Ed Glaeser: "Taking a Hard Line on Rewriting the Bankruptcy Code"

Having disagreed with Ed Glaeser on several occasions, I should also note when we agree, and though I have a few questions, I do agree with the main message of this commentary that it's a bad idea "to give bankruptcy judges the power to rewrite mortgage terms":

Taking a hard line on rewriting the bankruptcy code, by Edward L. Glaeser, Commentary, Boston Globe: The average sales price of a Massachusetts home fell 4.6 percent last year to $310,000. The state's housing market is doing well relative to California, where average prices have fallen by 26 percent. ...

In places with fewer building restrictions, like Atlanta and Dallas, housing price volatility is moderated by a construction sector that supplies extra houses during booms and ratchets back building during downturns. In California and Massachusetts, where abundant land use restrictions keep new construction low, any uptick in demand translates into higher prices, which then come back to earth. If an area's prices go up by an extra $100,000 over five years, then, on average, those prices fall by an extra $32,000 over the next five years.

There are winners and losers in both booms and busts. Owners, who win during booms and lose during busts, get the most attention. We often ignore prospective home buyers, who lose just as much as owners gain during booms and gain just as much as owners lose during busts. Moreover, housing cycles don't pose huge risks to most homeowners, whose longer time horizons enable them to sit out downturns.

Housing cycles pose the most danger for deeply leveraged, short-term investors. No matter what the get-rich-quick-in-real-estate infomercials say, short-term bets on housing are a terrible, hard-to-diversify investment for the little guy. While I don't have much sympathy for speculators caught in the current housing downturn, there are plenty of homeowners who are in the same position as those speculators, despite the best of intentions. These owners got in trouble, either because their incomes fell or because their interest payments rose. Now they are looking at either foreclosure or large capital losses.

There are good and bad ways for the government to do something to help worthy, desperate owners facing foreclosure. The most honest and best way is to spend taxpayer dollars. The worst way is to change laws and regulations that don't need changing, so that money can be redistributed without raising taxes.

The current proposal for the Federal Housing Administration to increase its refinancing of troubled mortgages is an example of honest redistribution. The FHA can issue mortgages and resell them in a transparent way that aids those with the most need. Moreover, the FHA can access Social Security records so that it can avoid bailing out those borrowers who misrepresented their incomes on their mortgage applications.

By contrast, there is little to like about the proposal to give bankruptcy judges the power to rewrite mortgage terms. ... An abundance of economic data show that when you make it more difficult for lenders to collect, interest rates rise and borrowing falls. ...

Moving from the current system to one in which hundreds of judges make up the rules for millions of mortgages is a recipe for confusion, administrative waste, and higher interest rates. Ultimately, that will make housing less affordable to ordinary Americans.

Ed Glaeser's last column said that "the weaknesses of the housing market reflect[s] too much, not too little, regulation, especially those rules that stymie construction and make housing unaffordable." My response was that although regulation in the housing market may have amplified shocks thereby making business cycle peaks higher and recessions deeper, the regulations were not the source of the shocks and in that sense are not the cause of the problem.

I think a reasonable response to my comment is to argue that without the land-use and construction regulation, the shocks would have been absorbed with much, much less variation in output. Hence, any additional variation in foreclosures over and above the baseline no regulation outcome is, in fact, caused by the regulation. If most of the fluctuation in foreclosures comes from this additional, regulation induced movement, then there is a sense in which we can say that regulation caused the problems we are seeing in financial markets even though the shocks driving the process are unrelated to the regulatory structure (how much additional variation in foreclosures actually occurs in the presence of regulation is an empirical question).

The other comment I made in response to the previous column was that the actual mechanism driving the additional fluctuation was not specified making the claim hard to evaluate. This post fills in a lot of the missing details, but I still have question. It's about a topic discussed here recently, whether the source of foreclosures is falling prices or interest rate resets.

