The $75 billion mortgage relief program President Barack Obama announced Feb. 18 is completely voluntary on the part of the banks, and uses public dollars to subsidize the inflated payments homeowners must make to keep up with their mortgages. Under the plan, lenders who participate must reduce mortgage payments to no more than 31 percent of a borrower’s income with the government making up the difference between the old payments and the new.
In Obama’s version of help, the predatory lender gets subsidized by his individual victim and, by you, the taxpayer.
Giving struggling homeowners access to a much bolder remedy known as a “cram-down” is required to reverse the vast transfer of wealth upward the sub-prime lending crisis represents.
Prior to a 1993 Supreme Court decision (Nobelman v. American Savings Bank), bankruptcy judges had the power to modify the repayment terms of a mortgage when the value of the house was less than what was still owed (“underwater”). Since 1993, residential mortgages on a principal residence have been the only loan that could not be modified by a bankruptcy judge. Landlords, owners of yachts or second-home owners were entitled to cram down any liens on these items if they filed bankruptcy. They could strip off any amount of debt that exceeded the market value of the asset. Thus, bankruptcy judges had the discretion to adjust a debt load in response to loss of value.
Fierce opposition from Wall Street has previously stymied legislation that would permit judicial modification of mortgages (a more delicate phrasing than “cram-down”).
Beginning in 2002, mortgage-backed securities became the darling of Wall Street. HSBC, the subprime giant, issued or underwrote $200 billion in securities backed by subprime lending between 2002 and 2006. Deutsche Bank underwrote $120 billion in that same time period. Citigroup’s share was $166 billion, according to a 2008 lawsuit the city of Cleveland, Ohio, filed against predatory lenders.
By 2003, Wall Street was aggressively searching for borrowers who would accept subprime mortgages because the rate of return was so much higher than from conforming 30-year fixed-rate mortgages that required a down payment.
“The big demand was not so much on the part of the borrowers as it was on the part of the suppliers who were giving loans which really most people couldn’t afford,” said then-U.S. Federal Reserve Chairman Alan Greenspan. “We created something which was unsustainable. If it weren’t for securitization, the subprime loan market would have been much smaller.”
But reviving cramdown would allow 8.1 million homeowners who are likely to face foreclosure in the next five years to remain in their homes and pay back only what the house is actually worth. Unlike Obama’s plan, it would not cost the government a penny. And if the legislation even looked like it had a chance of passing, it would open the floodgates to true, sustainable voluntary mortgage modification, outside of bankruptcy. Consider this: as of October 2008, only 3.5 percent of delinquent subprime loans were voluntarily reformed by lenders. One professor who studied the issue found that of 3.5 million modifications, less than one-third actually lowered the monthly payment. Two-thirds kept the payments the same, or increased them, to cover missed payments. The result is re-default. It is only the threat of judicial modification that forces the lender to be reasonable.
Since the Wall Street bailout, Citigroup has said it would accept cramdown, provided it was only applied retroactively. It wants assurances that it can issue new mortgages that would not become subject to judicial modification. The other subprime lending giant banks, Wells Fargo, Bank of America and JPMorgan Chase, have not dropped their opposition.
In his Feb. 18 announcement, President Obama called upon Congress to amend the bankruptcy law to permit cramdown for underwater homeowners. Only cramdown would begin to restore a measure of the ill-gotten gains that Wall Street acquired at the expense of Black and Latino homeowners who were the primary victims of the subprime scam.
The People’s Lawyer is a project of the NYC chapter of the National Lawyers Guild (nlgnyc.org).