A terrible housing idea

More

Today Obama is expected to announce his proposal to prop up the beleaguered housing market later today. An article in the Washington Post this morning discusses several potential components of the plan, some of which (interest rate reductions, workout incentives) are good ideas. One piece that should not be included, however, is a provision for bankruptcy cram downs.

Cram downs would allow bankruptcy judges to reduce the outstanding principal on mortgages for homeowners filing for bankruptcy. This is what judges already do for many types of debt (loans to buy cars, yachts, vacation ski lodges) during bankruptcy proceedings. But primary residence mortgages have historically been outside the purview of bankruptcy debt reductions in order to keep mortgage rates low. The reason for that is simple: if lenders knew bankruptcy judges might reduce the principal owed, they would charge higher mortgage spreads to compensate for that risk. But some Democrats like the idea of cram-down provisions and have been frustrated by Obama's reluctance to embrace them.

But the fundamental risk of cram down provisions -- that mortgage rates would rise as a result -- is still relevant, however, and the last thing we need in an ailing housing market is an increase in mortgage rates. Furthermore, cram-down provisions create moral hazard by making bankruptcy relatively more appealing (emphasis on "relatively," as the Dems are quick to point out that nobody likes declaring bankruptcy) and thereby might clog bankruptcy courts with underwater mortgages that could be better dealt with through a standardized loan modification process.

Jump to comments
Presented by

Benjamin Lockwood

Benjamin Lockwood is a researcher at Columbia University Business School.
Get Today's Top Stories in Your Inbox (preview)

Adventures in Legal Weed

Colorado is now well into its first year as the first state to legalize recreational marijuana. How's it going? James Hamblin visits Aspen.


Elsewhere on the web

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register. blog comments powered by Disqus

Video

Adventures in Legal Weed

Colorado is now well into its first year as the first state to legalize recreational marijuana. How's it going? James Hamblin visits Aspen.

Video

What Makes a Story Great?

The storytellers behind House of CardsandThis American Life reflect on the creative process.

Video

Tracing Sriracha's Origin to Thailand

Ever wonder how the wildly popular hot sauce got its name? It all started in Si Racha.

Video

Where Confiscated Wildlife Ends Up

A government facility outside of Denver houses more than a million products of the illegal wildlife trade, from tigers and bears to bald eagles.

Video

Is Wine Healthy?

James Hamblin prepares to impress his date with knowledge about the health benefits of wine.

Video

The World's Largest Balloon Festival

Nine days, more than 700 balloons, and a whole lot of hot air

Writers

Up
Down

More in Business

Just In