Earlier today, an article, written by Roger Lowenstein for the New York Times, discussed the pros and cons of homeowners, who have mortgage balances that exceed the value of their homes, voluntarily defaulting on their mortgage obligations and, in essence, preparing to walk away from their homes.
Voluntary defaults are far from a new phenomenon. In each of the last three major recessions over the past 20+ years, numerous homeowners have faced the "moral dilemma" of either fighting to keep their home out of foreclosure or walking away and allowing the bank to foreclosure.
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The "moral dilemma" is deeply rooted in bankruptcy and, as a consumer bankruptcy attorney, it is a topic that I discuss with clients on a daily basis. We have been taught to do the right thing - work hard, pay your bills on time, meet your obligations, save to buy a home and achieve the American dream. Sometimes this does not go exactly as planned. Bad things happen to good people. Some of it is outside of our control - illness, unemployment and the like. Some of it is within our control - poor decisions, either in business, or personal in nature. One of the hardest decisions that an individual has to make is when he or she has had enough and comes to realize that they have dug themselves a financial hole that they cannot climb out of without some assistance, and many times, that assistance is the protection of the Federal Bankruptcy laws.
Unfortunately, Mr. Lowenstein has not delved deeply enough to discuss what may actually be the root of the current problem, or what Malcolm Gladwell has termed "The Tipping Point" - that which causes a phenomenon to take hold and become mainstream.
The goal of the present efforts in the public and private sector is supposed to be to keep homeowners in their homes, and avoid the extensive psychological and sociological repercussions of foreclosure - the viewing of block upon block of boarded up homes in your own backyard. Both sides, public and private, are touting that their respective efforts are working, and in many cases, they have avoided, or postponed, a number of foreclosures. What has not been said, is that from these efforts, a new psychology has emerged - what does an individual homeowner have to do to get the attention of their lender.
When the present financial crisis started to come to a head, the public sector determined that the root of the rise in foreclosures was sub-prime mortgages. So, in its infinite wisdom, the public sector shifted all of its efforts to deal with sub-prime mortgages. Then came the questions: What exactly is a sub-prime mortgage? and Where do we draw the line? The public sector then looked to the private sector to answer these questions...and this is where our present dilemma takes shape.
Banks, in the traditional term, are no longer lenders, they are mortgage service companies. In the vast majority of the cases, the bank that originated and now services a mortgage most likely no longer owns the mortgage. In fact, the mortgage may be owned by multiple entities. Who makes the decision as to which mortgage gets modified and which one does not? The public sector, and in particular Congress, has rolled over, played dead, and has allowed the mortgage servicing companies to make these critical decisions. This has resulted in the creation of the Wild West version of mortgage triage - the Mortgage Modification.
Banks do not want to lose money. They also do not want to have vast portfolios of non-performing loans, and eventually bank-owned real estate. So what do they do - they decide to put off what may be the inevitable, and put thousands of homeowners into trial mortgage modifications to generate cash flow and make these potentially non-performing mortgages performing loans again. Problem solved - I don't think so....
The inevitable is now beginning to come to a head and is discussed by Mr. Lowenstein. No one has addressed the issue of the decrease in property values. There are thousands upon thousands of hard working homeowners who have seen the little equity they may have had in their home evaporate over the past 18-24 months. These are the people who have to make the hard decisions.
Mr. Lowenstein has presented a strong analogy in his discussion of Morgan Stanley in San Francisco. I honestly do not believe that Morgan's mortgage holder is going to roll over and allow this to result in a non-performing loan. The parties are most likely going to sit down and hammer out an arrangement that both sides can live with. It will also most likely be comprised of both an interest rate reduction and a reduction in the principal balance. Why can't the residential mortgage lenders do the same thing?
As a bankruptcy practitioner, I have a natural bias toward my craft. The answer was proposed in Congress early last year and was shot down in the Senate by ten votes. If the situations in which there are dual problems - that of interest rate and property value, were placed in the hands of an arbiter - perhaps a United States Bankruptcy Judge - an acceptable, binding long term arrangement could be hammered out in which the banks could end up in a much better position than they are now placing themselves in trial mortgage modifications. If the principal balance of a mortgage were reduced to the present market value, the banks may no longer be required to temporarily reduce the interest rates to ridiculously low levels to achieve the result of a performing loan. In addition, this scenario would result in more performing mortgage loans over the long haul and avoid a great number of voluntary mortgage defaults. It is time for Congress to readdress the amendment to the Bankruptcy laws which would permit Bankruptcy Judges to modify mortgages in Chapter 13 Bankruptcy Proceedings.
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