Audit Notes: Spruced Up Reform, HAMP Failure, Cramdown

David Weidner nails it with a piece on financial reform.

I’m glad someone else agrees with me on this:

Financial overhaul is the law of the land, but while it is true that the Dodd-Frank Act is a sweeping bill for the financial industry, it is hardly the most sweeping bill for Wall Street since the Great Depression as many argue.

That distinction goes to a law passed in the Internet age, the Gramm-Leach-Bliley Act of 1999.

And this is a great point:

We think the modern age of hedge funds, computerized trading, consumer finance, securitization, globalization, private equity and other relatively recent developments is so far removed from the realities of the 1930s that solutions that worked then seem quaint now. Separate investment and commercial banking? Oh, how innocent we were!

Nothing could be further from the truth. The modern financial world is the one that is naive. It slogs from one economic cycle to another without any short-term memory, much less a sense of history. Modern finance is Narcissus with every new gilded age fueled by technology or a real-estate bubble and absolutely stunned when wealth without work is exposed by harsh reality.

Only once have the people with power had the clarity to recognize that the financial world’s problems were structural. As John Kenneth Galbraith wrote in The Great Crash of 1929, the causes of the Great Depression lay in fundamental problems: uneven distribution of wealth, poor corporate structure susceptible to reverse leverage, imbalance in the world economy, a lack of economic intelligence and, for the financial world: bad banking structure.

There’s no structural reform in the new law. As Weidner says, it just “spruces up the house. Gramm-Leach-Bliley undermined the engineering.”

Read the whole thing.

— The Huffington Post’s Shahien Nasiripour and Arthur Delaney look at the failure of the Obama administration’s foreclosure prevention policies.

They’re good to note that the policy was “extend and pretend”—it’s allowed banks to delay writing down loans that ought to be written down. And it’s helped the entire housing market by slowing the flood of foreclosures.

But at what cost? It would be better for many or most of these homeowners if they just walked away.

More than 529,000 homeowners have been kicked out of HAMP through June, Treasury figures show. About 1.2 million entered the program with a promise and expectation of permanent relief. Roughly 389,000 are benefiting from the “permanent” modifications guaranteed to keep their payments down for five years.

Lenders have repossessed more than three times as many homes during this time.

And the administration’s spin is pretty shameless:

Treasury Department officials downplayed HAMP’s role in the administration’s foreclosure prevention efforts in an interview with HuffPost, insisting that the goal of helping three to four million people is broader than just HAMP or even the umbrella program under which it falls, Making Home Affordable.

“Foreclosure prevention was only one piece of the administration’s approach to stabilize the housing market that included… interest rates at historic lows [for] increased affordability and refinancing, support for [Fannie Mae and Freddie Mac] to make sure there was a mortgage market available, and the homebuyer tax credit to stimulate demand,” says Phyllis Caldwell, chief of Treasury’s Homeownership Preservation Office. “HAMP is one part of foreclosure prevention.”

Nice work by the HuffPo.

— What would actually work? Some people have supported the unfortunately named “cramdown,” which would allow judges to reduce mortgage principle in bankruptcy cases. Most banks have fought this tooth and nail (Bank of America being an exception), but Calculated Risk points to new research from the Federal Reserve that says cramdown worked in a previous farm-lending crisis.

What is interesting about the creation of Chapter 12 for the current debate on allowing stripdowns of debt secured by a primary residence is that the Congress responded to the farm foreclosure crisis of the 1980s with legislation that contained a stripdown provision. Stripdowns were permitted for farmers because voluntary modification efforts, even when subsidized by the government, did not lead agricultural lenders to negotiate loan modifications. At the time, opponents of stripdowns made the same arguments people are raising today: Allowing stripdowns would flood bankruptcy courts, permit abuse by borrowers who could afford to pay their loans, and reduce the availability of credit, among other things.

The actual negative impact of the farm stripdown legislation was minor. Although the legislation created a special chapter in the Bankruptcy Code for farmers and allowed stripdowns on primary residences, it did not change the cost and availability of farm credit dramatically. In fact, a United States General Accounting Office (1989) survey of a small group of bankers found that none of them raised interest rates to farmers more than 50 basis points. While this rate change may have been a response to the Chapter 12, it is also consistent with increasing premiums due to the economic environment. This suggests that the changes in the cost and availability of farm credit after the bankruptcy reform differed little from what would be expected in that economic environment, absent reform.

What was most interesting about Chapter 12 is that it worked without working. According to studies by Robert Collender (1993) and Jerome Stam and Bruce Dixon (2004), instead of flooding bankruptcy courts, Chapter 12 drove the parties to make private loan modifications.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.