Sunday, July 3, 2011

Banks Reducing Principal for Current Mortgage Borrowers

A New York Times report has shed light on a new program being implemented by the TBTF (too big to fail) bank zombies where mortgage borrowers are being given principal reductions even though the borrowers were current on their loans.

From the story:

Two of the nation’s biggest lenders, JPMorgan Chase and Bank of America, are quietly modifying loans for tens of thousands of borrowers who have not asked for help but whom the banks deem to be at special risk.

Rula Giosmas is one of the beneficiaries. Last year she received a letter from Chase saying it was cutting in half the amount she owed on her condominium.
Ms. Giosmas, who lives in Miami, was not in default on her $300,000 loan. She did not understand why she would receive this gift — although she wasted no time in taking it.

Banks are proactively overhauling loans for borrowers like Ms. Giosmas who have so-called pay option adjustable rate mortgages, which were popular in the wild late stages of the housing boom but which banks now view as potentially troublesome.
Before Chase shaved $150,000 off her mortgage, Ms. Giosmas owed much more on her place than it was worth. It was a fate she shared with a quarter of all homeowners with mortgages across the nation. Being underwater, as it is called, can prevent these owners from moving and taking new jobs, and places the households at greater risk of foreclosure.

The article discusses pools of ARM loans that Bank of America and Chase purchased from other bankrupt lenders. Because current ARM loan borrowers were at high risk of default, the banks elected to hedge by giving them principal reductions. It makes sense from an economic point of view because delinquent borrowers can live in the house for years without making a payment and the risk of the house being trashed and looted increases exponentially. Ms. Giosmas elected to dump the place a few months later making a tiny profit LOL. Fucking Greeks.

The hope for student loan leveraged CDO grads is that principal reductions occur on a larger scale for delinquent mortgage borrowers. This way the idea of “jubilee” becomes more mainstream and also gives us more ammunition to reform the current system. In addition, the larger the difference in the treatment of mortgage borrowers vs student loan borrowers becomes, the more we can show how gross the inequity is in the matter. Again, mean reversion in play. Putting it simply, the mortgage borrower whose home drops 50% relative to the debt they owe gets his debt wiped out. The student loan borrower whose earning potential drops 50% relative to the debt they owe grows bigger and bigger. At the end of the day, both borrowers assumed that the asset they borrower to acquire was worth the debt they incurred. While in housing we see a correction taking place, the same scenario is absent in the student loan market.

Anyway this development is huge and a step in the right direction. So long as banks implement principal reductions without requiring more tax payer bailouts, this is a great way to get the housing market on the right track. Personally I’d rather see these TBTF be taken apart, sold off into parts and create 100 new banks out of each TBTF. Instead of 4 monster banks, we can have 400 new banks. There goes systemic risk as the risk is now spread out amongst 400 players instead of 4.

In addition, we can use this story in our fight for student loan reform. At the very least, the department of education can reduce student loan principal for delinquent borrowers back to the original amount they borrowed. However, gross principal reductions across the board would be great for the borrower and the economy as less money gets sucked into the student loan black hole. The fact remains that for many in this country, the amount of debt they owe versus their realistic earning power is grossly mismatched. Adjusting existing debts to current labor market realities would provide a jump across the economy and provide emotional rejuvenation to hundreds of thousands of borrowers.

Every 50 to 70 years the country needs a jubilee. We saw jubilee in the 30’s and we will see jubilee in the years ahead. From Wikipedia, take a look at what the ancient Babylonian kings would do:

These Babylonian kings (to whom could be added Ammizaduga) occasionally issued decrees for the cancellation of debts and/or the return of the people to the lands they had sold. Such "clean slate" decrees were intended to redress the tendency of debtors, in ancient societies, to become hopelessly in debt to their creditors, thus accumulating most of the arable land into the control of a wealthy few. The decrees were issued sporadically. Economist Michael Hudson maintains that the Biblical legislation of the Jubilee and Sabbatical years addressed the same problems encountered by these Babylonian kings, but the Biblical formulation of the laws presented a significant advance in justice and the rights of the people.

