I favor cramdowns for now, becauseLike 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.
We’re approaching the point of recognition, at least. Whether we’ll be able to survive the outcome is another matter.
While I agree with the proposal, I can’t see how it does anything to home values but drive them down further and faster. And that seems at cross purposes with the authorities’ frantic efforts to put a “floor” on home prices through the purchase of MBS paper, not to mention its (quasi? I’m still not sure)guarantee of agency debt.
It’s also amusing to read how TPTB are spinning Citi’s endorsement of the plan as some kind of key breakthrough. $45 billion ought to buy at least that much…….
Seems like a cramdown could work out to be in the banks’ best interest: like a ‘short’ sale, it should usually have a much better result than a foreclosure, since foreclosures are so toxic (abandoned property deteriorates, buyers see foreclosed properties as suspect). With equity participation, it works much like corporate bankruptcy: the homeowner’s equity is wiped out, and the debt is partially replaced with new equity. Not ideal, but usually better than liquidation.
I don’t like the idea of a cramdown. Here’s why:
Cramdowns create what is effectively a position in real estate with a put option (a hedged position, if you will). The problem is that they never paid the premium up front for that put.
As someone who has been saving for the past several years to buy a home, it’s annoying to think that I could have just bought the biggest house possible on easy credit, went into foreclosure and then had the principal on the loan marked down to whatever I can afford.
For corporations, bailouts lay down the foundation for excessive risk taking in the future (because if I take excessive risk and run the company into the ground, the gubmint will save me, and the upside potential is unbalanced by risk of serious loss).
Likewise, it seems like this will create the same moral hazard for borrowers: Borrow as recklessly as possible and then if you can’t afford it, the loan gets marked down to whatever you can afford.
And the assumption that the cramdowns hurt the lenders to the point that they tighten lending standards is inconsistent with the American financial model. Right now, the government is saying from all points that lending needs to loosen. Additionally, the corporate bailouts create an environment where lenders probably don’t feel the pain from the cramdowns because the loss is simply absorbed by the bailout money.