Mortgage cram-downs bug banks

From a recent news feed comes this story. It is growing increasingly likely that judges will get the power to rewrite mortgages for homeowners facing bankruptcy, some analysts say.

Currently, judges can modify personal loans and mortgages on vacation homes, but they can’t change mortgages on primary residences.

The banking industry has been fighting what is known as mortgage cram-downs because banks would have to absorb the losses. And the National Association of Home Builders has been on the side of banks.

But with Democrats about to control Washington and as voluntary foreclosure-prevention programs continue to fail, the likelihood of the passage of bankruptcy-reform legislation increases.

"To the extent that nothing else is working, bankruptcy cram-downs are becoming more likely," says Rod Dubitsky, head of asset-backed-securities research at Credit Suisse.

Proponents of cram-downs say that investors are more likely to agree to loan modifications prior to foreclosure and bankruptcy if modifications after bankruptcy are inevitable. "You have to deal with the systematic problem of underwater mortgages or you are not going to stop foreclosures," says Harvard University economist Martin Feldstein. Currently banks have shown that they will wait and take their chances on foreclosure rather than agree to a short-sale price prior to taking possession of the property - usually a short-sighted decision.

Feinstein proposes a plan that would replace mortgages that have negative equity with new, lower-cost loans. Mark Zandi, chief economist at Moody’s Economy.com would go even further. He proposes that the government spend $100 billion subsidizing the bulk of principal write-downs.

It's relatively hard to have lots of empathy with or sympathy for the banks, since most of them got themselves into the messes that they are in out of greed and poor management practices. There needs to be a compromise that forces workout first and then only resorts to a cram-down approach if the workout attempt fails. I would normally have added that the banks need an out for both approached with some really bad loans, but banks have proven over and over again that, given any wiggle room, they will find a way to game the system and soon all of their bad loans will somehow magically qualify for that out. It's human nature in action again. Banks that refuse to cooperate or are found to be cheating the system should be told to take their bailout and cram it.