President Barack Obama offered $75 billion of relief on Wednesday to homeowners facing foreclosure. He also gave bankers a reprieve.
Some lenders, including New York-based JPMorgan Chase & Co, have worried that proposed “cramdown” legislation giving judges the power to modify mortgages of those who file for bankruptcy would increase the number of filings. Obama, who said on Wednesday he supports a cramdown law, signalled that it would only be a last resort for struggling borrowers.
“Allowing cramdowns is a bad idea,” said Andrew Sandler, a partner in the Washington office of law firm Skadden, Arps, Slate, Meagher & Flom LLP, whose clients include mortgage companies. “Obama’s programme has the potential to reduce the number of bankruptcies. The fewer loans that go to bankruptcy and are subject to cramdowns the better.”
Lenders that have large amounts of other types of consumer loans, such as home equity and credit cards, could suffer further losses because bankruptcy judges are likely to wipe out that debt, Paul Miller, analyst at Friedman, Billings, Ramsey Group Inc, said in a January 26 research note.
“That’s what scares a lot of people, especially anybody that has second liens,” he said in an interview on Wednesday. “The mortgage industry does not want cramdowns because it’s going to open up a Pandora’s box.”
The foreclosure plan is part of a broader $275 billion proposal announced by Obama.
The $75 billion would reduce monthly payments for borrowers, help homeowners with loans owned or backed by Fannie Mae and Freddie Mac to refinance at lower rates, and provide incentives to the industry. The government committed to buy up to $200 billion of preferred stock in each of the two housing lenders, twice as much as previously pledged.
Jamie Dimon
JPMorgan Chase Chief Executive Officer Jamie Dimon said in an interview that modification in bankruptcy will be “the last resort, not the first resort.” He called Obama’s plan an “elegant” way for homeowners to have recourse if they’re unable to change loan terms by any other means. JPMorgan held $352.4 billion in consumer loans on its books in the retail bank at the end of the fourth quarter.
Obama’s support for changing the bankruptcy rules is intended to help “borrowers who have run out of options,” according to a White House fact sheet released on Wednesday.
“My administration will continue to support reforming our bankruptcy rules so that we allow judges to reduce home mortgages on primary residences to their fair-market value, as long as borrowers pay their debts under a court-ordered plan,” Obama said yesterday in Mesa, Arizona.
Instability
The bankruptcy change has come under criticism from investors and analysts who say modifying loan terms would add more instability to the market for debt packaged into securities.
“Cramdowns encourage more people to consider bankruptcy,” said Andrew Harding, who helps manage $20 billion as chief investment officer for fixed income at Allegiant Asset Management in Cleveland. “It might sound good to the politicians, but it’s certainly not something that behooves the securitized market.”
Mortgage securities that are rated AAA were sold with the expectation they would be the last to suffer losses, said Gerard Cassidy, a banking analyst at RBC Capital Markets in Portland, Maine. Once those securities take losses, their value will have to be marked down, he said.
Lenders may also pass on higher rates to consumers as risk increases, said David Olson, president of Wholesale Access Mortgage Research, a research firm based in Columbia, Maryland, and a former Freddie Mac economist. “You are saying that contracts can be broken, which is a dangerous concept,” he said.
Foreclosures
US foreclosures reached 274,399 in January, the 10th straight month in which more than a quarter-million filings were processed, according to RealtyTrac Inc., the Irvine, California- based provider of real estate data. Last year, more than 2.3 million homeowners faced foreclosure proceedings, an 81 per cent increase from 2007, and analysts say that number may soar to as many as 10 million in coming years.
The Obama plan would cut mortgage payments for as many as 9 million struggling homeowners and work with banks to reduce payments to 31 per cent of a borrower’s monthly income.
“The refinancing pieces of the plan open up a new tool or opportunity for many consumers across America who really didn’t have refinancing as a viable option before,” said Mike Heid, co- president of Wells Fargo Home Mortgage in Des Moines, Iowa. “It’s a very comprehensive, very thoughtful plan that will go a long way towards helping stabilise housing in America.”
Bank of America Corp. and Citigroup Inc. said in statements they supported the government’s initiative. Citigroup, which has taken $45 billion in government funding and a $301 billion backstop on assets, said in January it supported giving bankruptcy judges the ability to alter loan terms.
In a February 11 hearing before the US House Financial Services Committee, chief executives of seven large banks said that while they supported modifying loans, they didn’t share Citigroup’s view that bankruptcy courts should have the leeway to change payments.
