Broken Records: It’s About Bankruptcy Relief, Stupid

If hypocrisy is your cup of tea, you can’t get much better than this. The New York Times reports that hedge funds—who stand a good chance of being the direct or indirect beneficiaries of about $1 trillion in U.S. financial bailout money—do not think homeowners should catch a break. They—like banks and bondholders before them—have come out against any proposal to amend the Bankruptcy Code to provide relief to homeowners by giving judges the power to modify mortgages to fair market value. According the the Times,

“Hedge funds are fighting proposals to ease the terms of home mortgages, arguing that such a move would hurt their investments. Two funds recently warned mortgage companies that they might take action if the companies participated in government-backed plans to renegotiate delinquent loans in a way that undercut the funds’ interests”

Although there is evidence that that there has been some drop in mortgage foreclosure numbers in the last month, it remains true that we are experiencing record numbers of home foreclosures, and this will likely continue well into the future absent some sort of government intervention.

One reason for the recent dip is that some states are apparently making it more difficult to foreclose, although this would seem only to forestall the inevitable. For her part, Sheila Bair, FDIC chair, has proposed streamlining restructuring procedures at the homeowner level in order to facilitate renegotiations.

While these are laudable attempts to address the fundamental market failure that has occurred by virtue of the investor-servicer-homeowner CF (“CF” is a term of art. The first letter stands for the word “cluster.” I cannot print the second word), I remain convinced that the most fair and efficient way to deal with this is through bankruptcy.

As I have groused on CoOp before, McCain’s proposal to buy mortgages will simply socialize the losses, rather than placing them with the homeowners and lenders who made the bad deals in the first place. Amending the Bankruptcy Code to give bankruptcy judges the power to modify mortgages, by contrast, would be better than a blind bailout for at least three reasons:

First, it would be a rotorooter to the blockage that has occurred between homeowners and lenders, because it would give judges the power to simply bypass the servicers, who have seemed far more interested in foreclosing than in renegotiating, President Bush’s “Hope” program notwithstanding.

Second, it would create a far more case-specific mechanism for addressing fraud, on either side. Bankruptcy judges are generally a talented—if underappreciated (and underpaid) lot—who can usually detect bad behavior quickly, and deploy a variety of tools to address it. Nothing in the current bailout bill or McCain’s proposal can do this.

Third, it should lead to more renegotiations, which is ultimately a far better result. This is because investors may not want bankruptcy judges to rewrite the underlying mortgages. If hey don’t, they will have an incentive to rewrite the servicing agreements that currently prevent servicers from making meaningful changes to the underlying mortgages. It is this stalemate—this fragmentation of renegotiation authority—that has, I suspect, been a major force in today’s crisis.

The bizarre part of all this is the reluctance to recognize the value of bankruptcy relief. Although Obama and the Democrats have indicated that this would be on the agenda (should he win), it does not get the prominent attention it deserves. Even smart articles about addressing the crisis at this fundamental level fail to mention the value of bankruptcy in this context.

So, while we are breaking foreclosure records, I continue to sound like a broken record. To paraphrase Clinton’s mantra: It’s About Bankruptcy Relief, Stupid.

You may also like...

2 Responses

  1. C Smith says:

    The standard approach is the military phonetic alphabet.

    These “Alpha Hotels” with their giant “Charlie Foxtrot” have us all saying: “Whiskey Tango Foxtrot”?

  2. Frank says:

    If they get away with opposing relief to broke, needy, and deserving homeowners (a type of individualized determination bankruptcy judges are suited to make), while preserving their own chance to buy second and third homes and yachts, we will truly be a kleptocracy.