Don’t Cave On Cramdowns

From CongressDaily, via the Wonk Room:

“Senate Majority Leader Reid said today he would drop a cram-down provision from a House-passed banking bill if the language threatened to keep the Senate from passing the overall bill. The provision would allow a bankruptcy judge to reduce a homeowner’s mortgage principal. “If we can’t get the votes for that, and I am hopeful we can — I am semiconfident we can — then what I’ll do is take that off [the bill] and do the other banking provisions,” Reid said at a Christian Science Monitor breakfast. Reid said he would work to keep the package intact, but raising the prospect of pulling the provision seemed to acknowledge assertions by Sen. Evan Bayh, D-Ind., and others that the cram-down bill cannot pass due to opposition from Republicans and some Democratic moderates.”

As I’ve said before, caving on cramdowns would be a big mistake. Presently, every other form of secured debt can be written down to its present value in bankruptcy, provided the borrower can make payments on it at its new, reduced value. Allowing cramdowns would simply treat mortgages like any other form of secured debt. This matters for a number of reasons.

Often, the alternative is foreclosure. Foreclosures are not good for anyone: not the homeowner, not the neighborhood, not the bank. Banks are now starting to walk away from foreclosures: this means that after a homeowner has gotten a foreclosure notice and moved out, after the now-vacant property has been vandalized or turned into a crack house and lost a lot of its value, the bank refuses to take title, and the homeowner is stuck with both the house and the debt s/he can’t pay.

One reason this happens is that if the mortgage has been securitized, it’s very hard to locate all the people who now own a tiny little piece of it, let alone to get them all to sign off on renegotiating it. Cramdowns would get around this problem: bankruptcy judges can write a mortgage down to the present value of the home unilaterally, without having to get all the people who own some part of the mortgage to sign off.

Another is that banks are sometimes unwilling to write down a mortgage because they do not want to have to write down any comparable mortgages they might have on their books. If the mortgage is, in fact, not worth as much as they value it at, then they ought to write it down, along with any comparable mortgages. Bankruptcy judges do not take into account banks’ desire not to acknowledge losses they have already taken, nor should they.

Besides all that, though, there’s a good economic case for allowing cramdowns. We seem to be rescuing a lot of companies lately. But it’s no good trying, for instance, to save GM if we don’t have customers who are able and willing to buy cars. As any number of commenters have said, we need to shore up the not just businesses’ balance sheets, but consumers’, since if they are not able and willing to spend, then even the best-run businesses will fail.

Some ways of doing this — e.g., putting people to work doing things that need doing — don’t involve problems of moral hazard. But any attempt to try to reduce people’s debts does. However, in the case of cramdowns, these concerns are a lot smaller than they would be otherwise, since in order to get this kind of debt relief, you need to declare bankruptcy. And no one likes declaring bankruptcy. No one declares bankruptcy just for fun. So the problem of moral hazard is, in this case, a lot smaller than it would be otherwise.

Allowing cramdowns is good for everyone. It’s good for homeowners, since if they could make payments on their house if it were written down to its present value, they get to stay in it. It’s good for the neighborhoods in which these homes are found, since it prevents abandonment and blight. It’s good for the housing market, since it means fewer foreclosed homes for sale. It’s good for the banks, except that they will have to acknowledge losses they ought to acknowledge anyways.

Caving on this would be a serious mistake. If your Senator is among those who are wavering, let him or her know how you feel.

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