Above, it says:

Housing cycles pose the most danger for deeply leveraged, short-term investors. ... While I don't have much sympathy for speculators caught in the current housing downturn, there are plenty of homeowners who are in the same position as those speculators, despite the best of intentions.

I think housing cycles refers to the cyclical behavior of prices, and these cycles are amplified by regulation as described above ("those prices fall by an extra $32,000"). But foreclosures do not arise because of changes in prices, it says above that they come about due to changes in income or from interest rate resets:

These owners got in trouble, either because their incomes fell or because their interest payments rose. Now they are looking at either foreclosure or large capital losses.

I don't see how cycles in housing prices are causing foreclosures in this story. According to the article, it's the monthly payment going up relative to income that is the problem causing the foreclosures, and that is independent of the value of the house at a point in time. If the foreclosures are from interest rate resets and falling income rather than falling prices, then  I don't see how regulation is the causal factor in this story.

I think there are ways to tell a story about how falling prices cause foreclosures, and how regulation could make it worse, and as noted here and here, there is evidence that falling prices are a big factor in explaining foreclosures. I am just looking for more clarity on how land-use regulation and foreclosures are related, and since I'm skeptical about regulation being the major cause of foreclosures, for evidence on how important this relationship is in explaining the troubles we are seeing in housing markets.

I want to add one more thing. In a column last September, Glaeser proposed:

Another way is to make refinancing at lower interest rates more attractive for lenders by encouraging shared-appreciation mortgages. These mortgages ... offer lower interest rates in exchange for some of the upside potential on the house. For example, a lender might offer a 6 percent interest rate instead of an 8 percent rate, in exchange for 50 percent of the increase in the value of the house at the time of eventual sale. Most borrowers don't want to lose this upside, but for someone facing foreclosure, losing the upside may be a lot better than losing the house altogether.

The proposal doesn't have to work exactly like this, but I like the idea of having homeowners give something up in return for better terms on their loans or other types of help. That would help to ensure, for example, that only the people who really need help apply to the program. And, since making monthly payments is the problem, I also like that the payment is not directly out of pocket at the time the loan is renegotiated, or an additional monthly expense.

Comments

[ndd]

By contrast, there is little to like about the proposal to give bankruptcy judges the power to rewrite mortgage terms. ... An abundance of economic data show that when you make it more difficult for lenders to collect, interest rates rise and borrowing falls. ...

Moving from the current system to one in which hundreds of judges make up the rules for millions of mortgages is a recipe for confusion, administrative waste, and higher interest rates. Ultimately, that will make housing less affordable to ordinary Americans.

Nice economic theory you have there:

Since Bankruptcy judges ACTUALLY HAD THIS POWER until 2005, please explain
- how difficult it was for lenders to collect
- how high interest rates were
- how borrowing fell
- how there was confusion
- how there was administrative waste
- how housing was less affordable for ordinary Americans

Why is it so many economists prefer their pretty graphs to actual real live history that is slapping them in the face?

(apologies to our gracious host: but I wanted to make a point here....)

[ndd]

Oh, and another thing:

Since Bankruptcy judges STILL have this power with respect to commercial real estate, please explain by what mathematical fairy dust the Cone of Economic Efficiency extends over the Donald Trumps of this world, but causes catastrophe when extended to Joe Sixpack.

[save_the_rustbelt]

The overwhelming majority of foreclosure cases are NOT bankruptcy cases, the case is a county court civil case.

Those who advocate bankruptcy reform as a solution either 1) don't understand or 2) want a lot more bankruptcy filings. So why is it discussed so much?

[PSP]

Ah, BAPCPA did not take away the power to modify residential mortgages. Section 1322(b)(2) of my 2001 copy of the Code reads "Modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence ..." That language has existed since 1978.

But ndd is right in that secured debt on cars, businesses, vacation homes, rental properties, washers and dryers, or anything else could be crammed down. Yet CDOs were marketable.

