Flip Thy House

Thumbs Down to Real Estate Cramdowns

You’d think that the news that Citigroup was backing a plan to let bankruptcy court judges modify mortgages was good news, based on much of the press it’s gotten as a necessary tool to combat the rising tide of foreclosures, letting bankrupt homeowners reduce their mortgage obligations and monthly mortgage payments so that they can stay in their homes.

The logic behind the idea is pretty simple: housing markets will never stablize until the flood of foreclosures hitting the market dries up. Letting bankruptcy court judges modify mortgages will reduce the overall number of foreclosures by keeping people in their homes, which will speed the stablization of the overall housing market.

Sounds great in a vacuum, but this is yet another example of a colossaly stupid “solution” that only will exacerbate the problem it’s claiming to try to fix. Does anyone with a hint of a clue honestly think that lenders will continue merrily along their way if the cramdown proposal becomes law, and not alter their business model whatsoever? That they’ll just bend over and grin and bear the losses and holes in their balance sheets that it creates, and say “Thanks sir, can I have another? Anything else I can do to help?”

They’d suddenly be facing the prospect of many millions of dollars in mortgages they’d lent out suddenly evaporating, with absolutely no compensation to them whatsoever, if a judge lopped off $70,000 from a mortage here, $80,000 from a mortgage over there, or whacked a few percentage points off their interest rate, just so a bankrupt borrower could stay in their home a few extra months. We’re already getting the results back from the first wave of borrowers that lenders let modify their mortgages, hoping that the lower payments would help them keep their home, and the data so far is pretty abysmal, as a high percentage of those borrowers that modified their loans are once again late on their payments.

The real problem we’re facing is getting liquidity back into the housing market, getting lenders comfortable again with putting their cash hoards to use, lending, instead of just sitting on it and trying to weather the storm, letting the foreclosure cards fall, taking their hits, and moving forward once all of the trash gets cleaned out of the system.

The only thing letting bankruptcy court judges modify mortgages will accomplish is to cause lenders to tighten their purse strings even more, and raise interest rates across the board on the few products they’re still willing to offer, as they have to somehow make up the losses they’ll be hit with once mortgages start getting modified. And not only will rates rise, but there’s no evidence that the rate of foreclosures will even diminish, as modifying mortgages at best only seems to delay the inevitable for most borrowers.