Are cramdowns the answer?

With the media spotlight clearly focused upon the economic stimulus bill that is making its way through Congress, there has been little attention given to another important and perhaps just as important piece of legislation for distressed homeowners.

Bills in both the House and Senate would allow bankruptcy court judges to cut - or "cramdown" - the loan balances owed by home owners, plus reduce the interest rate and monthly payments to affordable levels. To qualify, borrowers will need to file for Chapter 13 bankruptcy, agree to a court-supervised household expenditures plan for up to five years, and make at least partial repayments on debts to their creditors.

Not surprisingly, banks and mortgage lenders hotly oppose the whole idea -- and warn that they'll have to raise interest rates on all future borrowers if they can't foreclose to recover what they loaned out.

Though the final version of the legislation still must be negotiated between House and Senate, it's likely it will be passed by the end of February and will come with three key features:

First, only mortgages closed prior to the date of enactment will be covered. I suppose that new mortgage will be helped by other programs and the renewed emphasis on workouts for bad loans.

Second, all delinquent borrowers will need to contact their lenders and inform them of their intention to file for bankruptcy. That will allow lenders to put together their best offer -- including a reduction of the amount owed and the interest rate -- before the borrower actually files. It remains to be seen if the banks will act in their own best interests, as ex-Fed Chairman Alan Greenspan mistakenly thought that they would in the first place, and get more aggressive with loan modification programs.

And third, if there is an increase in the value of the house during the five year bankruptcy period, the lender will be owed some portion of it. Since most economic and housing market forecasters believe that home values will stabilize and start to rise again within the next 2-3 years, the banks should get at least some of their losses back through that provision; although, I don't understand how that provision will work if the place is sold in the next couple of years...maybe the homeowner can't sell.

I think the banks must have invented the word "cramdown" to describe this process hoping that by using such a disgusting analogy it would put legislators off of adopting it. Let's hope that doesn't work. I'm not a big fan of government or courts mandating behavior in people or business; however, when business goes as wrong as it did in the bad loan feeding frenzy of the early 2000's and then drags its feet on loan restructuring and principal modification, something drastic needs to be done. If the bankruptcy courts are the only place where the issue can be forced, then let them do it.

Let's be honest; the idiots who made the bad $200,000 loan on the house that is now only worth $100,000 (and likely was never worth $200,000 anyway) to the buyer that they knew (or should have known) could only afford a $100,000 house, deserve to share the pain with that idiot who bought more house than he could afford in the first place. There were no innocent victims in those transactions and there should be an equal opportunity for all to share the pain. And lest you ask where's the pain for the homeowner who's supposedly getting of the hook here; remember that he is declaring bankruptcy, not a good thing for anyone.

But, hey, that's just my opinion.