Offering cramdowns to underwater homeowners is the solution for the struggling housing industry, according to the firm, long-standing conviction of economist, Robert J. Shiller.
Shiller claims writing down a home’s loan balance to reflect its fair market value (FMVThe price a reasonable, unpressured buyer would pay for property on the open market) would decrease default potential, revive homeowner optimism, increase home values and revitalize neighborhoods.
Shiller presents two routes for the U.S. to arrive in cramdown land.
The first road: the government creates an Office of Mortgage Modification, and gives it the authority to impose cramdowns if it is more cost effective for a lender’s balance sheet than the alternative foreclosure or loan modification. This plan was proposed by three economists as the Mortgage and Securities Stabilization, Recovery and Modification Program Act of 2009, and has yet to be sponsored by anyone in Congress.
The second road: the government seizes home loans through its eminent domain authority, using investor cash to pay the lender the home’s FMVThe price a reasonable, unpressured buyer would pay for property on the open market, and then reduce the home loan’s principal balance. Only homeowners current on their home loans can participate, as they are able to continue making payments to those new investors, keeping the program soluble.
California’s own San Bernardino County has volunteered to be the guinea pig for this second idea, recently having unanimously voted to explore this eminent domain cramdown project as a viable practice for their county.
Shiller demands a collective movement toward cramdowns from the entire housing industry. This would be ideal. However, it’s already been five years since the housing crisis hit (and two attempts in Congress to reinstate judicial cramdown authority). Worse, many of the powers-that-be are still hung up on punishing underwater homeowners as the sinners instead of fixing the damage done by an entire industry’s profligate boom-time lending and sales standards.
In other words, it’s more likely we’ll see a sudden era of political compromise and bountiful efficiency in Congress than see the real estate players agree to get along to “solve” the housing problem. Instead, the simplest solution is to return cramdown authority to bankruptcy courts. This competition is what the lenders need to act on their own behalf. Surprising how that works.
Until 2005, bankruptcy courts had the authority to institute cramdowns on debt secured by singlefamily residences (SFRs) as part of bankruptcy proceedings. In the 1980s, when bankruptcy courts were given this authority, lenders responded with eager willingness to cramdown home loans for distressed homeowners to avoid the more expensive judicial hammer (which went largely unused). This has worked in the past, so why reinvent the wheel with more government programs and roundabout government encouragement?
Allowing judges the power to decide what is best, and fair, for underwater homeowners will alleviate the moral hazard cramdown critics rest on, while awakening lender morality in conduct toward the public they view as serfs – the 99%.
Lenders are never going to realize cramdowns are in their best interest on their own, but they might somehow get the point with a little encouragement from bankruptcy courts.
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