Congress is currently considering legislation that will allow borrowers in Chapter 13 bankruptcy to have the court modify their loan by changing the terms or by lowering the principal amount down to the current market value. This is just inherently wrong. It is just another example of our entitled society not having to be responsible for the decisions they make or the deals they negotiate as individuals. It is much like the criticism being levied against business, which is getting the upside if it works to their favor and expecting assistance or the rules to be changed to cover any downside.

The borrowers are not just innocent victims as the press and the Government would like us to believe. The ones that got caught up in this debacle generally fall into two categories. The first are the ones that purchased a home at the height of the market, thus overpaying. The others are those that have owned a home for years and had equity from which they proceeded to strip out with the current market values supporting it. In either case, these borrowers made an individual choice that did not turn out well. This occurs each and every day when people purchase a car, buy a stock, invest in a business etc. Sometimes it works out successfully and sometimes it does not. People that obtained their loans long ago and resisted the temptation to strip out the equity as market values increased are continuing to make the same payments as always, and even though values have clearly receded, they are still in good shape with their homes.

It is concerning to hear reports of borrowers claiming that lenders took advantage of them. There is a certain amount of personal responsibility that we must all exercise in our business dealings. Had these borrowers been interested enough to scrutinize and understand a 3-4 page promissory note, it would have informed them of their loan terms exactly. It seems to be a minimal amount of diligence considering it is the largest financing that most people experience in their lives. Almost certainly the majority of them had full knowledge of the terms, but their desire for the loan and its purpose exceeded the perceived risk, and for the people that did not know, shame on them for failing to question what they were signing. Participants had mistakenly viewed that the market would continue its upward journey, thus lessening the risk by allowing them to refinance or flip the house for a profit. However, the market started turning downward instead, thus they became locked once the tide turned away, and the cries of foul play began to surface right into the ears of a sympathetic Government that now wants to use cramdowns as part of the solution.

If mortgage cramdowns are allowed, it will directly impact the entities that provided liquidity into the mortgage market over the years, the same entities that will be needed for this market to rebound. These firms just provided money in an investor capacity in exchange for securities backed by mortgage loans, they are not the parties that originated or securitized these loans that are currently being criticized. The end result is that any relief given to the borrower through cramdowns will be fully realized by these firms that hold the mortgage securities that we may depend on for future liquidity. This same argument applies even if the credit associated with these securities is insured by the various structuring methods that were used. Some entity, through the process of securitization, is going to realize any losses that are generated. Should these firms bear the loss with a cramdown while the borrowers are being excused for their bad decisions, or should they have the right to exercise their available contractual remedies to mitigate their own losses?

Another issue that will appear in the wake of exercising cramdowns will be the extra cost associated with getting future mortgages. Many viewpoints expressed suggest this will not be the case or that it is unknown. An area that might provide some guidance on this is the added costs of a second home or an investment property financing. Regardless of your credit profile, the industry has long adjusted rates upward for these loans. They are considered riskier than a primary residence loan because it is viewed that a borrower will forego the payments on other loans before they will their primary home. The market also realizes that these loans currently can be modified in the courts during a bankruptcy. Introducing this same cramdown risk in the financing of a primary residence will pressure rates upward to reflect this risk in much the same way. Plus, the investors that get burned by cramdowns will require a higher rate going forward to offset this risk as well as more stringent guidelines on new loans, both of which will not be conducive to restoring the mortgage market.

Supporters of mortgage cramdowns also suggest that using them are a better and less costly solution than the foreclosure process. This is a judgment that should be reserved for the parties that are at risk for these losses, and they should be free to exercise any preferred course of action using their contractual rights to lessen expected losses. The whole issue of cramdown really boils down to the validity of contracts and the rights associated with them. However, since we are now facing a calamity, our Government is willing to trounce all over those rights under the guise of rescuing the economy. It will undoubtedly result in unintended consequences that we will all be paying or regretting for years to come.