Why a Mortgage Cramdown Bill Is Still the Best Bet to 
Save the Economy
Alex Ulam
The Nation
October 20, 2011  
http://www.thenation.com/article/164096/why-mortgage-cramdown-bill-still-best-bet-save-economy

Many Americans believe that the financial crisis stems
from the Bush administration's running up the federal
debt and out-of-control spending by the American
consumer. But much of the blame for the country's
current economic woes lies with the Obama
administration's failure to forcefully tackle the
biggest threat to the American economy today: the
housing crisis. 

Nearly 6 million Americans have already lost their homes
to foreclosure since the housing bubble popped, and
about 3.5 million are in foreclosure proceedings. But
the worst is yet to come. This past September, a US
Senate Banking subcommittee heard testimony from a
prominent mortgage industry analyst that 10.4 million
mortgages, approximately one of every five outstanding
mortgages in the country, could default, if Congress
does not take action to address the housing crisis.

Over the past several months, editorial pages and
economists such as Paul Krugman and Carmen Reinhart have
stressed that restructuring US household debt would be
one of the most effective means of speeding economic
growth and putting Americans back to work. According to
a recent report by The New Bottom Line, a coalition of
labor groups and grassroots networks, if all underwater
mortgages were written down to market value and
refinanced into thirty-year fixed mortgages, it would
add about $71 billion a year to the economy and create 1
million jobs.

But despite the outcry, Washington currently does not
have a viable plan to deal with the plight of the more
than 14 million Americans who are currently underwater
on their mortgages by more than $700 billion. With the
mortgage meltdown showing no signs of abating, it is the
time to set the record straight on the best plan we have
had for reviving the housing market: the 2009 bankruptcy
reform bill known as the cram-down bill. That
controversial piece of legislation would have given
bankruptcy judges the authority to write down mortgages
on a primary residence to the current fair-market price
of the property. In addition, cram-downs would have
enabled bankruptcy judges to monitor and stop some of
the widespread robo-signing abuses-where banks have been
using fraudulent documents to foreclose on homeowners.

Proponents of the bill believe many if not most of the
homeowners who would have benefited from it would not
have even needed to file for bankruptcy. Indeed the
cram-down provision would have provided homeowners and
their advocates with a critical bargaining chip to
negotiate sustainable loan modifications from the banks.

When Senator Barack Obama was running for president he
told voters that he would support legislation to allow
homeowners to get relief in bankruptcy court. The
legislation would have repealed a bankruptcy provision
that prohibits modifications of mortgages on a primary
residence. "I will change our bankruptcy laws to make it
easier for families to stay in their homes," he told
voters at a campaign rally in September 2008, describing
the bankruptcy exemption for mortgages as "the kind of
out-of-touch Washington loophole that makes no sense."

Today cram-downs make even more sense than they did in
2009. The various bank proprietary loan modification
programs and the government-sponsored loan modification
programs are widely acknowledged to be failures for not
helping enough homeowners and also for having high re-
default rates. But one of the biggest unmitigated
disasters about these programs is that homeowners who
have succeeded in obtaining loan modifications actually
have become mired in more debt. That is because instead
of reducing homeowners overall debt, these loan
modification programs have focused on lowering monthly
payments on a homeowner's primary mortgage by reducing
interest rates and extending the term of the loan. In
2010, nearly 95 percent of active, permanent loan
modifications resulted in homeowners' actually owing
more debt on their homes than before the modification
according to a Congressional Oversight Panel report.

The reason that we don't have cram-downs is that the
banks lobbied heavily against the 2009 bill. They said
it would further destabilize home prices and that they
would have to raise interest rates to account for the
risk of underwater homeowners' having their mortgages
modified in a bankruptcy. They also argued that
bankruptcy reform would create a "moral hazard" by
rewarding irresponsible borrowers who took out mortgages
that they couldn't afford.

The misleading message on cram-downs that stuck in the
minds of many voters came from CNBC host Rick Santelli.
It was Santelli's 2009 rant about cram-downs that
launched the Tea Party. "This is America!" Santelli told
cheering traders on the floor of the Chicago Mercantile
Exchange, "How many of you people want to pay for your
neighbor's mortgage that has an extra bathroom and can't
pay their bills?"

In contrast to candidate Obama, President Obama was
conspicuously silent on cram-downs. According to
ProPublica, Treasury Department staffers actually
cautioned lawmakers against the bankruptcy reform
legislation. Unfortunately for underwater homeowners,
although the cramdown legislation passed Congress in
March 2009, it was defeated the following month in the
Senate by a vote of 45 to 51. Georgetown Law School
professor Adam Levitin, who has written extensively on
cram-down legislation, says that Obama's lack of support
doomed the bill. "Had Obama put his weight into it, it
would have passed," says Levitin, "It would have been a
fight, but he was too chicken to have the fight."

