Cramming Down - On Whom?

I favor cramdowns for now, because like the recently departed Tanta at Calculated Risk, I also favor the concept of cramdowns in mortgage foreclosure proceedings. It would bring balance to the negotiations, and discourage banks from making bad loans. If a bank could be forced to compromise during a foreclosure (odd because it is secured lending), the result could leave more homeowners in their homes, and with mortgages where the principal balances reflect current conditions.

In order for loan modifications to work, there has to be forgiveness of principal owed, though perhaps by granting the banks a part of the upside if the property is sold at a gain in later days. Forgiveness of principal allows the LTV ratio to remain whole, while reducing the payment at the same time.

But what does that do to the banks? The cramdowns cram immediate losses onto the banks. What if the actions of judges lead to the insolvency of banks? What if the possibility of future cramdowns lead mortgage rates to rise, in order to account for the risk? This is not a costless exercise in fairness.

Articles on the cramdown proposal:

• Lawmakers set new mortgage bankruptcy bill
• Stimulus Package to Include Cram-Downs: Report
• Banks to Lose a Security Blanket
• Plan to Cut Foreclosure Rate Clears Key Hurdle

I favor cramdowns for now, because it can be a win-win for the borrowers and banks. Leave the homeowner in place, who values the home, while making him pay something close to maximum sustainable monthly amount.

It makes the system more flexible, and at this point, that is a good thing.

Comments

[bosun.j:]

Agreed. Right on this time.

Jan 09 12:47 PM

[prudentinve...:]

The problem is that when the banks lose, savers and taxpayers are forced to fund their losses, either via below-inflation rates (ZIRP) for savers, or via increased taxes to pay for TARP, TALF, and their certain sequels.

So, at the end of the day, it is savers and taxpayers who are penalized to allow imprudent people to live beyond their means.

Jan 09 12:49 PM

[District Ba...:]

I've got to disagree with you here, David. If it was really a "win-win" situation for both borrower AND bank... wouldn't the bank voluntarily modify the loan? By definition, a 'cram-down' is forced on the bank, implying that (at least in the bank's view), the modification is not in their best economic interest.

Further, I disagree with your notion that, "[cram-downs] will discourage banks from making bad loans." Banks are learning all they ever dreamed about the penalties of mispriced credit. Just look at their balance sheets and stock prices. In contrast, I think you're sending the wrong message to the consumer, who borrowed (in many cases) irresponsibly to begin with.

Mortgage loans are black letter contract law, and should be treated as such. To the extent that cram-downs are implemented, they ABSOLUTELY should be forced on only those banks who have applied for, and received, government assistance in the form of TARP capital.

Finally, those banks who are having their credits 'crammed-down' should be allowed to participate in any upside in the property. Without that provision, you are letting borrowers (who bit off more than they could chew) off easy when times got tough, without giving banks a chance to benefit in the event the environment returns to that in which they originally wrote the mortgage!

Jan 09 01:04 PM

[Pent up demand:]

I don't think this is a solution. You can bet they will drop the principal just enough to put the borrower up to his eyeballs in debt vs. six feet underwater. So any future hiccup in cashflow puts them right back into foreclosure.

Not to mention the issue of refinancing these people into 30 year fixed mortgages at historically low interest rates. How do you think those assets will look (assuming they don't default first) 5-10 years down the line? Especially if, as I expect, our little ZIRP-TARP adventure results in high inflation/high rates.

Jan 09 01:29 PM

[Roger Knights:]

"there has to be forgiveness of principal owed, though perhaps by granting the banks a part of the upside if the property is sold at a gain in later days."

A win/win solution. Or at least a no-lose/no-lose solution. (Especially if the banks could count that upside potential as an asset, to avoid being adjudged insolvent.)

Jan 09 02:39 PM

[satellite r...:]

The author misses a much bigger point. Mortgages were the last survivors of a long list of solemn oaths that we make as Americans. Now it's possible to renege on pretty much every agreement that you pledged your commitment to fulfill. Marriage, credit card bills, auto loans, you don't have to commit yourself to the other party, there's a well-defined "way out" for all of these. Add to the list your oath to pay your monthly mortgage, now you can just have a judge rewrite the terms in your favor. This, in essence, is a severe fracture in the foundation of American integrity, which explains the direction of our financial foundation.

Jan 09 02:45 PM

[Alan Young:]

Sadly, recent reports suggest that modified loans are not usually enough to make under-equitized homeowners succeed at paying their mortgages.
But we lose too much as a society when people are forced out of their homes.
Why can't the mortgage holders take the title, reduce the payment to the current market rate, and tell the mortgagee/occupant that they are now renters rather than owners? That way we don't have people being forced out, we don't get more empty houses forced onto the market, the banks don't have to take a loss by selling into a depressed market, and the banks keep most of the income stream they bargained for. I've never understood why foreclosure must entail eviction--especially when innocent renters are living in the home.