The actual effect of cram down should also be examined before screaming about how bad it would be for the market. The mortgage is reduced to the fair market value of the property. Lets be clear here, valuations assuming liquidation value or firesale prices may be offered, but are objectionable. (ie. This is not a liquidation analysis.) The bank can, and usually does anyway, get its own appraisal as evidence of fair market value.

Since every property in question is in foreclosure or at near risk of foreclosure because the owners are insolvent, the most signifigant fact is that foreclosure sales NEVER bring fair market value as used in chapter 13 cram down. Foreclosure sale prices tend low, when the creditor doen't credit bid. In addition, the attorneys, sheriff, and others all get their bite out of that low ball sale price.

So, The banks would virtually always do better in a Chapter 13 modification of the principal amount than they will in foreclosure. The sky will not fall, and the effect on markets should not be so drastic.

Where there may be more effect of the market is reductions of the interest rate. On non-residential mortgage notes, interest rates can be modified, which the Supremes have decreed should be prime plus 2 or 3%. On the vast majority of mortgages, that would mean no change. But it would do a job on some of the real rip off loans with 13-18% mortgages. Should we cry for the disappearance of those guys? I don't think so.

Lastly, allowing a Chapter 13 cram down and sale would pretty much eliminate jingle mail. Most of those people want to sell. The banks are so hard to negotiate a short sale with, that the people just give up. And in recourse states, what is the point, when they will be liable for the shortfall. This sets up a process that lets people force the short sale that most of them would prefer to jingle mail. The plan would provide for all proceeds, less expenses of the sale, to go to secured creditors.

(Note to 11 practioners who are inclined to comment, Chapter 13 world is different than Chapter 11 land, and cram down is different too).

[PSP]

to save_the_rustbelt,

You are right that virtually all foreclosures occur in state court. In fact, none occur in Bankruptcy Court. In state Court(or with an option to go to state court), the mortgage is accelerated, and you either pay in full or get foreclosed upon.

But, Chapter 13 bankruptcy is THE ONLY way to deaccelerate the loan, cure a deficiency over time, and stop the State Court foreclosure process. That is what Chapter 13 is all about.

So, the easiest way to stop people from losing their homes is to improve the standard process used to stop people from losing their homes to foreclosure. That is bankruptcy.

[jim]

Glaeser's argument proves too much. It would support bankruptcy judges having no power to modify any loan.

He (and you) needs to come up with an argument that shows why mortgages and only mortgages need special treatment in bankruptcy.

[ken melvin]

Dear CATO Institute (may I call you institute?), I don't think that urban sprawl is the answer to the housing problem. Nor do I believe that the high prices are due regulation (think cheap interest rates).

I think it males all kinds of sense to renegotiate the mortgages on over priced homes, for both the buyer and lender. A home owner making payments on a liability is not a happy camper and the lender would get a much a=or more than they will through foreclosure and resale.

Cactus at AB just posted a piece of mine on lender/buyer partnership
http://angrybear.blogspot.com/2008/04/ken-melvin-on-housing-prices.html

[save_the_rustbelt]

"But, Chapter 13 bankruptcy is THE ONLY way to deaccelerate the loan, cure a deficiency over time, and stop the State Court foreclosure process. That is what Chapter 13 is all about."

I understand that, but what would be the consequences of moving a couple of million cases to Chapter 13?

I don't think the system could handle this load.

[anne]

Thank you, all, for explaining the technicalities, with which I am not at all familiar; please do add detail and any reference that comes to mind.

[Organic George]

How can one seriously discuss this issue when the author in living in Never, Never Land.

The worlds financial system imploded do to Laissez Faire advocates. You sound like a heroine addict trying to justify contuned use of the drug.

[Gene O'Grady]

It always bothers me to hear stuff about "places with fewer housing restrictions." Has the guy been to San Francisco? Where is the city supposed to sprawl to? It's not exactly like Dallas where there's open land in every direction. And Los Angeles could presumably sprawl east of San Bernardino and north of Palmdale, but to what purpose? And with what effect on livability?

