Cramdown was once viewed as a major way to help homeowners who were deeply underwater keep their home by forcibly reducing the mortgage principal in court. This hasn’t been a considered solution for a number of years, in large part because banks deployed an effective “moral hazard” argument and legislators of both parties didn’t want to take action that risked banks’ existence.
Professor Adam Levitin has a new theory as to how cramdown could be achieved now, outside of the legislative process. Levitin writes:
For the past couple of years, I’ve been thinking that cramdown is dead as a policy solution. But I was thinking about cramdown as requiring legislation. It doesn’t. We could start doing it tomorrow. Under current bankruptcy law, a Chapter 13 plan may be confirmed only if secured creditors receive their collateral, receive the value of their collateral, or consent to the plan. The legislative proposals for cramdown all sought to enable involuntary modification of mortgages; cramdown was to be the stick that would encourage voluntary modifications.
But we could have voluntary cramdown under existing law and this could be done on a large scale staring immediately. Specifically, FHFA could require the GSEs to adopt a policy of consenting to Chapter 13 plans that have cramdown. (FHA/VA/Ginnie Mae could adopt a parallel policy for government insured loans.) Such a policy would address the two major objections that have been raised to principal reduction by the GSEs: the much dreaded (and overstated, imho) moral hazard problem and the second lien free-rider problem.
Levitin addresses how this solution would deal with moral hazard, as well as second liens, then asks, ” I can’t emphasize enough, all of this could be done tomorrow. So what’s Ed DeMarco’s excuse now? Shaun Donovan’s?”
Yves Smith takes a stab at answering Donovan’s excuse:
But it also happens that the Administration is well served having DeMarco in place as a house stooge. That way, the failure of Obama policies can be pinned on FHFA intransigence rather than a series of half-hearted remedies: HAMP, HARP, HAMP 2.0, and of course, the bank gimmie branded as a mortgage “settlement”. So Levitin’s clever approach is a reminder that there are lots of potential remedies to the housing mess. The problem is that any that solution that will do lasting good would reveal the near or actual insolvency of the four biggest US banks by forcing them to write down their second liens. Since that’s what both parties are determined to avoid, zombification, continued abuse of borrowers, and posturing will continue to be the order of the day.
The relevant portion here isn’t that DeMarco is useful for the Obama administration as a puppet master villain behind the housing crisis, but rather then reality that solutions which would fundamentally overturn the current banking system by revealing major US banks as insolvent will be rejected. Smith is right that this is a bipartisan position and one which is ensuring not only a continuously weak economy, but human suffering on a massive scale. And all of it is unnecessary.