Jan 09 03:51 PM

[dw57:]

not sure i buy that all of these folks were living beyond their means. and if they were , why didn't the mortgage brokers no make the contracts since they knew they wouldn't be able to afford it. and the old saw the government made me do it, doesn't cut. the vast majority of these contracts were written by brokers, not subject to CRA or much of any other laws. and some states were licensing brokers who had criminal records. even for robbery.



On Jan 09 12:49 PM prudentinvestor wrote:

> The problem is that when the banks lose, savers and taxpayers are
> forced to fund their losses, either via below-inflation rates (ZIRP)
> for savers, or via increased taxes to pay for TARP, TALF, and their
> certain sequels.
>
> So, at the end of the day, it is savers and taxpayers who are penalized
> to allow imprudent people to live beyond their means.

Jan 09 08:17 PM

[dw57:]

i doubt that they were the last survivors. they were just the latest get rich scheme cooked by brokers. to many assume that every body knows about mortgages. and has enough knowledge to know that they can't afford it. the brokers knew going in that these folks couldn't make the mortgage, but didn't care cause they didn't care if it got paid back or not. cause they made their commission in the first 3 to 6 months of the contract by selling it to some body else. the banks are in trouble because they thought that a mortgage was a mortgage, and that nobody would write one that they knew would fail. but for the lack of better words, some folks who had no business writing the contracts (in some states they were felons!) were doing so. and they then resold them to others. who didn't know what they bought! and the rating companies didn't. and every one is now paying the price for that!

On Jan 09 02:45 PM satellite radio is dead wrote:

> The author misses a much bigger point. Mortgages were the last survivors
> of a long list of solemn oaths that we make as Americans. Now it's
> possible to renege on pretty much every agreement that you pledged
> your commitment to fulfill. Marriage, credit card bills, auto loans,
> you don't have to commit yourself to the other party, there's a well-defined
> "way out" for all of these. Add to the list your oath to pay your
> monthly mortgage, now you can just have a judge rewrite the terms
> in your favor. This, in essence, is a severe fracture in the foundation
> of American integrity, which explains the direction of our financial
> foundation.

Jan 09 08:31 PM

[ferguson:]

I have read a previous proposal along the lines of the one advanced by Aalan that gave the renter the option of buying the home back after a period of time at the market price. It strikes me that, together, these are common sense approaches that would work in a minority of cases, but perhaps contribute to an overall solution. As for those who object to the "cramdown" of residential mortgages in bankruptcy, how do they justify the "cramdown" of far more frivolous purchases, such as vacation homes and BMWs? I suppose the answer is that the latter commanded higher interest rates in the first place. But, since the wealthy can readily afford those interest rates, the practical effect is to excuse the wealthy for irresponsible behaviour while offering no comparable break to those struggling to make ends meet or even to the average person. In this, as in many areas of taxation, policy offers a disproportionate share of benefits to the wealthy. Since equal treatment under the law is one of the foundations of our democracy, it seems to me that this disparity cannot and should not stand.

Jan 10 09:45 AM

[Old Rick:]

Disagree!! Cramdowns of residential mortgages amount to changing the rules and adjusting the score of the game at half time to benefit the team that is behind. What follows next when default recidivism rears its head (as it has already started to do) is that the rules will then be modified at the end of the 3rd quarter and then probably also at the end of the game. This will result in higher borrowing costs for everyone while the banks recoup their "halftime adjustments" and a lockdown on the ALT-A/subprime class, at least until Barney Frank and ACORN decide that everyone is "entitled" to home ownership.

I have no problem with cramdown rules if instituted before the game starts.

Jan 10 11:08 AM

[Augustus:]

Allowing cram downs will reduce mortgages to being the same risky loan that is the credit card debt. If cram down is allowed, lenders will only make these loans with at least 20% and maybe 25% down payment. Terms will be shorter to give the lender additional opportunities to evaluate the borrower credit condition. Rates will go quite a bit higher, reflecting the additional credit risk. Borrowers will simply have an optional "put" of the mortgage and the ability to exercise that "put" when it is most to the borrower's advantage. There will be no negative consequence to the borrower, they can keep the property that the lender will have bought for them at a sizeable discount. It is just nutty to believe that this can be a "solution". It will very much dry up mortgage credit and kill the securitization market. Who would invest their IRA money or money market funds in bonds backed by 95% LTV home loans subject to cram down discounts? House prices have to decline, no doubt. The owners will have to take the pain along with some lenders.

Suppose I don't have a home loan. My home value is decreasing along with all others. Who can I go to to get a cram down discount? It is just another way to screw the financially prudent and benefit the financially reckless.

Jan 10 04:41 PM

[Augustus:]

The ABA opposes Cram Downs.
An update to the news reporsts is here:

ABA: Citi Worked Alone on Cram-Down Deal
www.housingwire.com/20.../

Jan 10 11:21 PM