feedback effect, making it harder to clear existing foreclosures.
My subdivision outside Phoenix has about 1/10 houses for sale or rent. One property had 2 burned-out cars in the driveway for 2 months, and our all-powerful homeowners' association couldn't do a thing. I swear I saw breathless news reports about dictatorial HOA's on the rampage, bankrupting homeowners and making lives miserable for building your swing set an inch too high. But they didn't do much about those cars.
July 20, 2008 5:36 AM | Reply | Permalink
they have declared war on most Americans
The war was declared in 1913 when the Federal Reserve Act was passed. It was a law that was sold as protecting the public from the bankers (money changers), when in fact it was for the bankers to make more money. They didn't get everything they wanted, but they have slowly been getting what they want over the years in thousands of laws passed, much of it in earmarks. We've been duped.
He who has the money makes the rules, and we gave the control of our money supply to a private bank controlled by a few wealthy men who formed a partnership with the U.S. Federal Government. This partnership has been slowly picking the pockets of Americans ever since. The party may almost be over and will Americans just go broke, unless they figure out a way to drag it out a little longer.
We just need to stop borrowing money if we want preserve our own households as much as possible. Get out of debt, ASAP. The value of your money can disappear, but the debt won't. Live on less than you make, and put money aside for emergencies in a credit union that isn't steep into mortgage lending. Its up to you, you will ultimately have to live with your decision.
July 19, 2008 11:26 AM | Reply | Permalink
A reapplication of usury laws would go a long way to keeping the predatory banks from farming the public for money.
I can't help but wonder if organized crime has found a lot less market for loan sharking because the banks have changed the rules and taken most of what used to be loan sharking over.
July 19, 2008 11:42 AM | Reply | Permalink
Don't bet on it. It is delegated to the states and since the Federal Supreme Court Marquette decision, interest rates can be exported to other states. Banks simply locate in states without usury laws and export their business to the rest of the country. Once the Supreme Court sets a precident like this, there is little that can be done.
July 20, 2008 10:57 AM | Reply | Permalink
Re: First, the middle class tends to have regular income and stable jobs. The working class does not have stable jobs, so the income is not as predictable.
I think you have a different definition of "working class" than I do. The people you are talking about I would class as "working poor". I thinl of working class people as being people like my step-sister, a tool-and-dye maker at an aircraft parts manufacturer, where she has worked for over a dozen years, and who has adequete (albeit not stellar) benefits and a modest sized bank account.
July 19, 2008 6:47 PM | Reply | Permalink
Amazingly I think that the rating agencies can't be sued for their recommendations. Ratings agencies aren't like banks or other commercial institutions that, theoretically at least, have to release financial information. They have the power they do only because the buyers and sellers of financial instruments agree that S&P, Moody and Fitch should determine the value of any bond issue or SIV or whatever. There's no regulation or oversight and their ratings are legally simply opinions. It's as though everyone suddenly started paying attention to my financial pronouncements, the media starting reporting that PeonInChief had approved this or that SIV, and the Wall Street Journal nodded approvingly.
July 19, 2008 8:42 PM | Reply | Permalink
It couldn't be more clear that our financial system has been raided by banks and other financial institutions with the single goal of gaining as much control over the economy as possible. This control has been largely achieved and then with the power afforded that control those institutions have proceeded to steal every dime.
This would not have been possible had not the congress, our elected officials, at the behest of the financial community, repealed law after law that regulated those institutions and created new ones that gave them even more power. We really need to launch a national campaign that restores our protections in the financial marketplace. I have written letters about this to my congresspersons but they have fallen on deaf ears. The reason for that is obvious. It is these same institutions which contribute significantly to political campaigns. That also needs to come to a dead stop. And I don't give a hoot about the rights of these corporations. They are not citizens and as far as I am concerned they have no rights. They have no right to unduly attempt to influence my representatives in congress that creates an obvious conflict of interest. And they certainly don't have the right to use the money I have placed with them for safekeeping in a way that is harmful to me. And that is exactly what they have done. Used my own money to give me the shaft. How f***** up is that?
July 20, 2008 8:24 AM | Reply | Permalink
Take your money out of the bank and open an account with a credit union. Credit unions are non-profit organizations and are regulated differently. They are also insured by a different insurance program, so if the FDIC goes broke paying off depositors of failed banks, it won't affect you. Plus, credit unions don't have the profit motive, so they are managed differently and won't jab you for fees every time you blink.
