Buried in the International Monetary Fund’s annual survey of the U.S. economy is a contentious suggestion for fixing the housing market. The survey, which the IMF published on July 3, when many people were probably more focused on fireworks than finance, wasn’t upbeat. It said the recovery was “tepid” and pointed to housing as one place where the Obama administration could help things along. “The recovery could also strengthen if the policy measures aimed at a faster resolution of the housing crisis gain traction,” the IMF wrote.
The survey applauded the Obama administration for recent steps to help resolve the housing crisis, including more support for reducing the mortgage principal for borrowers who own more than their house is worth. The IMF went on to make three housing recommendations. It said the administration should accelerate two existing programs that convert foreclosures to rentals and that encourage refinancing at today’s low rates. Nothing controversial there. But then the IMF made a bolder proposal, saying the U.S. should consider changing its laws to let judges modify home loans in bankruptcy—or, in more popular parlance, mortgage cramdown. (Hat tip to the Credit Slips blog for pointing this out.)
Laws enacted since 1978 have stripped judges of the right to modify the terms of a mortgage, even though they could alter the terms of other secured debts. Mortgage bankers hate cramdowns, saying they cause a moral hazard by creating an incentive for homeowners to file for bankruptcy even when they can afford their loans. Consumer advocates have asked Congress to rewrite the laws, arguing that giving judges the power to alter mortgages would encourage banks to modify loans on their own, reducing the number of foreclosures. That, they say, would be better for borrowers and banks—and the economy.
In 2008, candidate Barack Obama said he supported cramdowns too. But after he became president, Obama backed away from that stance. (The nonprofit investigative newsroom ProPublica has reported details of that retreat.) The administration instead pursued programs that provided incentives for banks to modify loans. Those programs have faced criticism for having too many carrots and not enough sticks. “Cramdown, on balance, today would have been a good idea,” Peter Swire, who coordinated housing finance policy for the president’s National Economic Council, told Bloomberg News recently.
But regrets and IMF recommendations aside, the U.S. is in an election year, so don’t count on cramdown coming anytime soon.