Thursday, January 01, 2009

No to "Cram Downs"

In a "cram down," according to the WSJ yesterday, "a judge modifies a mortgage [usually in foreclosure or bankruptcy proceedings] so a borrower can afford it." The article did not explicitly describe the modifications in question, but the variables would include lengthening the term, lowering the interest rate, or simply decreasing the outstanding loan balance. In other words, the borrower's obligation to pay back what he borrowed would be significantly reduced.

Right now, judges do not have that authority, but the WSJ reports that momentum is building in "Democrat-controlled Washington" to confer that power on bankruptcy judges.

The moral hazard here is obvious: Borrowers will be less careful about the obligations they assume. Furthermore, the cost of borrowing will increase, as the risk of default will shift back to the lenders who will, in turn, raise their rates to compensate for it. By raising their rates, people who might otherwise have afforded a mortgage on a new home might be frozen out.

And "cram downs" may not work. According to the WSJ article, "Lenders argue that loans modified by bankruptcy judges often have high rates of default on the new payment plans." (I assume that this has been in situations where the lender consents to the modification.)

Email your Congressman.

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