Though the cramdown threat has been (temporarily) vanquished, there are still more issues Congress is facing that could skew the market. Senator Dick Durbin, who drove the lost fight for cramdowns, separated the measure from a larger bill that passed the House (HR 1106) that is aiming to redefine how the mortgage industry works. The "Helping Families Save Their Homes Act of 2009" (now S.B. 896) also contains provisions that will protect mortgage lenders from being sued by investors for rewriting mortgage terms on their own--measures the Senate supported today.
This has set up a Wall Street Civil War, as The New Republic's Noam Scheiber puts it, between the big banks that are dealing with foreclosed homes that want to restructure them, and investors that do not want to take a loss on the mortgages as a result of a restructuring.
One of the questions I have come back to on this blog on occasion is, why would banks not just restructure a mortgage on their own so that someone could stay in their home if the bank wouldn't be able to sell the home anyway? And one of the reasons is fear of lawsuits from investors that bought securities based on certain contract conditions that they would rather not see restructured. Another is fear from investors that in a restructuring of a mortgage, banks will simultaneously restructure that mortgage with a secondary mortgage that many homeowners have in such a way that banks don't suffer losses, but investors in the first mortgage do.
To fight this, banks have been pushing for "safe harbor", essentially protection from lawsuits by investors if they restructure mortgages. However, the investors have been pushing back that such protection would allow banks to abuse the restructuring privilege. Investors, after all, want to make money of their investment too and have it tied up when the mortgage is in foreclosure. Investors want people in their homes paying for them. They don't like foreclosure either, but they also don't have control of the renewed terms, allowing the mortgage holder to focus only on their own interests. Scheiber writes:
"...it's far from clear that banks won't abuse the safe-harbor provision they've lobbied for; if it passes, the investors could push to prevent them from using it as a shield against liability for peddling fraudulent mortgages. Investors could also play a constructive role on other issues, such as the attempt by banks to return their bailout money quickly in order to wriggle free of pay restrictions. Investors who own the banks' bonds aren't likely to be keen on this, because the bailout money insulates them from potential losses."
So with banks and investors duking it out, the Senate weighed in today, defeating a bill amendment that would have given investors the right to sue, essentially protecting safe harbor, and backing the banks they have also bailed out. The Helping Families Save Their Homes Act in amended form (without cramdowns) remains before the Senate for a vote later this week.
I stand with the investors in this battle, purely on the grounds that banks should be able to restructure loans to avoid losses on a foreclosed home but have the incentives of the investors in mind when they restructure. If they act in good faith in taking some losses on their own, while passing off a justifiable share of losses to the investors, then there should be no grounds for suit. The banks and investors should have the proper incentives to work together, to the benefit of the consumer, not have one favored over the other by Congress.
I just read this editorial from the New York Times which points out about the cramdown bill that:
"Senator Obama campaigned on the provision. And President Obama made its passage part of his antiforeclosure plan. It would have been a very useful prod to get lenders to rework bad loans rather than leaving the modification to a judge. But when the time came to stand up to the banking lobbies and cajole yes votes from reluctant senators — the White House didn’t. When the measure failed, there wasn’t even a statement of regret."
And that's true... which makes me wonder if there is some political strategy behind allowing cramdowns to fail, but then use safe harbor provisions to achieve the same goal--preventing foreclosures (again, a good endgame, but this way is going to make it more expensive long-term for homebuyers).