By Mike Appleton, Guest Blogger
In 1984 Leonard and Harriet Nobelman purchased a condominium with the assistance of an adjustable rate mortgage loan from American Savings Bank. Six years later, the Nobelmans encountered financial difficulties and filed Chapter 13 proceedings in bankruptcy court. At the time of their filing, their mortgage balance, including accrued interest and late fees, was $71,335.00 and the fair market value of their home was only $23,500.00. Accordingly, the Nobelmans proposed a reorganization plan which treated the difference between the mortgage balance and the fair market value, a total of $47,835.00, as unsecured debt.
Under bankruptcy law, the reclassification of indebtedness exceeding the value of the collateral from secured to unsecured status is known as a “cramdown.” This is a commonly used device that effectively “strips” the lien of a security interest down to the collateral’s value. It enables a debtor to retain property while insuring that the secured creditor will recover at least as much as it would realize from a foreclosure sale of the property.
The problem is that as a practical matter, unsecured creditors, whether in reorganization or straight liquidating bankruptcies, seldom receive any of the amounts owed to them. So American Savings Bank, staring at the potential loss of more than half of the mortgage principal, filed an objection to the Nobelmans’ plan. The ensuing litigation odyssey required three years and produced a Supreme Court decision that has particular significance in the current housing crisis.
The Court ruled that the Nobelmans could not cram down their mortgage with American Savings Bank. Why? Because, said the Court, when Congress reformed the bankruptcy laws in 1978, it eliminated the availability of cramdown for mortgages encumbering a debtor’s home. More specifically, Section 1332(b)2 permits the modification of any secured debt “other than a claim secured only by a security interest in real property that is the debtor’s principal residence.” Had the Nobelmans’ condominium been held as an investment or used as a vacation home, the cramdown provisions could have been applied and their plan would have been approved. Nobelman v. American Savings Bank, 508 U.S. 324 (1993).
The change in the law was a result of intense lobbying by groups such as the Mortgage Bankers Association. The industry argued that it was entitled to special protection in view of the fact that lenders were providing a “valuable social service” for people desirous of purchasing a home and that the risk of modification in bankruptcy would adversely impact the mortgage market and make home ownership more difficult. How the “valuable social service” attending the approval of a home mortgage is distinguishable from the “valuable social service” rendered when the loan is secured by an office building or strip mall has never been satisfactorily explained.
The impact of the Nobelman decision has been significant. Prior to 1978, home mortgages were frequently modified in bankruptcy. Even after the passage of the 1978 act, many courts interpreted the statutory amendments to still permit cramdowns of such mortgages. There have been attempts to restore the pre-1978 cramdown rules, but they have been met with strong opposition, and that opposition is frequently couched in distinctly moral terms. During Congressional debate in March of 2009 over the proposed Helping Families Save Their Homes Act, for example, Rep. Michele Bachmann advanced a form of sacred covenant argument. “Of the foundational policies of American exceptionalism,” she said, “the concepts that have inspired our great Nation are the sanctity of contracts and upholding the rule of law.” Rep. Louis Gohmert added that permitting home mortgage modification by bankruptcy judges was “rewarding greed and improper conduct” and warned it would enable bankruptcy judges to modify mortgages on a “whim.” The only thing missing from the debate was a request for publication of the Collected Sermons of Cotton Mather in the Congressional Record. In April of that year, a Republican filibuster killed the bill.
A version of these arguments was repeated again two weeks ago by Edward DeMarco, who is apparently destined to remain acting director of the Federal Housing Finance Agency as long as Pres. Obama remains in the White House, and who once again declared his opposition to Administration proposals to permit refinancing of home loans by Fannie Mae and Freddie Mac, citing a vaguely defined “moral hazard” that would follow pursuit of such a policy.
