“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.

Mortgage Cramdown Measure Fails in House

Last Friday, the U.S. House of Representatives voted to reject a mortgage "Cramdown" measure that is sure to impact homeowners here in Alameda. The piece of legislation would have given bankruptcy judges the freedom to change the terms of mortgages for distressed homeowners and modify loans without bank approval.

The banking industry had been vigorously fighting the measure known as "mortgage cramdown," not wanting the courts to control this portion of the induustry. The measure was defeated by more than 50 votes, in a 188-241 decision. The House had approved a similar measure in March over the objections of Republicans and bank lobbyists, but it died in the Senate.

Under present law primary residence can not have the debt reduced. The bankruptcy courts may reduce other loans for a car, vacation home or family farm.

This decision is a blow for those still on the verge of losing their home in Alameda and throughout the country. Just as it appears that parts of the housing market have stabilized hundreds of thousands of distressed homeowners now have one less option to save their home.

The industry counters that the legislation had the potential to do long-term damage to the mortgage market. In a letter to House Speaker Nancy Pelosi the Mortgage Bankers Association stated “Our primary goal should be to help keep more families in their homes and to unfreeze the credit markets,” the MBA letter said. “Cram down legislation fails on both marks. It will encourage more homeowners to opt for bankruptcy, and it will inject new risk into the mortgage market, thus making it more difficult for borrowers to buy, sell or refinance a home.”

The industry has a point. If all of the current homes that are on the verge of foreclosure file for bankruptcy, then credit will become harder to get for the rest of the homeowner community.
The MBA also wrote that the bill “directly undermines” the Obama administration’s Home Affordable Modification Program (HAMP). “We clearly need to work to refine and improve this program to increase the rate of permanent modifications, but we should not raise potential new problems for HAMP by layering the possibility of cram down on top of it,” the letter said.

The problem as I see it is that it appears Congress means to push the foreclosure crisis out and hope that a remedy will just come along and the “Banking Industry” has been slow to modify loans. Neither side has found a solution for the homeowner.

Without some type of solution the distressed properties will continue to slowly turn into foreclosures in 2010 and beyond. Combine the introduction of additional inventory with continued high unemployment and that is a receipt for a new glut of housing

I am not sure what the correct answer to the problem is, but a solution does need to be found. It may take more foreclosures that the Banks will need to put on their books and manage for the industry to move faster and upset former homeowners for politicians to find a workable solution.