Cramdown smackdown

The American Prospect has a good wrap-up of the political situation surrounding the recent defeat of “cramdown” legislation (starring Illinois’ own Senator Dick Durbin).

Cramdown is when a bankruptcy judge can reduce the amount of a mortgage once a person goes into bankruptcy court. Current law forbids a judge from lowering the amount of a first mortgage (although judges can reduce second mortgages).

The benefits to bankrupt homeowners are pretty obvious. They could emerge from bankruptcy with a mortgage that they could actually afford.

The mortgage bankers obviously would lose plenty of money on existing mortgages held by people who are going under (which could further hurt the banks in the short-run, leading to more bank bailouts, presumably).

But the bankers also say that allowing cramdown would ultimately increase borrowing costs because they’d have to protect themselves against people going into bankruptcy.

To which I say, so what?

We actually need less borrowing and debt by American households going forward. It’s the debt overhang of both U.S. households and companies that made this particular financial crisis so devastating. Incomes may collapse, but debt remains the same. Raising the price of mortgages should lead to fewer of them and at lower dollar amounts.

And, by the way, if the dollar value of mortgages declines, house prices likely will, too. Prices will have to adjust to the fact that there would be fewer mortgage dollars available to buy the houses out there. That’s a benefit to first-time buyers and other people who want houses.

Of course, that’s cold comfort to people who bought houses at the peak (like me). Many, many people have seen their home equity wiped out (not me) and severely cut (like me). I would like to see more programs addressing this specific issue, particularly for those who are wiped out (again, not me). I don’t think it should be a permanent policy. It should be an emergency measure – like all of those confounding, multi-billion-dollar Wall Street bailouts. We could design something for households – for the people – caught up in this mess that would allow them to begin rebuilding their economic lives and, in turn, the nation’s prosperity.

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