A while back I got a presentation on the rather impressive infrastructure planning Palo Alto did in the early 60's on the assumption that the hills up to and beyond 280 would be developed. I hate the real estate price inflation, and it's certainly one reason I moved away, but was it an illegitimate decision not to cover those hills with upscale housing?

Probably a good idea to blame God, not the board of supervisors in a lot of these cases.

[jim]

Arizona and Nevada, which have essentially no land use restrictions, are in as bad a shape as California and much worse shape than BosWash. Atlanta isn't doing so hot either.

It's not zoning.

House price drops, coupled with really bad loan policies, are the proximate cause of many of the foreclosures. You could take out an unaffordable loan with some safety while house prices were rising, because you could bail out of it, either by selling or refinancing the house. Once house prices fall, that escape route is closed: the unaffordable loan leads to foreclosure. It's not the reset alone that leads to foreclosure, it's the reset when the borrower is underwater.

[Bernard Yomtov]

I agree with PSP's main point. Where is the problem if the bankruptcy judge lowers the mortgage to the FMV of the house? It looks like everyone comes out ahead. The buyer keeps the house and the mortgage holder gets FMV without going to the trouble and expense of foreclosure.

I think Glaeser's objections are overwrought. Judges aren't going to "making up the rules" willy-nilly.

[anne]

http://www.nytimes.com/2008/04/04/business/04housing.html

April 4, 2008

Senate Rejects a Proposal to Allow Bankruptcy Judges to Alter Home Mortgages
By DAVID M. HERSZENHORN

The Senate on Thursday rejected a proposal to let bankruptcy judges modify mortgages on primary residences to help financially distressed homeowners.

[bakho]

There are several problems that will require several solutions. That makes it more difficult to discuss. There are "predatory lending contracts" and those contracts need to be rewritten. That can and should be done.

There are other issues that require other solutions.

[Bruce Wilder]

"The most honest and best way is to spend taxpayer dollars. The worst way is to change laws and regulations that don't need changing, so that money can be redistributed without raising taxes."

Mr. Glaeser only wants redistribution from raising taxes, I guess.

The whole argument seems like a crock to me. Housing regulations are introduced into the argument to keep the libertarian fraud going. Restrictions on land use and density may cause prices to rise, but it is hard to see how they make prices more volatile. Volatility in Manhatten, West Los Angeles or the City of San Francisco does not seem likely.

And, of course, a focus on land use, avoids an acknowledgement of increasingly exploitive lending practices, which actually could be appropriately dealt with in some circumstances by bankruptcy judges. Foreclosure is not cheap; the supervised negotiation of bankruptcy proceedings could actually be the cheaper institutional process.

The deeper problem is that the plutocratic agenda continues to be pressed by shills like Glaeser, without much effective push-back from anyone else.

This is all about re-designing the financial systems of the U.S. to redistribute wealth and income upward, concentrating as much weath as possible in the top one-half of 1%.

Home ownership has been maintained at very high rates, but home equity has been in steady decline. Now, Glaeser is proposing that mortgage lending be further revised to reduce equity accumulation. Just great.

[dd]

What if bankruptcy modification is good for homeowners but fatal to the hi fi system already under severe duress? The best guess is that any government mandated solution that makes homeowners winners may create unanticipated market losers, further undermine markets (RMBS, CDS, CDO), hedge funds, & monolines, and totally up-end risk models that did not factor in government intervention.
It is worth noting that Chapter 11 2005 bankruptcy provisions gave special treatment to derivatives on the theory of avoiding systemic meltdown especially in a Bear type situation; yet the threat of a Bear bankruptcy is what motivated the Fed's actions as the 2005 code changes actually amplified system meltdown risks.
see:http://www0.gsb.columbia.edu/faculty/fedwards/papers/Morrison%20&%20Edwards%20Yale%20Rev%20final.pdf

So if the driving force behind the 2005 Bankruptcy Code changes was elevating the interests of the hi fi system participants above traditional creditors and debtors it is unlikely any mandated changes favoring debtors can be made without further destabilizing a system teetering on meltdown.

