The Wall Street Journal has an article on bankruptcy cramdowns for primary residences in general and Citibank’s capitulation in particular.

Until recently, Citigroup had fiercely opposed proposals to give bankruptcy judges latitude to change the terms of mortgages. Its about-face comes after the federal government has pumped $45 billion into the company since last fall. The government is now keeping the company on a tight leash.

Tight leash? Yikes!

Although, I’m not opposed to bankruptcy cramdowns for primary residences if temporary (a couple of years) and reasonable, however, the apparent influence the partial nationalization of Citibank had on its position on this issue, scares the bejesus out of me.

It foreshadows a likely skyrocketing of political control over the enormously influential United States financial markets. It could take a generation of hard work to unwind this nationalization boom the United States is going to put together in a year or less… that is, if it is possible to unwind it at all.

Cramdown Compromise

  • Allows bankruptcy judges to lower interest rate, reduce principal, shorten the term of a primary mortgage, or any combination of the three.
  • Homeowners must certify that they have tried to renegotiate loan with the lender outside bankruptcy court.
  • Applies to all loans written before the date of enactment of the legislation, should it pass.

The banks haven’t significantly reduced the principal on mortgage loans, in part because because the loans were sliced up and sold to different people. No single person could approve a principal reduction. A cramdown overcomes that logistical constraint because it is ordered by the court.

In addition, cramdowns would only go to those who were completely wiped out financially by bankruptcy. That is a stiff price to pay to qualify.

Filing for Chapter 13 bankruptcy, under which debtors can work out a plan to reduce some debts and pay back creditors over three to five years, is a painful and potentially costly option for homeowners. The proceedings can cost borrowers about $4,000, according to Katherine Porter, a University of Iowa law professor, and result in a blot on personal credit reports for seven to 10 years. That could make getting credit in the future more costly.

Currently, bankruptcy judges can ratify reorganization plans that reduce principal owed on auto and student loans and mortgages on second homes. But they cannot modify the terms of a primary mortgage.

The passage below came as a shock to me.

In a concession to lenders, a mortgage debt could be forgiven entirely only if the lender was found to have committed a major violation of the Truth in Lending Act. Under the bill’s original language, the entire mortgage debt could be wiped away based on a violation of any number of state and federal consumer lending laws.

I didn’t know there was even a possibility that a bankruptcy judge could just give you the house for free! I would consider a complete write-down as completely unreasonable.

Of course, any such legislation would be brought to you by those brilliant politicians who brought you the Community Reinvestment Act and its sub-prime mortgages which exacerbated the real estate boom and bust.

Earlier discussion here, “Bankruptcy mortgage reduction “cram-downs” getting ink.”