Friday, March 20, 2009

So what's wrong with cramdown?

The banks are against it, naturally. The way things work now, bankruptcy court has full power to tell creditors how much they are going to recover, if anything, and in general divvy up the bankrupt's assets among his creditors. Typically the holders of credit cards and car loans take a haircut, the bankrupt gets to keep enough of his salary to buy groceries and everyone goes away mad, except the bank. Home mortgages are exempt, the bankruptcy court cannot write them down ("cramdown"). The banks get a bigger slice of the bankrupt's assets than the other creditors.
The banks like it this way, and claim that mortgage rates are lower because the mortgage is more secure, so they can offer a better rate, and are more likely to do a mortgage than they would be if bankruptcy could lower the value of said mortgage.
Of course, as we struggle with Great Depression II, that was caused by absolutely reckless mortgage lending by the banks, we might have been better off if the banks had been less eager to do sub prime, alt A, and liars loans.
In the real world, banks shouldn't be granting mortgages to people likely to declare bankruptcy. Plus the mortgage rate is whatever Fannie, Freddie, or the Fed are willing to lend at.
Maybe cramdown would improve mortgage lending standards, something sorely needed.

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