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The Unintended Consequences of Citigroup's "Cram-downs"

Written By Brian Hicks

Posted January 12, 2009


no brain


Politicians really irk me.

But the truth is they are so reckless that they scare me more than anything else.

Because when given a choice between the hard way and the easy way, they choose the easy way every single time. It is as natural to them as talking out of the both sides of their mouths.

The result is one slippery slope after another. Unfortunately, we are the ones that get stuck with the bill.

That’s how I feel about the latest efforts of Democratic lawmakers and Citigroup to allow bankruptcy judges to reduce the mortgage balances of borrowers in foreclosure.

It sounds nice, but in practice it will lead to nothing but unintended consequences.

Among them will be much higher mortgage rates in the future if these politicians manage to get their way.

But that’s not just my opinion by any stretch of the imagination.

It’s a view shared by both the American Bankers Association and the Mortgage Banker Association. Between them, they ought to know.

From Originator Times entitled: Citigroup Deal may Push All Mortgage Rates Higher

"Last week, Democratic law makers and Citigroup reached a deal that will allow bankruptcy judges the power to reduce principle amounts on loans to help borrowers avoid foreclosure, also known as a "cram-down."

Industry trade groups including the American Bankers Association (ABA) and the Mortgage Bankers Association (MBA) said the proposal to give bankruptcy judges broad authority to modify mortgage terms could make home loans more expensive.

"We remain opposed to bankruptcy cram down legislation because of the destabilizing effect it will have on an already turbulent mortgage market," said the MBA in a released statement. "We were surprised by the suddenness of the announcement and are still evaluating the proposed deal, but we believe there remain a number of crucial issues that need to be addressed.

David G. Kittle, CMB, Chairman of the MBA has stated previously that is cram-downs are enacted it may cause rates to increase up to two percentage points.

In a prior testimony before congress on proposed cram-down legislation, Kittle maintained that reforming the bankruptcy code to allow judges to "cram-down" debt on primary residential mortgages will impose significant costs on consumers by restricting the flow of capital into the mortgage market and increasing the price tag on all mortgages.

"If you chip away at the security created on home mortgages-and this bill is not a small chip, it is a sledgehammer attack-you chip away at the entire core of the mortgage finance system," said Kittle. "In order to account for the added risk you will add significant costs to obtaining a mortgage. If this bill becomes law, we believe mortgage rates would jump significantly, going up 1½ to 2 points for everyone taking out a loan."

So what’s wrong with helping to keep some people in their homes by reducing their principal you ask?

Well, aside from the obvious moral hazard (rewarding the foolish), any governmental action that magically reduces the principal completely calls into question the validity of contracts—which is one of the essential bedrocks of doing business.

And when you weaken even slightly the ability to enforce a contract; it puts you entirely on the slippery slope —even if your intentions are admirable.

After all what good is a contract between two parties if it can essentially be torn up and thrown away years later by the borrower with a little help from the government?

The answer, of course, is not much.

And if that is the case, why would anyone in their right minds even offer a "cheap" mortgage anymore if it could be tossed aside later to score political points? And moreover, what investor would buy one?

So while this deal may one day help keep to a few folks their homes, it will also pushed the mortgage industry deep into the land of unintended consequences—big time.

Because like it or not, this is one judgment day that can’t be avoided--no matter how much politicians claim to care.

They irk me to no end.