Wednesday, August 04, 2010

Fed Research Supports Mortgage Cram Downs

by Bill McBride on 8/04/2010 12:30:00 PM

Thomas J. Fitzpatrick IV and James B. Thomson at the Cleveland Fed provide new research that supports residential mortgage cram downs: Stripdowns and Bankruptcy: Lessons from Agricultural Bankruptcy Reform . A few excerpts:

[One proposal is] to revise Chapter 13 of the bankruptcy code to allow judges to modify mortgages on primary residences. The type of loan modification under consideration is known as a loan cramdown or loan stripdown because the judge would reduce the balance of the secured claim to the current market value of the house, turning the remaining balance of the mortgage into an unsecured claim (which would receive the same proportionate payout as other unsecured debts included in the bankruptcy petition).
And the authors discuss how this worked for farm loans:
The actual negative impact of the farm stripdown legislation was minor. Although the legislation created a special chapter in the Bankruptcy Code for farmers and allowed stripdowns on primary residences, it did not change the cost and availability of farm credit dramatically. In fact, a United States General Accounting Office (1989) survey of a small group of bankers found that none of them raised interest rates to farmers more than 50 basis points. While this rate change may have been a response to the Chapter 12, it is also consistent with increasing premiums due to the economic environment. This suggests that the changes in the cost and availability of farm credit after the bankruptcy reform differed little from what would be expected in that economic environment, absent reform.

What was most interesting about Chapter 12 is that it worked without working. According to studies by Robert Collender (1993) and Jerome Stam and Bruce Dixon (2004), instead of flooding bankruptcy courts, Chapter 12 drove the parties to make private loan modifications. In fact, although the U.S. General Accounting Office reports that more than 30,000 bankruptcy filings were expected the year Chapter 12 went into effect, only 8,500 were filed in the first two years. Since then, Chapter 12 bankruptcy filings have continued to fall.
It appears the cram down legislation was very effective.

And residential mortgage cram downs are not new. The law was changed in 1978 and cram downs eliminated in 1993.

In 2007 my former co-blogger and mortgage banker Tanta explained the history of mortgage cram downs and argued they would be helpful now: Just Say Yes To Cram Downs
I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.
Looking at the Fed research, it appears Tanta's argument about mortgage cram downs bringing stability and discipline to the residential mortgage market long term would be correct. It is never too late: Say yes to cram downs!

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