New Year's Cramdown

Will the cramdown survive into the next decade?

Banks have successfully lobbied against many proposed financial reforms, but perhaps none more strenuously than the cramdown -- a court-ordered reduction of a mortgage loan's outstanding principal. Although lowering principal is arguably one of the most effective ways to stem foreclosures, banks have killed numerous attempts to allow bankruptcy judges to cramdown.

As the year drew to a close, however, a surprising pattern was observed: more banks and thrifts were stepping up to the plate and lowering mortgage principals themselves, according to a report released in late December by the Office of the Comptroller (OCC) and the Office of Thrift Supervisions. Even though banks and hedge funds have spent millions to stop such regulations, they seem to realize the times are changing.
According to the report, mortgage modifications that include principal reductions increased to 13% of all modifications, up from 10% in the second quarter and 3% in the first quarter. Reducing a loan's principal to a number closer to the home's true market value not only decreases the monthly payment for struggling homeowners, it also gives them more reason to stay in a home that has lost value.

Over the past few years, banks have successfully blocked attempts to add a cramdown provision for primary home mortgages, even though bankruptcy judges routinely use it for all other types of loans for which an asset is the underlying guarantee. Even vacation home mortgages can be crammed down.

Last year, a cramdown bill passed the House of Representatives but failed in the Senate. After the big banks and hedge funds succeeded in killing the Senate measure, Dick Durbin spoke for many a frustrated citizen when he railed: "What price did Wall Street pay for their miserable decisions creating rotten portfolios, destroying the credit of America and its businesses? Oh, they paid a pretty heavy price. Hundreds of billions of dollars of taxpayers' money sent to them to bail them out, to put them back in business, even to fund executive bonuses for those guilty of mismanaging. Moral hazard, huh? How can they argue that with a straight face?"

Moral hazard is the favored defense invoked by Wall Street lobbyists to defend their position. In their view, people irresponsibly accepted loans and must now pay the price. But can we put all the blame on the people who bought a home that now is worth $100,000 or so less than what they paid for it? Wasn't the lender the professional in this deal? Shouldn't the lender take some responsibility for the bad choices made?

Obviously, the lenders don't think so, and the Congress, which gets lots of money from Wall Street, continues to go along with them. Don't expect that to change any time too soon. But, it is good to see that the some lenders are taking responsibility and decreasing principal to help people stay in their homes and avoid foreclosure. Let's hope that trend catches on in the new year.

Lita Epstein has written more than 25 books including The 250 Questions You Should Ask to Avoid Foreclosure.
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