“Cramdowns”: Will they work?

I get a lot of good Real Estate information from First Tuesday. They are a Real Estate education firm, but they have an online newsletter that summarizes some of the big issues in real estate for the wee and in this week’s newsletter they wrote about “Cramdowns” and it was a very interesting take.

A cramdown is the involuntary imposition by a court of a reorganization plan over the objection of some classes of creditors. Basically the court tells the bank these are the new terms of the loan so a borrower can stay in a home.

First Tuesday’s take was basically the since the New York Times reported housing prices in the U.S. flatlined in October, 2009 despite low mortgage rates and a homebuyer’s tax credit, the housing market has a new wave of foreclosures on the horizon and the only way to cure this ill is to force banks to take court institute financial terms.

Section from the First Tuesday article:

A combination of high unemployment and the failure of the current administration’s foreclosure prevention measures will result in an estimated 2.4 million foreclosures this year.

Considering the fresh wave of foreclosures expected, what will happen to prices in the coming months when the Federal Reserve Bank (The Fed) begins to raise interest rates and the government tax credit extension has expired?

Prices are predicted to fall by another 10% nationwide. Another price drop would push more homeowners into underwater situations. The only timely and affective way to deal with an underwater home – negative equity and homeowner insolvency – is to reduce the principal balance on the home loan, or in other words, a cramdown.

It is an interesting take, and I agree that high unemployment, a new wave of foreclosures, and falling prices will continue to add pressure to the market. But forcing lenders with cramdowns will not improve the entire situation. Future buyers could then pay more for loans, because banks will make up the losses by charging more.

A national policy would be difficult, because in high demand areas like the Bay Area and Alameda a 10 percent decline would most likely impact those who purchased in the last five years, but not a majority of homeowners. The lack of inventory in California has become and issue and allowing homes to come on to the market could actually improve the housing market.

Buyers have an opportunity with low interest rates, low prices (compared to three years ago) and goverment assistance, but they lack inventory to select from in the current environment.