The appeal to American exceptionalism and the neo-Calvinist assault on the good faith of the average homeowner is both absurd and insulting. There is certainly no evidence that would suggest that homeowners treat their contractual responsibilities with less regard than do commercial businesses. And the “sanctity of contract” argument has neither discouraged the political resolve to eliminate public employee union contracts nor dissuaded the Bain Capitals in the land from bankrupting companies and walking away from pension obligations.
Moreover, the various proposals for mortgage modification and partial principal forgiveness are not without historical precedent. In 1933, Pres. Franklin Roosevelt created the Home Owners Loan Corporation in response to the surge in home foreclosures. Over the next several years the HOLC purchased mortgages from lenders in exchange for government bonds. Hundreds of thousands of these loans were thereafter refinanced for longer terms at fixed interest rates and, in many instances, with principal reductions to 80% of appraised values. By the time the HOLC had completed selling off the loans and ceasing operations in 1951, it had actually made a small profit.
Few people will remember the HOLC, but many will recall the Farm Aid concerts begun in 1985 in response to a farm foreclosure crisis in the Midwest and Great Plains states. Record profits from agricultural exports during the 1970s generated demand for more farm land, leading in turn to higher land prices. In Iowa alone, the price per acre of farm land quadrupled between 1970 and 1982. Farmers accumulated significant debt to finance expansion and banks, eager to cash in on the boom, made huge loans largely in reliance on anticipated increases in land values. Sound familiar? When demand for farm products slackened beginning in the late 1970s, farm revenues became insufficient to service debt and land prices plummeted. The efforts of Willie Nelson, John Mellencamp, Neil Young and others brought pressure to bear on Congress, and in 1986 a new Chapter 12 became part of the bankruptcy code. Designed specifically for family farmers, it permitted the stripdown of secured debt, including debt encumbering a farmer’s residence. Chapter 12 became a permanent part of the bankruptcy code in 2005. The legislation did not produce the flood of farm bankruptcies predicted by its critics nor appreciably hamper the ability of farmers to obtain credit.
The claim that underwater homeowners are “undeserving” of assistance or that providing that assistance will encourage irresponsible behavior is not a conclusion from evidence, but a moral judgment predicated upon a cynical view of human nature. And the myth of “sanctity of contract” no more justifies legislative inaction than the myth of “voter fraud” justifies voter suppression laws. As Justice Holmes once observed, “Nowhere is the confusion between legal and moral ideas more manifest than in the law of contract. . . . The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it-and nothing more.” Holmes, The Path of the Law, 10 Harvard L. Rev. 457, 462 (1897). Of course the duties imposed by a contract are to be taken seriously, but being overtaken by events over which one has no control is an increasingly common fact of life. Under such circumstances, the inability to continue meeting the payment terms in one’s home mortgage is not a mortal sin or cause for moral censure. It is instead an example of precisely the sort of difficulty for which bankruptcy laws were intended to provide relief.
A mortgage is not a sacred instrument and the housing crisis is not a moral dilemma, but an economic problem requiring economic solutions. There is no rational basis for compelling homeowners to adhere to a set of rules applicable to no one else. Mr. DeMarco and members of Congress need to climb down from their moral high horses and recognize that the needs of distressed homeowners are at least as important as the needs of holders of mortgage securities.
Elaine,
Thanks … 😉
Curious,
Barack Obama can absolutely replace Ed DeMarco
http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/07/31/barack-obama-can-absolutely-replace-ed-demarco/
I mentioned below that there might be a legal barrier to Barack Obama firing chief Fannie and Freddie regulator Edward DeMarco, as the heads of independent agencies have to be fired for cause. This could frustrate liberals such as Paul Krugman who want DeMarco gone. But Adam Levitin, a professor at Georgetown University Law Center who is an expert on housing finance law, informs me that this worry is misplaced. Obama may not be able to fire DeMarco, but he sure can replace him. Here’s Levitin:
“The FHFA statute provides that the FHFA Director is only removable “for cause”. 12 U.S. Code sec. 4512. That sort of provision usually means that the President can only remove the officer for malfeasance or misconduct, not just a policy disagreement. (See In re Humphrey’s Executor.).
