A Cure for the Housing Blues
The cramdown solution.
Nov 7, 2011, Vol. 17, No. 08 • By IKE BRANNON
When I was a newly minted Ph.D. economist I was asked to meet with my hometown bank on behalf of a lawyer who had some clients who needed auto loans and had recently filed for bankruptcy. The terms we proposed seemed sensible: a loan for half the value of the automobile, secured by the car itself, at an interest rate 50 percent higher than what the bank charged its normal customers.
The bank refused, saying they worried that these clients would file for bankruptcy again and stiff them. Impossible, I pointed out—someone can file only once every six years, and besides that, the car would deed to the bank—insured for its full amount—should the client cease payment. And these people were now debt-free, making them good bets for at least the three-year term of the loan. All had steady jobs.
The bank president responded by asking me to leave his office, explaining tersely that it was not a matter of profits or losses—it was a moral matter, and that the bank didn’t feel comfortable having clients who had previously reneged on their debts, even if such a stance cost the bank profits.
I left the premises and sold my stock in the bank shortly thereafter. The bank no longer exists, a casualty of a previous downturn, exacerbated by what I imagine were a host of poor decisions made for reasons other than maximizing returns to the shareholders.
Appeals to morality are a poor excuse for inaction. After four years of declining home prices and concomitantly negligible economic growth, it is time to abandon talk of stimulus plans and focus on fixing the housing market. Once we make that transition, the relevant question is how to most quickly and at the least cost reduce the number of homes either being foreclosed on or likely to be foreclosed on because they are so far under water. Allowing mortgage cramdowns in bankruptcy reorganization offers a way out for homeowners who are hopelessly under water and for lenders who are putting off the day of reckoning. Everyone who wants an economic recovery would benefit from this change in our bankruptcy code.
Ike Brannon is director of economic policy at the American Action Forum.