An article in yesterday’s WSJ, Mortgage ‘Cram-Downs’ Loom as Foreclosures Mount’ describes an effort to give bankruptcy judges the ability to rewrite mortgages on primary residences.
In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it.
In this situation, the borrower will only be required to pay back to the bank a portion of the original load amount, resulting in a loss for the bank. While this might sound great, save the homeowner at the expense of a big, bad, bank, it will have far reaching consequences as explained in the article.
Lenders warn that mortgage cram-downs will lead to higher interest rates and down payments, as banks seek to mitigate future losses from judicially imposed write-downs.
Now that lenders risk losing loaning money and then, at some point in the future, being told that they don’t deserve to have it all paid back, they are taking on more risk in loaning money for mortgages. A higher risk neccesarily requires a higher return (Why risk lending on mortgags when you can get a safe return investing in government notes). Therefore, while this measure might save some current homeowners who took on too much debt, it will affecct every person getting mortgage in the future by making them pay for the extra risk these people created.