The Trouble With Cramdowns

It’s very clear that a lot of the political support for allowing bankruptcy judges to make changes to mortgages to reduce the principal owed or the payment terms is rooted in the idea that we should stick it to the predatory lenders and wealthy bankers who got us into this mess.

Of course, a key problem with this is that a lot of those lenders and the banks that securitized the mortgages don’t have the money to afford to take the cramdown hit.

Megan McArdle, who is running Atlantic magazine’s cool new business site, explains the problem:

They want to bail out distressed homeowners.  And because this will be very expensive, they want to do so in a way that does not involve a direct government outlay of cash.  The normal way that the government gets what it wants without paying for it is to make a rule forcing someone else to shell out.

We’re fundamentally having an argument about who should bear the systemic risk of a fall in housing prices.  There is a sizeable constituency that wants to put the entire price on the banking system, both because they think bankers are ultimately responsible for the problem, and because they think of banks as rich corporations that won’t be hurt the way ordinary homeowners or taxpayers would.

This belief seems odd to me, given that we’re in this mess in large part because the banking system is in such parlous shape.

To draw out McArdle’s point a bit more: if cramdowns causes losses to banks, the taxpayers will simply wind up contributing more to the nearly insolvent institutions. So why not pay the price for mortgage cramdowns directly, instead of doing it through the banks?

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