"The principal objective of the Obama administration and
the Bush administration before that was to let the banks
avoid taking immediate losses," says Democratic
Representative Brad Miller of North Carolina, who
sponsored the cram-down bill, "The bankruptcy law change
was incompatible with that, it would have required the
banks to recognize a lot of losses immediately and might
very well have revealed some of them to be very nearly
insolvent or actually insolvent."

The country's four largest banks stand to lose the most
from cram-downs. The legal fees they would face in
bankruptcy courts would be enormous. In addition, these
banks hold a substantial amount of the outstanding
unsecured debt on underwater homes in the form of
hundreds of billions of dollars of second loans and home
equity lines of credit. Because they are in second-lien
position, with the drop in housing prices, many of these
loans have become partially or completely unsecured,
meaning they no longer attached to any underlying equity
in the home. And while some bankruptcy courts have
allowed wholly unsecured second-lien mortgages to be
written off completely, other courts have ruled against
writing down these mortgages. Under the 2009 proposed
cram-down legislation, the law would have been much
clearer, and many of these junior loans would be written
off completely.

Aside from propping up the country's largest banks,
there's very little reason not to pass bankruptcy
reform. In contrast to the Obama administration's Home
Affordable Modification Program, under which the
taxpayer is partially footing the bill, court ordered
mortgage cram-downs would cost the federal government
nothing. Indeed, cram-down legislation requires no
government bailouts or financial incentives for lenders
or for borrowers. The 2009 CBO cost estimate of the
proposed cram-down legislation shows that the federal
government actually would have made money on the bill
through the increase in bankruptcy filing fees.

What about the argument that cram-downs would force
banks to raise interest rates, thus making credit more
expensive for borrowers and depressing home values in
the very neighborhoods hit hardest by the meltdown?
Interest rates on fixed-rate mortgages have been on a
downward trajectory, and in early October the rate on a
thirty-year fixed-rate mortgage fell below 4 percent,
the lowest it has been in recorded history. But
prospective homeowners still are not buying. In an era
of falling home prices, lenders understandably are
worried about lending on an asset that is losing value
and prospective homebuyers understandably are worried
about making a bad investment. Indeed the debate over
whether or not cram-downs would have resulted in market
crippling higher interest rates proved to be a major red
herring from the main ailment afflicting the housing
market today-the inflated mortgages, many of which were
based on fraudulent appraisals, that were originated
during the bubble.

The argument that cram-downs would have rewarded
irresponsible borrowers is also misleading. Chapter 13
Bankruptcy is not a get-out-of-debt-free option. It
requires borrowers to live on a court-monitored budget
for three to five years. Further, in many parts of the
country, there are Americans who owe more than twice as
much on their mortgages as their homes are worth. Many
of these people are victims of predatory lending and
appraisal fraud. The most authoritative official report
that we have on the events that led to the 2007
meltdown, the Financial Crisis Inquiry Commission's
final report cites widespread instances of predatory
lending during the housing bubble. For example, the
commission's report discusses how the quality assurance
department of New Century, once the nation's second-
largest subprime lender, found evidence of predatory
lending, legal and state violations and credit issues in
25 percent of the mortgages that they audited. Yet
instead of reforming the company's business practices,
New Century executives dissolved their quality assurance
department and terminated its personnel.

In addition to potentially helping millions of Americans
get back on track, bankruptcy reform actually would have
benefited the entities that own most of the outstanding
secured mortgage debt in this country-Fannie Mae,
Freddie Mac, pension funds and private investors.
"Investors recognize that a 20 or 30 percent principal
write down creates re-performance," says Joshua Rosner,
managing director at Graham Fisher & Co, a company that
advises investors, "and it beats absolutely a 70 percent
plus loss in a default."

Even one of the major unstated reasons for not passing
the bankruptcy reform bill, protecting the nation's
largest banks, no longer holds water. Failure to pass
the cram-down legislation has not in fact saved the
banks from their travails. Bank of America, the nation's
largest bank, is going wobbly due in large part to its
continuing problems with mortgage meltdown. If the cram-
down legislation had passed and BoA had failed as a
result, then so be it. Millions of Americans facing
foreclosure would have had a much better shot at saving
their homes, and that would have been a much bigger boon
to the overall economy than bailing out the banks.

However, although the big banks are tottering, they
still appear to call the shots in Washington. "There
seems to be an unstated but perhaps conscious policy of
not forcing them [banks] to recognize losses," says
Miller, " And almost everything that we can do to help
the balance sheet problems for households-to help reduce
household debt-would require the banks to recognize
losses."

___________________________________________

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