FDIC head says: We need cramdownsby Tim Manni
We noted previously that cramdowns are coming, courtesy of legislative action moving through Congress. To refresh your memory, it’s an involuntary loan modification: a cramdown happens when a bankruptcy judge reduces the principal amount of an outstanding mortgage.
In a recent interview on National Public Radio, the head of the Federal Deposit Insurance Corp. admitted that she supports cramdowns:
“The carrot is agreeing to share some of the costs associated with lowering the payments,” Bair says, adding that those subsidies will benefit both homeowners as well as those who service and own the mortgage.
“The stick is really the administration’s support for bankruptcy reform, which basically says that if the loan continues to be unaffordable, and the borrower goes to bankruptcy, then a bankruptcy judge has the authority to do a cram-down, which is to reduce the principal amount on that loan to whatever the current appraised value is,” she says.
How this will impact the government’s still-embryonic plan for voluntary loan mods is unclear. It will, however, add yet another layer of complexity — to say nothing of uncertainty — to the mortgage and credit markets. As we noted in that post:
Mortgage cramdown legislation, if passed, would likely lead to rising losses for home equity and credit card lenders, while also reducing housing affordability, Friedman, Billings, Ramsey & Co. analyst Paul Miller wrote …
In bankruptcy proceedings, Miller said judges are likely to wipe out home equity loans or lines of credit and credit card debt from customers, leaving those lenders with losses as the primary mortgage is modified. Financial firms with large portfolios of those types of loans are likely to see even greater losses than they’ve already been facing amid the downturn in the housing market and ongoing recession.
There’s also the fear on the part of many industry observers that cramdowns will increase the cost of mortgages for all borrowers. That’s called “the price of uncertainty.”
Rhetorical question: How will inflicting still more losses on financial institutions help the credit markets?
Exit question: Will cramdowns help fix, or will it prolong, the housing-market mess?