[dd]

What if bankruptcy modification is good for homeowners but fatal to the hi fi system already under severe duress? The best guess is that any government mandated solution that makes homeowners winners may create unanticipated market losers, further undermine markets (RMBS, CDS, CDO), hedge funds, & monolines, and totally up-end risk models that did not factor in government intervention.
It is worth noting that Chapter 11 2005 bankruptcy provisions gave special treatment to derivatives on the theory of avoiding systemic meltdown especially in a Bear type situation; yet the threat of a Bear bankruptcy is what motivated the Fed's actions as the 2005 code changes actually amplified system meltdown risks.
see:http://www0.gsb.columbia.edu/faculty/fedwards/papers/Morrison%20&%20Edwards%20Yale%20Rev%20final.pdf

So if the driving force behind the 2005 Bankruptcy Code changes was elevating the interests of the hi fi system participants above traditional creditors and debtors it is unlikely any mandated changes favoring debtors can be made without further destabilizing a system teetering on meltdown.

[sgc]

I agree with many above that Glaeser's argument is profoundly flawed. (He should read Tanta over at Calculated Risk, before trying to comment on the mortgage situation.)

(i) Under current law it is precisely the speculators (i.e. owners of second, third, etc. homes) whose loans are crammed down in bankruptcy court (as PSP points out). All the proposed law would do is extend this standard bankruptcy procedure to typical homeowners. Given that speculators were able to get generous loan terms over the past few years, I can't help wondering what support there is for this statement: "An abundance of economic data show that when you make it more difficult for lenders to collect, interest rates rise and borrowing falls." If this statement were accurate, our bankruptcy laws should have saved us from the housing bubble.

(ii) The whole point of bankruptcy law is to encourage entrepreneurship by ensuring that people are not punished too severely (e.g. debtor's prison) for taking on financial risk. While one can certainly argue that the process has gone too far in favor of, for example, strategic corporate bankruptcy, Glaeser's article seems to turn the very concept of bankruptcy law on it head. The purpose of bankruptcy law is not, and, as long as we wish to protect the dynamism of our economy, can not be the protection of creditors' interests.

Re: will induce excessive bankruptcies. The point of changing the law is to increase the quantity and quality of lender modifications. Once lenders know that homeowners in default can declare bankruptcy to shrink the size of their secured debt, they will be more likely to "voluntarily" offer the homeowner better terms on the loan.

[btg]

"I agree with PSP's main point. Where is the problem if the bankruptcy judge lowers the mortgage to the FMV of the house? It looks like everyone comes out ahead. The buyer keeps the house and the mortgage holder gets FMV without going to the trouble and expense of foreclosure."

My point, made elsewhere, is that even if a house is slightly underwater, why not just let the mortgage convert to interest only (for the short term only with payments then increasing 2% each year), but at current market rates... this isn't just a problem of FMV, but also of the high interest rate resets in the original mortgage.

[sgc]

dd: It's hard to see how one can help homeowners in default without adversely impacting lenders. After the Senate hearings -- where the severity of the financial situation was acknowledged -- I imagine that we are heading towards a joint bailout.

btw, great link!

[kharris]

This argument that regulation is the cause of bubble-like prices and lack of flexibility seems to me to have reached the knee-jerk stage. If regulation is to blame for excessive price appreciation in the housing market, and regulation has not changed on a large scale, then somebody needs to do a lot of explaining to make regulation the or even a big source of the bubble. Land-use restrictions still in place should still be limiting supply, so still be supporting prices. Demand fell? No problem with that, but land-use restrictions are a supply-side issue.

