Economists at the Federal Reserve Bank of Cleveland see parallels between the current national housing and finance crisis and the 1980s farm crisis, suggesting a solution from then may point us out of the current mess.
In the Cleveland Fed analysis, Stripdowns and Bankruptcy: Lessons from Agricultural Bankruptcy Reform, economists Thomas J. Fitzpatrick IV and James B. Thomson point to changes in the 1987 bankruptcy law that allowed judges to write down mortgages to current land market values and effectively order lenders to restructure the loans.
That component played a key role in ending the 1982-1987 farm financial crisis, recalls St. Paul banker Larry Buegler. It cleared legal obstacles to restructuring, or rewriting loans, he said, even though the “tipping point” that made loan modifications work came from stabilizing land values.
As president of the St. Paul Farm Credit Bank (now known as AgriBank FCB) in 1987, Buegler worked on shaping what became federal law that year and on starting a land values guarantee program for Midwestern farm mortgages.
“The Cleveland Fed is asking the same question we asked ourselves in ’87,” Buegler said. “Is it cheaper to restructure, or foreclose?”
The 1987 changes in ag credit and bankruptcy laws that paved the way to recovery largely came out of bipartisan leadership from then-Sen. Rudy Boschwitz, R-Minn., Rep. Collin Peterson, D-Minn., and farm-state allies such as Sens. David Boren, D-Okla., and Richard Lugar, R-Ind.
Two years ago, Minnesota 2020 teamed with Buegler, crafting a Minnesota home values program based on that experience as a way of fixing the current housing crisis.
Today’s Housing Picture
At the current rate, more than 1 million homes will be lost to foreclosure by the end of this year. That’s up from about 900,000 in 2009, and a “normal” annual rate of about 100,000 foreclosures.
Nearly 50 percent of the 1.3 million homeowners enrolled in the Obama administration’s mortgage relief initiative have fallen out of the program, reported Associated Press economics writer Martin Crutsinger on August 20.
He also warns that Moody’s is forecasting a combination of 1.5 million foreclosures or short sales – where homeowners or lenders sell homes for less than is owed – in 2011.
This will bring even more downward pressure on home values going forward. And from Buegler’s perspective, no one should be surprised. Despite some statistical improvement in Minnesota, unemployment remains high across the nation in real terms. That doesn’t help stressed homeowners keep current on debts – restructured or not.
Connection to 1897
Sara Lepro, writing in the Aug. 17 American Banker magazine, said the Cleveland Fed noted that opponents of the 1987 farm credit reform used the same arguments heard about mortgage reform efforts today. Namely, that “stripdowns,” now often called “cramdowns,” would flood the courts with bankruptcy petitions that could lead to higher interest rates on mortgages.
But, she noted the economists’ study found that it had no statistical impact on the cost or availability of credit. Moreover, she said, the economists found that the farm credit program “worked without working.” Its mere presence on the books was enough to get lenders and borrowers working out their problems.
That is true. But the underlying reason the changes in bankruptcy law “worked without working,” Buegler states, is because the then and still largest agricultural mortgage lender in the Midwest was guaranteeing farmers and lenders alike that farmland values wouldn’t fall any further. His St. Paul bank guaranteed borrowers it would make up the difference in land purchases for five years ahead, thus assuring that new farm loans would not fall “underwater.”
That was a “tipping point,” Buegler said, referring to a concept and the title of one of his favorite books, The Tipping Point, by journalist and sociological writer Malcolm Gladwell. In it, the author cites occasions when society changed, an epidemic spread, or other “small” things occurred that altered personal or societal behavior.
With a combination of actions in 1987, the farm financial crisis ended almost overnight. A tipping point was when farmers became convinced that land values would fall no further. They started buying land again and thus restored land prices. And when lenders and borrowers learned they could restructure existing loans without triggering lawsuits, they went about the task without having to be ordered to do so by the courts.
Consumer confidence, business and investment confidence now appear to hinge on something that will tip society into getting back into markets, expand employment and stabilize housing values.
The Farm Credit Bank in St. Paul quickly learned it could restructure 80 percent of its troubled farm mortgage portfolio and get its borrowers back on their feet and making payments.
About 10 percent of borrowers had the capacity to make payments, but didn’t. There were probably different reasons why, but Buegler said some farmers were probably like today’s borrowers who know they can buy the house across the street for 30 percent less than their existing mortgage.
Finally, there were 10 percent of borrowers that had no capacity to pay off or keep current on an existing or restructured farm mortgage in the 1980s. While that raises questions about prior farm lending practices, there was little that farm credit banks or other lenders could do but foreclose in those circumstances.
Looking back, Buegler said those borrowers were like today’s homeowners who have lost their jobs and incomes or suffered other problems that make paying mortgages impossible. Foreclosures, short sales and property abandonment were the only remaining options.
“We need a ‘tipping point’,” he said, referring to today’s housing markets. He’s not sure the same profile of troubled mortgages from the 1980s applies to today’s housing market. But this much he does know, he said: “This is the most affordable period to own houses in recent memory.”
Just what could tip the market isn’t clear. The time window on the Minnesota home values guarantee proposal “may have closed” because the housing market’s problems have spread and the state’s ability to intervene has become more compromised. But it might be part of an aligned federal-state effort if existing housing programs are retooled.
Sen. Dick Durkbin, D-Ill., has one proposal before Congress along the lines the Cleveland Fed economists discuss, although Buegler hasn’t studied it. Lepro, in the American Banker, said that bill has been held up in Congress with opposition from mortgage bankers and Republicans.
Bankers and others have philosophical problems with changing terms of contracts when other borrowers keep current making payments, Buegler said, recalling opposition he faced in the 1980s. That is understandable, he added, although bankers and others can come around when consequences of inaction become clear.
Some of Durbin’s problem may be timing. By 1987, bipartisan members of Congress from farm states did work together to combat shared problems. Obstructionism wasn’t a political strategy aimed at the next election.
Despite all the hardships the housing crash is now causing, we still have more political warriors than problems solvers in Congress. That environment, too, needs a tipping point.