Sense on Cents

As part of Obama’s proposal to support housing, the administration pushed the application of principal reduction via bankruptcy proceedings. This process, known as a mortgage cram-down, was pushed hard by the administration and many Democrats. Virtually all Republicans and mortgage investors viewed the mortgage cram-down as another in a long line of moral hazards.  In short, the mortgage cram-down would violate the implicit and explicit terms of a written contract. 

I wrote What Is a Mortgage Cram Down? on January 1st. While the Obama administration pushed hard for this legislation to be approved, ultimately those with a longer term vision prevailed. What are the concerns about principal reduction? As I wrote:

I personally find it difficult to swallow the concept of government funding for this program. At this juncture, though, the horse is so far out of the barn that we are trying to prevent the illness from becoming a full blown epidemic, if not a plague.

Home prices are down 18% year over year in the top 20 cities in the country and foreclosures have increased by approximately 40%. Both of these figures are certainly headed further in those directions with continued losses for the holders of the underlying mortgages, whether those mortgages are already pooled into securities or held in whole loan form.

The unintended consequences of a principal reduction program will likely be an increase in mortgage rates over the longer term along with a more stringent credit review for those applying for a mortgage. Why will this happen? Very simply, investors in mortgage securities will demand those concessions if they are to purchase mortgages that have the chance of being “crammed down.” Additionally, this program may actually incentivize some borrowers to intentionally become delinquent in their mortgage payments, and actually risk personal bankruptcy in an attempt to be “crammed down.” Where does the madness end?

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