My understanding is that land-use restrictions are far more common and more stringent in densely populated areas than in sparsely populated areas. One would expect prices to be higher in densely populated areas, so just pointing to land-use restrictions as coincident with rapid housing price increases misses a lot. Were there no land use restrictions in the early 1990s? The 1980s? Did those restrictions lead to bubbles then? If not, then land-use restrictions are not the root cause here. Did they make matters worse? Maybe, but then I'd ask, Which matters did they make worse? Prices were high? OK. But congestion was limited by those regulations, and for the people already there, that's a benefit. Whose to say that benefit counts for nothing.

Was it here or someplace similar that there was a recent post about the failure of new bankruptcy laws to bring down consumer credit rates. The common argument against rewriting mortgages is that if lenders feel they are at greater risk of loss through court action, they will demand higher rates. Consumer credit providers face a reduced risk of loss under the new bankruptcy law and haven't lowered their rates. Why do we put so much faith in this claim in the housing market when it has proven so flimsy in the consumer credit market?

The evidence marshalled by other responses here against the strong claims Glaeser makes, the failure of the model in the consumer credit market, the failure to consider the confounding influence of density, all make this look like a done-up job.

To bastardize the old joke about lawyers -- When theory is on your side, hammer on theory. When evidence is on your side, hammer on evidence. Glaeser is hammering on (a version of) theory because the evidence for his case doesn't seem strong. I wonder if, after a closer look at theory, Glaeser wouldn't hae to leave off hammering on theory and be left hammering on the table.

[Bruce Wilder]

dd: "The best guess is that any government mandated solution that makes homeowners winners may create unanticipated market losers, further undermine markets (RMBS, CDS, CDO), hedge funds, & monolines, and totally up-end risk models that did not factor in government intervention."

Feature or bug? Looks like a feature to me.

[billy]

http://www.washingtonpost.com/wp-dyn/content/article/2008/04/03/AR2008040303984.html

Buddy, Can You Spare a Billion?

Washington Sketch: Bear Stearns on Welfare
The Washington Post's Dana Milbank sketches Bear Stearns CEO Alan Schwartz's hearing on the hill before the Senate Banking Committee.

By Dana Milbank
Friday, April 4, 2008; Page A03

Meet Alan Schwartz, welfare recipient.

As the chief executive of Bear Stearns, he's getting rather more public assistance than your typical welfare mom -- specifically, $30 billion in federal loan guarantees to help J.P. Morgan Chase take over his firm. But then, Schwartz has had rather more than his share of suffering of late.

As his firm collapsed, he was forced to forgo his entire 2007 bonus, leaving his compensation for the past five years at a paltry $141 million, according to Business Week. Things have become so bad that, the Wall Street Journal discovered, Schwartz has had to rent out his 7,850-square-foot home on the ninth green of a suburban New York golf course -- leaving the poor fellow with only his 17-room, seven-acre home in Greenwich, his condo in Colorado and the athletic center he built for Duke University.

Schwartz's tale of woe tugs at the heartstrings all the more because he and his colleagues at Bear Stearns were, he believes, blameless for the bankruptcy of two hedge funds and the subsequent collapse of the 85-year-old investment bank. "I am saddened," Schwartz told the Senate banking committee yesterday. He was saddened that Bear Stearns was undone by "unfounded rumors and attendant speculation," despite its impeccable balance sheet.

"Due to the stressed condition of the credit market as a whole and the unprecedented speed at which rumors and speculation travel and echo through the modern financial media environment, the rumors and speculation became a self-fulfilling prophecy," Schwartz told the senators. "There was, simply put, a run on the bank."

Sen. Richard Shelby (R-Ala.) asked the corporate-welfare recipient whether he shares any blame for his indigent circumstances. "Do you believe that your management team has any responsibility for the company's collapse?"

Schwartz could think of no missteps -- not even his decision to remain at a conference at the Breakers in Palm Beach while his firm was imploding. "I just simply have not been able to come up with anything, even with the benefit of hindsight," said the blameless chief executive, escorted into the hearing room by superlawyer Robert Bennett.

