Bankrupt Ideas for Changing Bankruptcy

by Sean Purcell

Real Estate Renaissance Man

Author website

Two excerpts from a local article:  Bankruptcy reform could help hard-up homeowners

Overwhelmed by debt from credit cards, a $536-a-month truck payment, $8000 in overdue property taxes and two mortgages, the single homeowner is hoping (San Diego bankruptcy attorney) Colwell can remove the $84,000 second loan on his home, which is now worth about $100,000 less than what he originally paid.  (emphasis mine)

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House Speaker Nancy Pelosi (says) Congress is prepared to act on the (bankruptcy) legislation so “responsible homeowners can stay in their homes.” (emphasis mine)

The obvious question here is: Does House Speaker Nancy Pelosi know she’s a caricature?

But let’s go beyond the obvious for a moment and take a rational, economically based look at President Obama and Congress’ plan to allow bankruptcy judges to modify mortgages.  Why?  Because the effect of this legislation will impact not only home buyers, real estate agents and lenders but pretty much anyone who plans on using a mortgage to purchase or refinance a home in the foreseeable future.

This is not the venue to bore you with arcane language and minutiae on how mortgage back securities work.  Suffice to say that, as with all investments, investors in mortgage backs (upon which all mortgage rates are based) are happiest when they feel safest.  The more comfortable they are in their expectation of future redemption rates, the less profit they expect in return for purchasing mortgage backs.  Translation: a safe & happy mortgage back investor equals a low mortgage rate.

But, when you give a bankruptcy court the power to modify a loan at their own prerogative, you introduce the unknown and unstable into the world of our happy little mortgage back investors – you introduce risk.  Confronted with an increase in risk, investors naturally want an increase in reward.  That means higher rates across the board. This is not rocket science.

Says Dustin Hobbs, spokesman for the California Mortgage Bankers Association,

“If there’s the fear that judges can at any time modify mortgages, it’s no long the safe investment it was, and investors will charge mortgage bankers more to buy the loans – costs that will be passed on to the borrower in the form of higher rates.”

But wait, what about all the good this new law would do?  Won’t the ends justify the means?  According to a recent Credit Suisse analysis, this legislation would reduce foreclosures by approximately 20%.  That’s 20% of the homes that actually go into foreclosure.  In other words, everyone in the nation – all those who were responsible, all those who haven’t yet purchased, all those expecting to obtain a mortgage in the future – will pay a higher rate thanks to a change in the  bankruptcy law to help ease the pain of less than 1%  of total homeowners.  Does that seem rational to you?  Would you call that sound, economic thinking or just another bankrupt idea from a group of people that spell “economics:”  e-l-e-c-t-i-o-n?