DeMarco, however, is an Acting Director…This means he can be removed at any time simply by the Presidential appointment of a Director. That would require Senate confirmation (not happening before 2013 under political realities and the ridiculous Strom Thurmond rule) or a recess appointment (possible). Given the way Obama has interpreted the recess appointment power for the CFPB Director and NLRB appointments earlier this year, the ability to do a recess appointment means he can replace DeMarco pretty much whenever he wants.”
There are caveats. DeMarco is civil service, and so can only be moved, not fired outright. And Levitin notes that replacing him means Obama can’t blame DeMarco for the state of the housing sector. But Obama could have a new FHFA director whenever he wants one.
well done, Mike!
*****
From Paul Krugman
July 31, 2012
http://krugman.blogs.nytimes.com/2012/07/31/fire-ed-demarco/
Fire Ed DeMarco
Do it now.
Who? you ask. DeMarco heads the Federal Housing Finance Agency, which oversees Fannie and Freddie. And he has just rejected a request from the Treasury Department that he offer debt relief to troubled homeowners — a request backed by an offer by Treasury to pay up to 63 cents to the FHFA for every dollar of debt forgiven.
DeMarco’s basis for the rejection was that this forgiveness would represent a net loss to taxpayers, even if his agency came out ahead.
That’s a very arguable point even on its own terms, because the paper he cited (pdf) in support of his stance took no account of the positive effects on the economy of debt relief — even though those effects are the main reason for offering such relief. Since a reduction in debt burdens would strengthen the economy, this would mean greater revenue — and this might well offset any losses from the debt forgiveness itself.
Furthermore, even if there’s a small net cost to taxpayers, debt relief is still worth doing if it yields large economic benefits.
In any case, however, deciding whether debt relief is a good policy for the nation as a whole is not DeMarco’s job. His job — as long as he keeps it, which I hope is a very short period of time — is to run his agency. If the Secretary of the Treasury, acting on behalf of the president, believes that it is in the national interest to spend some taxpayer funds on debt relief, in a way that actually improves the FHFA’s budget position, the agency’s director has no business deciding on his own that he prefers not to act.
DeMarco’s basis for the rejection was that this forgiveness would represent a net loss to taxpayers, even if his agency came out ahead.
That’s a very arguable point even on its own terms, because the paper he cited (pdf) in support of his stance took no account of the positive effects on the economy of debt relief — even though those effects are the main reason for offering such relief. Since a reduction in debt burdens would strengthen the economy, this would mean greater revenue — and this might well offset any losses from the debt forgiveness itself.
Furthermore, even if there’s a small net cost to taxpayers, debt relief is still worth doing if it yields large economic benefits.
In any case, however, deciding whether debt relief is a good policy for the nation as a whole is not DeMarco’s job. His job — as long as he keeps it, which I hope is a very short period of time — is to run his agency. If the Secretary of the Treasury, acting on behalf of the president, believes that it is in the national interest to spend some taxpayer funds on debt relief, in a way that actually improves the FHFA’s budget position, the agency’s director has no business deciding on his own that he prefers not to act.
Great article Mike A.
“The appeal to American exceptionalism and the neo-Calvinist assault on the good faith of the average homeowner is both absurd and insulting. There is certainly no evidence that would suggest that homeowners treat their contractual responsibilities with less regard than do commercial businesses.”
Great piece Mike A.
Although it is not explicitly stated, you point out how the “Randian”, as Gene H puts it, elements actually want “socialist” application to their losses but “free market capitalism” to apply to the victim home owners.
When they want their monetary interests protected by government they don’t use the s word “socialism”, the use the Randian word “moral hazard”.
We saw this play out in a big way during the “too big to fail” bank bailouts.