Maybe our leaders can be enlightened with some wisdom from the past. But in the end, I believe that the forces of reality will force some time of resolution in the years to come as total US credit market debt exceeds $52 trillion. It can’t be repaid and won’t be repaid. And once this issue of debt repudiation gets resolved, we will all be able to move on from this current period of debt resolution. Whether its Dubai, Greece, Ireland, Portugal, Spain, Italy, Japan, China (off balance local level debt of over $3 trillion), California, or the United States, the main headline concerns DEBT. They holders of the debt can fight the current as much as they can but in the end I believe they will lose. It’s frankly a matter of scale. There’s so many of us and so few of them. How all the people of all the world ended up owing so few others is beyond me. But per the ancient Babylonian decree of Jubilee it must be human nature to create incredible ponzi schemes that blow up.

I will be following this story in the weeks ahead as more information comes out.
Happy 4th of July!


  1. Two quotes from that article that I think are worth including here:

    "Being underwater, as it is called, can prevent these owners from moving and taking new jobs, and places the households at greater risk of foreclosure."

    That's the case, certainly, in student lending, but the consequences must be multiplied 10- or 100-fold. Just as we can all quantify the lost opportunity cost of attending college and then some kind of further professional education, so you can quantify the cost of the proceeding brain drain. Add in outsourcing and spite - I've got a lot and maybe some for someone who might be experiencing a shortage - and that adds up to a self-perpetuating disaster for federal coffers.

    And this, well, this is just yet another demonstration of the car-crash arrogance of these mutants. Moral hazard already lost its virginity. This is the rapist impugning his victim for losing its virtue.

    "Bank of America’s chief executive, Brian T. Moynihan, told the attorneys general in April that cutting principal for current borrowers would send the wrong message to all those who have struggled to pay their bills"

  2. Law School did Fuck me...
    I'm barely alive...

    Obama did spunk me...
    Our leaders so jive...

    The J.D. to make me somebody...
    Put on a suit, a tie...

    Give me a place, stucture, order...
    Feel like I'm special inside...

    But the dream has crashed...
    I'm lost, in a cloud....

    Awaiting the Feuhrer...
    So that I can goosestep around....

  3. A representative of the ABA: "Let the market decide!"

  4. Not trying to be argumentative or anything, but the article is about someone who was current on their (toxic) loan, but got a principal reduction (on a loan that was unlikely to be paid anyway).

    To make an analogy-- the person in the story is like the hapless culinary students who borrowed six figures after being promised a high salary, only discover that the only gigs were making $10 an hour at a a pizzeria or diner.

    Law students and lawyers are unlikely to see this amnesty-- in fact, if anything, it will probably be everyone but lawyers. The reason is that it's too easy to get back on your feet with a law degree. And I say this as someone who's shelling out $1,100 a month on student loans, so I would very much like to see some solution, but I just don't see it.

  5. So those in dire straights are screwed, and unlikely to receive assistance - while those not in need of a reduction in their outstanding balance receive help?! That is sickening.

  6. I didn't understand why the banks were doing this until I read this blog post:

    It's an attempt to create a "carrot" for those paying their mortgages on time in combination with the "stick" of foreclosure. As more and more people are seeing foreclosure as a meaningless threat, the banks have to come up with another response.

    There will be no Jubilee. Instead, if there's anything for student loans, there will be widely reported stories of (limited) incidents of loan forgiveness for people who continue to pay their loans. These stories, however, will be like the winners of the "Running Man" game (remember that movie?).

    Pretty much the only solution I see here is massive inflation. The only way these debts are going to become manageable are if they get inflated down to the cost of a Chevy Malibu or Ford Focus. Look at it this way-- 15 to 20 years ago, a Big Law salary paying $65,000-80,000 was considered a great deal.

  7. There is no solution; the system is captured and will not likely be fixed.

    The response is to initiate and grow the *Debtors' Revolt* - intentional, strategic, 'efficient breach', where everyone simply refuses to service their debts - and once defaults reach a critical mass, the financial sector spirals into a desirable collapse. Rebuild from there, from scratch, with fair rules and responsible stewardship.

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