Obama/Biden Proposal: Bankruptcy Courts to Re-Adjust Interest Rates? (Or is the Cram-Down Full of Crap?)

Unless you’ve been living in cave, then surely you’ve heard or felt the effects of America’s — and now, apparently, the world’s — financial crisis.  One of the issues is what to do with all the bad mortgages and those who are on the brink of foreclosure.  Last week, during the Biden/Palin debate, Biden provided an interesting answer:

“Number two, with regard to bankruptcy now, Gwen, what we should be doing now — and Barack Obama and I support it — we should be allowing bankruptcy courts to be able to re-adjust not just the interest rate you’re paying on your mortgage to be able to stay in your home, but be able to adjust the principal that you owe, the principal that you owe.”

Although to some pundits out there, this may seem like a completely radical idea — many will claim that a court doing anything resembling this is akin to socialism or communism — it’s not so out of left field.  What Biden, and by extension Obama, are talking about is essentially known as a “mortgage cram down.”  Yeah, it’s a pretty horrible name, but it essentially is a way to make mortgage payments more affordable once you declare bankruptcy.  In fact, Bankruptcy Law alreadly allows “lendees” an opportunity to “cram down” a second mortgage . . . but under limited circumstances. 

For instance, under 11 USC 1322(b)(2), a person filing bankruptcy under Chapter 13 may “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims.” Okay, what the hell does that mean in plain english?  It means a judge can’t “cram down” or modify your mortgage if it is already secured by your principal home.

Bottom line:  under the law as it stands, if you have a bad first mortgage, then you can’t get it crammed down.  if you have a bad second mortgage, then there’s the possibility that you can get it crammed down.  This law was written at some point in the 1970s.  If you read some of the legislative history behind this section (go to google), then you see that it was designed to encourage lenders to lend money to new home buyers.

So with all that in the landscape comes the Obama/Biden proposal, which has been, in one form or another, sloshing around in the Senate for several months now . . . before the financial crisis/monster became apparent to even those George Bush scientists.  Of course, banks hate the proposal or anything that would presumably alter a contract — under the theory that all the crammed down mortgages have to be paid by someone, so that someone is going to be us “Joe-Six Packs,” in the form of double digit interest rates, the end of 10% or less down payments, or really high closing costs.  According to the bank, they’re actually thinking of our best interests.  In the current landscape, this claim certainly rings a bit hollow.  Thanks Darth Vader for your words of encourgement, but if you don’t mind, I’ll be standing way over here.

But I digress.  Although certain Republicans — particularly ones who believe that every government intervention except for national security, military spending, and corporate welfare tax breaks is one step closer to a socialist and communist America — believe that the Obama/Biden is somehow some sweeping proposal is giving their proposal more credit and more expansiveness than is due.

I know certain economic theorists get in trouble for using rational actor theory but I’m going to do so here anyway to turn the whole thing on its head.  Let’s look at that 5% percent of the population, and even the ones that are near that group, who need some serious help on their mortgage (when I mean “serious help,” I mean those borrowers who are on the verge of foreclosure or who are already in foreclosure proceedings).  Contrary to what the banks are saying, do you think the majority of rational borrowers are conspiring in a secret basement room, trying to figure out how they can get their mortgage crammed down to match the decrease in the value of their home?  Jeez, most people have no idea what that means anyway.  Frankly, the average borrower just wants to make their damn mortgage payment.  The majority of homeowners are not first and foremost considering the amount owed . . . they are considering first and foremost their monthly payments.  That’s what a rational actor would do. 

When does the issue of how much a homeowner owes become central?  Well, I would imagine when a homeowner wants to sell their house or refinance.

In the end, if the Obama/Biden plan were to pass, I’m sure there’d be a segment of the population that might decide to muck around with the bankruptcy law for a cram down.  But that certainly doesn’t represent the majority of people who truly want to reduce their mortgage payments.  And, the fact is, the Obama/Biden plan doesn’t specifically address the main issue of what the average Mr. Joe Six Pack is dealing with:  PAYMENT!!

Finally, contrary to what the banks and alarmists are saying, the Obama/Biden proposal — in the context of a bankruptcy proceeding . . . some pundits are claiming that the cram down proposal applies to everyone and anyone — does not give a borrower a windfall, in the sense of paying a lower principal amount and keeping the profits.


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