Socialization of loss for the elite privatization of loss for the 99%.
The America the world loved because of its fairness of opportunity and loss, has become to some extent the militant Amerika that worships bully essences.
David B, hilarious. My father used to ask why there were always more horses’ asses than horses at the racetrack.
Correction of my post.
“Laws, I thought, were meant…..(etc as before)
CLH
Snottiness won’t save you from being seen as stupid, when you attempt to transfer the problem to your accuser.
GBK
Agreed. “It” is a a curse on us all. And a constant irritation to me.
GeneH,
Let me use your instance to, as one has since you, point out the question of why OBAMA does not do things
obviously within his discretion. I don’t have a list, but our heads together for five minutes could make a long one.
It is OT but good for another session.
MikeA,
Thanks for illuminating another hard area to understand, if you have neither a home mortgage, nor a mall mortgage.
The perfidy of the banks and capital in acquiring advantage—- undeserved, unearned, and unfair —- seems unlimited. I thought were meant to stifle such things. Oh, yes. Someone paid for this one. It’s all up for bids here in good ol’ America. As in most place around the world. The universal governing models.
gbk- Non sequitur huh?
It’s a comment, not an article (my previous articles in comments notwithstanding) not a complex argument. I am simply agreeing with the above passage, therefore no support of my position is generally called for, mainly because “it” is supported in the above article. And why are you asking about a sister? Kind of creepy. Remind me never to meet you in person. I want to stay out of jail, and you probably want to stay out of hospitals. And “morals are an important part of government” is meant to be an idealistic position, in which morals are a part of good faith government, not what actually prevails. But I guess I assume too much about the reader’s mental acuity in this instance. So sorry dear.
“Mr. DeMarco and members of Congress need to climb down from their moral high horses”
Mike, did you mean crawl out of the horses ass.
CLH,
I really hate when people refer to a complex subject as “it.”
As in your sentence above: “I agree that it is an economic problem that needs an economic solution.”
Devastating circular logic with no subject; discounting “it” of course.
CLH,
Do you have a sister? I work for the government.
CLH,
“Morals are an important part of government . . .”
Sure they are, and my mother taught me never to lie.
GBK- tequila sounds good. Doctor won’t let me drink anymore though :*(
I agree that it is an economic problem that needs an economic solution. However, governance divorced from morals leads to things like despotism, restrictions on liberty, and basically China style government. Morals are an important part of government, but they should not, such as in this case, be used hypocritically to protect one group and deprive another of much needed relief. Of course, if people followed the morals of their (supposedly, in most cases in DC) christian heritage, forgivness of debt is a recurrent theme in biblical teachings. Lesson missed there, I suppose.
Does anybody have any tequila with the worm? I really like chewing worms.
DeMarco is a holdover appointment from the Bush administration and I’ve read somewhere that there may be some impediment to Obama’s ability to fire him. Sorry I haven’t better information, but if there is something to my recollection I’m betting that Swmom or Blouise may be able to dig it up.
Mike,
Third attempt at responding to your post. Just wanted to say thanks for discussing Edward DeMarco and provide two links for background.
http://tinyurl.com/cjqnnek
http://tinyurl.com/bqysays
Mike A.,
Great article and I’m really glad you rolled that weasel DeMarco into the conversation. That obstructionist should be fired immediately. He is, by his own volition and using that lovely Randian code word “moral hazard”, acting as a significant roadblock to actions that would substantively help boost the economy and help average citizens at the same time. All because he personally disagrees with both Congress and the White House. He should have been fired the instant he refused to go along with policy. He works at the pleasure of the President. Obama should just man up and send him packing.
Mike,
Fantastic article. How can these fascists claim that allowing the cramdown of mortgage debt on the prinicipal residence is morally wrong, but don’t you dare touch my business real estate or my vacation home mortgage escape clause? It is absurd and dangerous. These are probably the same individuals who want to get rid of the mortgage interest deduction.