Fortunately for Schwartz, he had a sympathetic audience in the banking committee, whose members have received more than $20 million in campaign contributions from the securities and investment industry, according to the Center for Responsive Politics. "I want the witnesses to know, and others, that as a bottom-line consideration, I happen to believe that this was the right decision," Chairman Chris Dodd (D-$5,796,000) said before hearing a single word of testimony.

"You made the right decision," Sen. Evan Bayh (D-$1,582,000) told the regulators who worked out the loan guarantee.

"The actions had to be done," agreed Sen. Chuck Schumer (D-$6,162,000).

Only a minority of senators, particularly those with smaller pieces of the campaign-cash pie, dissented. "That is socialism!" railed Sen. Jim Bunning (R-$452,000). "And it must not happen again."

[AJ]

While it's undoubtedly true Massachusetts has too many restrictions on building (mostly the fault of our local government finance structure that make almost all new housing a net loss to the town's finances), it's not clear that unrestrained housing construction has been a net boon in this crisis to those areas that allowed it. For example AZ or NV.

The tremendous growth that fueled Maricopa was driven by crazy speculative investment activity, both by investors and those who moved their families into the city. Some new homes have been reduced in price by 50% and are still not selling, because auction and bank-owned signs are everywhere. Why buy a brand new home from a builder in a community that will probably not be finished, when you can buy one in a completed community for less than the construction cost? To complicate matters, most potential new residents do not have a down payment saved

City officials in Maricopa and many other high-growth cities have their work cut out for them. Construction in many outlying areas has ground to a halt, which means city officials in many cities will need to focus on all of the problems that come along with halted growth: abandoned homes, empty lots with stubbed utilities, infrastructure bonds that go into default, and rising local unemployment. I wish them well.

[Ken Houghton]

What kharris said about Glaeser and What Jim Said about Nevada, Arizona, and especially Spraw-at-Atlanta. Glaeser's current delusion is clear, and misplaced.

If the PED is really less than 1/3 on the downside what it was on the upside, then I really need to see ANY model that realistically justifies that regulation is the cause of the skew.

But, more to the point, where was Ed Glaeser when the bankruptcy law was reformed to make mortgage debt subordinate to (or, at best, pari passu) with credit card and other high-interest debt? He (and you, Mark) appear quite willing to apply risk-IR finance theory to home ownership ("An abundance of economic data show that when you make it more difficult for lenders to collect, interest rates rise and borrowing falls").

Making it so that the bankruptcy court cannot reduce interest or principal expenses on 20% debt makes it clear what a rational investor will do: default on the lowest interest-rate, "safest" debt.

If Ed Glaeser's use of finance theory was correct, credit card debt should now be running at or below the interest rate offered to home buyers. (Below for precisely the reason cited above: the bank does not necessarily know if the purchase is a second or higher house, which is subject to cramdown.)

Since CC IRs are not LQ mortgage debt, we can safely dismiss the claim that allowing reducing mortgages to FMV would result in IR increases, since greater security of CC debt has not produced lower rates.

If you want to use a theory, then you should be able to show either (1) that the theory is new and has not been tested or (2) that it has been tested and appears to work.

In the case of IRs and risk, neither is true, and Glaeser's claim is absurd in the face of the evidence.

[lonesome_moderate]

jim:Arizona and Nevada, which have essentially no land use restrictions, are in as bad a shape as California and much worse shape than BosWash. Atlanta isn't doing so hot either.

It's not zoning.

My impression is that it does, but not directly. Some of the biggest bubbles have been in places with relatively liberal zoning that are fairly near to places that are already built-up. For example, prices have been stable on the San Francisco Peninsula, but have taken a huge dive in the areas just to the east of the Bay Area (Stockton, Sacramento, etc.).

[lonesome_moderate]

The state's housing market is doing well relative to California, where average prices have fallen by 26 percent. ...

The overall value of the state's housing stock can't possibly have fallen anywhere near that much; this has to be some kind of statistical glitch. Perhaps this is because of the large number of foreclosures and forced sales in post-bubble areas. That could cause a disproprionate share of the recorded sales to happen there, depressing the average price.

