Good News for Banks, No Cram Down

The Senate defeated a law that would have allowed a cram-down provision for mortgage lenders. This increases the value of mortgages, and so helps banks, not merely directly via their mortgages, but indirectly as this would have hurt home prices. The specter of Cram-Down legislation surely has put a drag on mortgages, though it seems there are so many Federal plans outstanding, it is probably too much to get worked up about defeating one of them. Bad mortgage fixes these days are like dandelions in my yard.

For unsecured debt like credit cards, or accounts payable, if you declare bankruptcy you can then go to court, and depending on your income and assets, the judge writes down your debts by 50% or 100%, depending on what seems feasible. After that judgment, credit card and other bills are simply no longer recoverable at par, but only at the new, lower amount. A home loan is a secured loan, meaning, the house is collateral that secures the loan. When you buy a house with a mortgage, the bank really owns the house until the mortgage is paid. It owns it in the sense that if you stop paying, they take the house back, just as if you stopped paying your auto loan your car would be repossessed. Historically, in conjunction with a large downpayment and good credit checks, this led to very small mortgage lending loss rates. As those paying mortgages have non-recourse loans, meaning the bank can only repossess the house and not go after other assets, the borrower has the option to walk away. Adding cram down means they would also have the option of writing down the mortgage.

In banking, you price a loan with an expected loss build in there. This is basically the probability of a default times the loss in event of default: E(loss)=PD*LIED. Allowing borrowers to write down their homes through bankruptcy, no matter what your motivation, increases both the PD and the LIED. This would lead to higher lending rates. If you don't believe that, then you don't believe businesses try to make money, or that markets are competitive. Lender lobbyists basically drove this point home, that this legislation would just kill the current mortgage market at an especially sensitive time, and scared 12 Democrats to join the Republicans in opposing the Cram-Down.

Of course, Elizabeth Warren, who cares deeply about the little guy, lobbied for the cram down. If she had succeeded, no doubt she would have responded to the higher rates, lower mortgage lending, and cratering bank stock prices, via Fannie-backed lending to rectify the situation. Every patch needs a fix, which needs a patch, which is nice because then everyone has a government job to implement these fixes. Who is left to actually make money that pays government salaries, is not her problem.

The bill won handily in the House, but lost pretty strongly in the Senate. I'm sure it will come up again, but at least for now it is dead.