Cramming sounds like Heartburn Highway

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So you bought a house, took advantage of lower interest rates to refinance and were satisfied.  Until the waiter came by and offered you something else, something very tasty:  lowering the principal value of your home and reducing your payments.  Compared to bankruptcy and foreclosure that's mighty tempting. What comes to mind is that old Monty Python scene where a harmless seeming, "wafer thin" after dinner mint leads to gastronomic explosion.  And much like that human bomb, messing with principals will upset the neighborhood (the "splatter" effect).

What's my beef you ask?  Well it seems ok at first glance.  Keep people in their homes.  Right the wrongs of overzealous and unscrupulous lenders and brokers.  Help people out who are losing their jobs.  Find a way to keep people from declaring bankruptcy.  All worthy goals and a big part of the debate over the stimulous bill on Capital Hill.

So here's part of the issue:  if you reduce the principal on my neighbor's mortgage, you actually decrease the value basis of his home.  Which is fine for him.  He can now sell it at a lower price and not lose money.  Now do that to more neighbors and you actually decrease the value of my home.  The problem is, you didn't adjust my investment basis.  So I can't do what my distressed neighbor can (sell) without incurring a loss.  At which point, I will need to start asking "Why am I still paying my mortgage?"

There's an issue of fairness here.  By most estimates, 90%+ of homeowners are on time with their mortgage payments.  Sure, a lot of us wish our homes were worth as much as we bought them for. But they aren't.  And we deal with our investment choice and continue to pay.

Look at the flip side of this:

QUESTION:  What I don't get is - if its ok for us to lower principals when values drop, why don't we increase principals when values increase?

ANSWER:  Because a home purchase is an investment.

Investments have risk don't they?  Since when am I guaranteed a positive return on all of my investments?  Wouldn't that be a nice easy world to plan for my family's future security.  And the risk runs both ways.  We don't allow lenders to reset the value of your mortgage upwards when its in their interest to do so either.

I know.  It sounds cold when you are talking about your neighbor or friend.  But step back from personal considerations and look at the big picture here.  If we institutionalize drops in value, then we are resetting the market.  But unless we reset it for EVERYONE, we end up with a bunch of "winners" (well, compared to getting foreclosed at least) and a whole lot of "losers" (anyone who actually planned well, made a good investment, doesn't qualify for a cramdown, and just keeps paying).  I'm not the only person thinking this way either (see comments on Inman News).

If the goal is to keep people in their homes, then there are other alternatives.

  • reset EVERYONE's principal to the current market values (probably an exceedingly bad precedent)
  • keep EVERYONE's principal where it is but provide payment assistance to those that qualify through deferred interest government loans (let the government keep some of the bailout dollars to back these loans)
  • give EVERYONE their portion of the bailout money directly (a couple hundred thousand dollars would go a long way toward getting people on top of their payments and freeing up discretionary spending again)

Sure, there are huge potential issues with each of these.  But what are our goals?  Perhaps putting money back in the hands of consumers (rather than directly to lending institutions) would be a good idea.  Give renters the funds to buy and watch properties fly off the market.  Give owners the funds to pay their mortgage and the keep (or even increase) the penalties for defaults and bankruptcies, and see people stay in their homes and pay on time.  Keep the lenders' cashflow coming from where it should be - their investments - and loosen up access to credit again.

On the day after the US Treasury had to call Citigroup and order them to cancel a $45million luxury jet purchase, and when 90% of top executives that were in power in 2006 at the financial institutions receiving bailout money are still in power, why would we think for a second that these institutions will use our money more wisely than we would?

Potential issues with these ideas abound - flooding the consumer space with cash could lead to quick and rapid inflation.  People might spend their money on vacations and flat screens rather than their homes.  "Free money" is bound to have negative impact that I'm not savvy enough to predict.  But at least it would be evenhanded.

I'm not an economic wiz kid. I do know that cramdowns are too much for my stomach to handle.  Cramdowns will hurt the majority of people.   In fact, I think its the equivalent of stealing  directly from all the other homeowner-investors.    We're seeing strong volume recovery in parts of the country, which will lead to price stability.  Yes, its going to take a while for values to get back to even on what people paid to get into their homes.  But sometimes you need to know when to leave that last bite on your plate and come back to the table when the time is right.

Image Credit: Southtyrolean on Flickr.com