[zuzu's petals]

As a non-economist, this is an enlightening discussion--many thanks.

May I ask a dumb question? If distressed homeowners choose Chap 13 bankruptcy in seeking to keep their homes, and if the bankruptcy judge finds evidence of mortgage fraud in their loan documents (which apparently is fairly common) then can the judge let the homeowner stay in the home, and tell the lender to suck it up & eat the loss because the fraudulent lender wrote the loan with "dirty hands" in the first place?

Is this can of worms-- mortgage fraud-- a possible reason why so many folks are loathe to want bankruptcy judges any further involved in the mortgage mess?

[ndd]

PSP, appreciate the input. I'm trying to recall where I got the first information, but haven't located it. Even if true, however, I have found information that primary residence cram downs were permissible before 1978. As I recall, the 1950s and 1960s were not terrible decades for home mortgages.

In addition to your list, you can also have the bankruptcy court cram down a loan on a yacht. So clearly the solution to our problems is to have people move out of their tract homes and into yachts and then declare bankruptcy.

[baileyman]

Thoma needs to justify why he thinks judges in commercial bankruptcies SHOULD have the right to rewrite contracts, which they do.

[dd]

sgc, there is a way to support the secondary markets without bailing out homeowners; but it involves support for pricing in innovative products until the magnitude of the real losses can be calculated and the situs determined. It may be that secondary mortgage instruments all take a manageable haircut. Oddly helping homeowners adds more complexity and uncertainty to that process. If aiding homeowners would aid secondary markets and investment banking there is no doubt Paulson would be backing the efforts. Just an observation.

[dd]

The Fed's $29 billion dollar loan portfolio supports pricing for a wide range of financial products including ABS and commercial MBS. "Various loan obligations" could include CDS:
"The portfolio consists of collateralized mortgage obligations (CMOs), the majority of which are obligations of government-sponsored entities (GSEs), such as the Federal Home Loan Mortgage Corporation (“Freddie Mac”), as well as asset-backed securities, adjustable-rate mortgages, commercial mortgage-backed securities, non-GSE CMOs, collateralized bond obligations, and various other loan obligations."
http://www.newyorkfed.org/newsevents/speeches/2008/AnnexII.html

So the secondary market will be supported (also through lending facilities). But what of homeowners and the Fed's policy take:
"In addition to these monetary policy and liquidity actions, the Federal Reserve has been working with community groups and housing advocates across the country to help homeowners navigate the complex challenges of higher resets and falling home prices. The Federal Reserve is actively working with homeowners and communities to identify solutions to avoid foreclosures and their negative effects...."
Geithner testimony: http://www.newyorkfed.org/newsevents/speeches/2008/gei080403.html

Notice not a hint of any other type of "appropriate" help for homeowners or support for such measures. Reading the "policy" portion of the testimony it contains only mention of "reducing avoidable foreclosures."

This again indicates homeowner "bailout" presents more problems than it solves in terms of mortgage products and related hedges. It would also pretty much foreclose re-starting the securitization engine because of the additional uncertainties.

[Bruce Wilder]

Via Calculated Risk, I read an interview about conditions in Denver U.S. News did with Ryan Tomazin, the director and chief financial officer of Integrated Asset Services, which tracks real estate prices for banks, investors, and others.

We're seeing historic all-time highs for foreclosures, all those types of things that are currently the storylines. But within the city, there are areas that are very hard hit in Denver, and yet there are areas that have been relatively unaffected or even appreciating. . . .

In Denver specifically, what we're seeing is there are some neighborhoods that are very valuable—old historic neighborhoods. Their values have historically held up just because there is a limited supply. They are located very centrally, and they are in fairly affluent areas.

And, what about the areas of greatest price decline?

Denver had some of the most unregulated lending practices in the country. And many of the borrowers in these areas are not able to meet the new payments of the adjustable-rate mortgages.