The New Cramdown

For the past couple of years, I've been thinking that cramdown is dead as a policy solution. But I was thinking about cramdown as requiring legislation. It doesn't. We could start doing it tomorrow. Under current bankruptcy law, a Chapter 13 plan may be confirmed only if secured creditors receive their collateral, receive the value of their collateral, or consent to the plan. The legislative proposals for cramdown all sought to enable involuntary modification of mortgages; cramdown was to be the stick that would encourage voluntary modifications. 

But we could have voluntary cramdown under existing law and this could be done on a large scale. Specifically, FHFA could require the GSEs to adopt a policy of consenting to Chapter 13 plans that have cramdown. (FHA/VA/Ginnie Mae could adopt a parallel policy for government insured loans.) Such a policy would address the two major objections that have been raised to principal reduction by the GSEs:  the much dreaded (and overstated, imho) moral hazard problem and the second lien free-rider problem.

Moral hazard. Chapter 13 bankruptcy presents a significant cost to the borrower--it means living on a court-supervised budget for 3-5 years and a 10-year escutcheon on the credit report plus the stigma of bankruptcy. One could debate whether these are sufficient costs to avoid all moral hazard, but they are real costs, and there are additional features like shared appreciation and eligibility cutoffs that could also limit moral hazard. The GSEs could make plan consent conditional on cramdown being done based on their valuation, rather than a judicial valuation, and on shared appreciation for the duration of the plan (or perhaps longer). 

Free-Riding Second Liens

Underwater second mortgages can already be crammed down in bankruptcy, but if you can't deal with the first, there's not much point dealing with the second. But if the GSEs would consent to cramdown in bankruptcy, the concern about a GSE-to-bank transfer would go away.

It would be easy enough to adopt this policy for the GSEs and FHA/VA/Ginnie Mae. I think it could also be extended to portfolio and private-label loans if the GSEs and FHA wanted to exercise their monopsony power and make adoption of such policies by banks and servicers a condition of doing business with the GSEs. But even if they thought this was improper and didn't (this isn't making them buy broccoli!), there is no obstacle to the GSEs and FHA/VA/Ginnie Mae adopting such a policy.

To be sure, such a policy would likely result in an upswing in bankruptcy filings and that would result in more losses for unsecured creditors (credit card lenders, especially). Call it the flip side of BAPCPA. 

Again, I can't emphasize enough, all of this could be done tomorrow.  So what's Ed DeMarco's excuse now?  Shaun Donovan's?