July 20, 2008 11:04 AM | Reply | Permalink
Since such interstate interest rates are almost by definition interstate commerce, Congress should be able to legislate them.
The Supreme Court is only the final word on items determined by the Constitution. When they review legislation - federal or state - they can be overridden by further legislation.
July 21, 2008 8:12 AM | Reply | Permalink
Since such interstate interest rates are almost by definition interstate commerce, Congress should be able to legislate them.
Good luck getting that Bill through Congress. It would have the potential of putting major banks out of business. With the willingness of the Federal Reserve to give banks a blank check to avoid a run on the banks with the way things are going now, I doubt Congress would see it as a good idea to legislate away the Marquette decision fallout. Banks are "too important" to the economy to fail. So the government would have to bail them out. The problem is that they are no longer a viable business with the overhead they carry and rely on the credit card shenanegans to stay in business.
Jim
http://www.thetruthaboutcredit.com
July 22, 2008 10:21 AM | Reply | Permalink
I tend to look past the moral aspects of consumer lending for the current crisis, and wonder instead about how markets have handled the situation. The vanguard of economic thought (rational expectations/EMH) would suggest that situations like our own would never arise. As Jim Bunning would have it, markets in their infinite wisdom just recognize value and adjust to expel bad ideas so that our economy can get back on its growth track (IT inovation, quantitative finance from theoretical physicists, etc).
But it just leads me to think that the ONLY solution to the problem is one based in morality, as we will never understand the operation of financial markets. That doesn't stop Wall Streeters from dominating the policy debate.
July 29, 2008 10:21 AM | Reply | Permalink
I remember telling one of my Realtor friends that the Bankruptcy Deform would cause major problems for his industry. One really only needs to ask a couple questions to see the problem:
(1) Who are the primary targets of Bankruptcy Deform? Upper end wage earners. While the documentation and other requirements of the act make a bankruptcy filing onerous for lower wage earners, the Act effectively deprives upper end earners bankruptcy relief.
If someone's income is above the median income for someone in their area, they are guaranteed to fail the means test. Besides no practicing attorney wants to get hit with sanctions for guessing wrong and this. If you are above the median income, no Chapter 7 for you.
There is absolutely no reason for someone to file under Chapter 13. Before deform, about 90% of these cases failed. After deform, it is fair to say that the number will approach 100%. Chapter 13 plans are impossible to complete. Just about everyone will flunk out before the five years they need to remain in the plan expires.
The reasons are numerous. But the odds are that within that five years, something will go wrong. Someone will lose a job; someone will get sick; someone will have an automobile accident; a car will break down, and so on and so on. Most Chapter 13 plans do not have contingencies for this, and when it happens, the plan becomes unworkable, and the Chapter 13 trustee files a motion to dismiss. Game over!
Besides, a creditor takes less by garnishment than the typical payments under the new Chapter 13. For example, in Colorado, a creditor can garnishee a maximum of 30% of wages. Under Chapter 13, the Trustee typically will get a much larger chunk. Most people don't have significant assets, and if they do, they have to turn them over or pay the trustee a like amount if they want to keep them. The trustee effectively is a collection agency.
When the victim flunks out of this scam called Chapter 13, all their debts suvive, while they have paid a huge chunk of their income into the plan.
(2) Who are the people best able to purchase a home? Those very same high income earners -- the people making more than the median income.
Single welfare moms are not good candidates to become homeowners. People working at WalMart are not going to be choice borrowers.
Before deform, those higher income earners would get rid of their debt. Banks typically would hold the bankruptcy against them for two years. But then they actually became a better credit risk. The bank no longer had to stand behind a long line of other creditors to get paid. Plus they could annoy and harrass the hapless borrower for six years. The bottom line was, the Bankruptcy actually improved a debtor's credit.
But all that has changed. The most qualified people can never dig their way out of debt. They can never qualify for a loan because there are too many other creditors out there -- all standing in line, and all wanting to be paid. No loan, no home sale.
The ninnies just made a dramatic reduction in the number of potential home purchasers. With the number of buyers reduced, home prices will crash.
This in turn leaves debtors with huge deficiencies which they cannot discharge.
July 30, 2008 7:08 PM | Reply | Permalink