Representative Zoe Lofgren, a California Democrat, proposed securing meaningful principal write-downs for underwater homeowners by allowing a temporary reduction in the interest rates of those homeowners who file for bankruptcy.

She presented the plan in a letter to President Barack Obama earlier this month and it was discussed by the Democratic lawmakers and FHFA’s acting director Edward DeMarco on Wednesday.

A cramdown is a would-be bankruptcy process whereby a borrower would file bankruptcy, and as part of a reorganization plan, cram a principle reduction of a mortgage down a lenders throat. (Not just a “temporary” reduction in interest, by the way, but a true write down of principal.)

Seems counter-intuitive, doesn’t it?

“Hi, Judge. I’m a bankrupt borrower, but I could afford my house if I owed less, and had to pay less interest. The lender won’t agree. Will you make them, please.”

How does someone who is “bankrupt” afford a house?

It’s simple, in some cases anyway.

The largest debt of a cramdown borrower would be the mortgage. The borrower ** would be ** able to afford the house mortgage ** if ** the mortgage amount was equal to the value of the house – not 125% or 150% of the value of the house. If the interest rate were lower, that would help too.

Who loses in this scenario?

Fannie Mae and Freddie Mac – those GSEs that hold 75-85% of all mortgages in the US. (Oh, and some private banks that hold the balance. After all, what’s good for the goose…)

Can Freddie and Fannie afford to take the hit? THAT’s the question.

We’ve (as a Country) already dumped 2 TRILLION dollars into the economy. The Government (that’d be you and me by the way) will need to pay for the write offs any cram down allowed. How much more would that be – and where would it come from?

Here’s my $0.02.

The economy limps along like overcooked spaghetti. It’s going nowhere until the banks can get rid of the toxic debt, and consumer confidence rebuilds. Take the losses now, and we can start the recovery sooner. Yes, the losses WILL BE staggering. The bankruptcy courts will be overwhelmed. (I’d bet that some smart folks will start renegotiating those loans without the need for bankruptcy court intervention if the law allowed a borrower to do it through a bankruptcy proceeding – after all, it’d be cheaper for the banks that way…)

But, once the borrowers start paying on their loans again, once borrowers “feel” like they have readjusted on their homes, confidence – i.e. certainty – returns. And with certainty comes spending. With spending comes an uptick in the economy, and the ability for everyone to start making money again. Even he Banks. THAT’s how we pay for the losses Fannie and Freddie will take. We tax our way through it, with the increased economic activity.

Hell no, it’s not pretty. But it could work!

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