Cramdown would slow housing recovery

Freedom New Mexico

As the ineffable H.L. Mencken once put it, “For every complex problem there is an answer that is clear, simple, and wrong.”

An example now working its way through the Senate is the proposal, embraced by President Barack Obama and passed (in a worse version) by the House to allow bankruptcy judges to reduce the principal owned on a mortgage, a practice popularly known as a cramdown.

It has the air of plausibility, but if passed it would make it even more difficult for people, especially first-time buyers and people with low-to-moderate incomes, to get mortgages and own houses.

To make matters worse, it would help only a few people avoid foreclosure, and likely those least in need of help.

It might seem sensible for people who find themselves in financial difficulty due to job loss or other circumstances related to the recession, or “upside down” on their mortgage to be able to declare bankruptcy and have a judge reduce the principal or interest rate on their loan. But this would create bigger problems for more people down the road.

If bankruptcy judges had the power to change the terms of mortgage contracts unilaterally, that would represent an additional risk for lenders. Additional risks are generally handled by changing the terms of contracts to minimize the impact of those risks. In the case of mortgages, this would almost certainly take the form of requiring a larger down payment or a higher interest rate.

These added costs would fall with disproportionate impact on lower-income would-be homebuyers or on first-time homebuyers who do not have equity in an existing home that they might be able to pull out to make a down payment. Thus fewer people would be able to take advantage of bargains that exist due to foreclosures and falling home prices — which would slow down recovery in the housing market.

The financial-services industry is divided in its approach to the proposal. Some banks are negotiating with Illinois Democratic Sen. Richard Durbin, the point man in the Senate on this proposal, to modify it to make it less onerous. Others — the Mortgage Bankers Association and the American Bankers Association — oppose the idea in any form.

The best bet would be for negotiations to reach an impasse and for the cramdown idea to die. One can understand the desire to want to reduce the number of foreclosures, but this proposal would create many more problems than it would solve.