“Cramdown” Legislation Fighting for Life…

… here’s hoping it dies.

In a March 13 article by the Wall Street Journal, Senator Bob Corker (R-TN) said, “The Momentum has swung against cramdown.” He was referring to the Senate’s attempt to pass legislation that would grant bankruptcy judges more authority to rewrite the terms of mortgages for struggling home owners.

The cramdown authority is favored by the White House, as part of its broader housing plan. But the idea has faced stiff competition from the financial community. And for good reason, since cramdowns would essentially destabilize all future mortgages and raise the rates for lower collateralized mortgages even higher.

Last week, the movement for cramdowns hit another snag. A Bloomberg April 16 article cites Sen. Dick Durbin’s (D-IL) office as stating the “sticking point” is whether cramdown laws should only apply to loans in a specific timeframe. But if even if that passed, there is always the possibility that Congress will come back and extend the dates, so mortgage issuers still have to worry about the future, not to mention their current contracts which they signed without knowing the government was going to just come in and change them to protect the homeowner.

A cramdown bill has already passed the House, but there aren’t enough votes for it in the Senate. Thus Senator Durbin’s office has created a compromise that, among other things, would:

  • force homeowners to accept loan modification under the Homeowner Affordability and Stability Plan if they qualify for that, instead of asking a judge for a cram down;
  • give property value increases over the first four years of any new mortgage contract created by a judge back to the banks (a “clawback”);
  • limit the amount judges could reduce and gives them more direction for how to value property; and
  • only count for loans between 2009 and 2014 under $729,750.

So as long as you don’t have a $729,751 home, you could be okay. Though the banks won’t. But even this compromise is being opposed by the National Association of Federal Credit Unions. The NAFCU came out against the proposed compromise today, “throwing a kink” into the compromise negotiations. Banks and lenders just don’t want to have a judge dictate terms of their contracts without any recourse. And understandably so.

Banks understand their own balance sheets. If they have homes that are dragging them down then they should be willing to negotiate with the homeowner. If the banks are stable, and are comfortable taking a home into foreclosure, then why should a delinquent homeowner receive special exception for not being about to pay the bank? Why should the bank lose money because the person it loaned money too can’t pay?

I understand that politicians want to try and keep their constituents in their homes. I get the desire to help people. What I fail to understand is why all the thought process is short-term. The moral hazard created by government actions like bailouts, stimulus packages, and cramdown legislation is doing inreperable damage to future economic growth as entrepreneurs and bankers will have pause in considering their business deals, wondering if the government will come along to wreck their hard work.

Reason contributor Mike Flynn also wrote on cramdowns here.