More questions about the mortgage cramdown
Here's one question that I haven't seen adequately addressed in the debate over cramdowns: what happens when the Chapter 13 plan gets dismissed without a discharge? Because 2/3 of Chapter 13 plans don't work.
To review: what proponents of cramdowns are proposing, as nearly as I can currently make out, is to treat mortgages the way we currently treat loans on most cars in Chapter 13. In Chapter 13, rather than simply discharging all your debts, you work out a payment plan that is supposed to keep your debts at a level you can afford. Secured claims are "stripped down" or "bifurcated" into two loans, one secured, one unsecured. The secured loan is written down to the value of the collateral, while the rest of the loan is transformed into an unsecured debt, the unpaid portion of which will be discharged at the end of your payment plan (generally, 5 years).
Mortgages are not treated this way in bankruptcy, though they were prior to the 1978 reform. The more conspiracy-minded readers and commentators have interpreted this as a bank-driven attempt to squeeze even more money out of the debtors they were sucking dry. In fact, prior to 1978, inflation-driven house price appreciation had made this clause moot for decades, before which time it hadn't really been relevant because the long-term self-amortizing mortgage didn't really come into widespread use until the 1950s.
No, the reason no one has been motivated to cram down mortgages like car loans is that doing so would have made loans more expensive (to compensate for risk), driven lenders to require higher downpayments, and shut many people out of the mortgage market entirely. Perhaps that would have been a good thing (though I think by the height of the bubble, lenders just weren't paying attention to depreciation risk at all). But politicians wisely knew what voters would think about suddenly finding it a lot harder to get a home loan.
At any rate, suddenly we do have a lot of house price depreciation, and a lot of people would like to see mortgages stripped down. Here's the question: what happens when the plan doesn't work? Even if we assume that cramdowns will attract a better class of debtor into Chapter 13, a near-majority of these plans are probably still going to fail.
What happens when a Chapter 13 plan gets dismissed is not pretty: the cramdown slips softly and silently away.
When a Chapter 13 case is dismissed prior to discharge, the protection of the automatic stay disappears and your creditors can pursue all available state remedies available to them. In a Chapter 13, the plan often changes the monthly payment to secured creditors like a car lender. So, for example, if your car payment was $450 per month pre-bankruptcy, and your Chapter 13 trustee paid the lender $300 per month, there is a $150 per month delinquency that is building. If your case goes through to discharge, no problem. But when your case is dismissed the lender will recalculate what you owe based on the contract rate. This may put you hundreds or thousands of dollars behind.
Now our homeowner has accumulated a bigger debt, and is going to be foreclosed upon anyway. Of course, they got to stay in their house an extra year or so. But the price was an extra 200 points off their credit score.
Meanwhile, what happens to the bank? A lot of people have been touting the notion that this is good, because it will stop the vicious cycle of foreclosure. But if 2/3 of these plans fail, all it does is delay it a while. Meanwhile, the bank has had the administrative expense of a bankruptcy proceeding and a foreclosure. Oh, and years of sharply reduced payments while the bad loan hangs out on their books. Double the number of months of nonpayment. And so on.
And the neighborhoods this was going to save? Again, all we've done is prolonged the crisis. Most of the houses that were going to end up in default will end up in default. It won't even take that long. Chapter 13 plans tend to fail pretty quickly.
Now, one could argue that even if most of the plans fail, we still have to consider the benefits of those that succeed. Indeed we do. But the costs of the failed plan are considerable. Especially if we contemplate the not-unlikely notion that the value of the cram down will encourage people who would not otherwise have gone through either bankruptcy or foreclosure to avail themselves of Chapter 13. Because if they go through Chapter 13, and they can't keep up the payments for any reason, they are now guaranteed to lose the house because of the arrearages they will have accumulated while making payments only on the secured portion of the suddenly-no-longer-bifurcated-loan.