Cram-Downs And Unintended Consequences

Housing Wire has a good, quick read on the unintended consequences of the proposed legislation to allow cram-downs of residential mortgage debt via the bankruptcy statutes. To be fair, here is one good result and one bad one.

Good

Analysts at Bank of America , while suggesting on Jan. 13 that such provisions would likely lead to a spike in bankruptcy filings, also said that aspects of the proposed bankruptcy law would serve to limit potential investor losses. In particular, the legislation as proposed establishes a floor on how much debt could be crammed down by a judge, while the fact that all assets must be disclosed to the court in filing for bankruptcy would prevent borrowers from going BK purely to obtain a lower payment.

Bad

There are other issues to be considered here, of course, that are more nuanced. Among them is the role of private mortgage insurers, who generally will not cover losses tied to a borrower bankruptcy. Bank of America analysts called attention to this issue on Jan. 21 — and it’s a vital issue for any investor. Here’s why: most MBS deals using mortgage insurance as a form of credit enhancement have thinner “padding” for investor losses, meaning that cram-downs would eat through overcollateralization at a faster rate for MI-enhanced deals than for other MBS deals. (Can you spell d-o-w-n-g-r-a-d-e?)

And just think of the perverse incentives here, too: on a mortgage involving MI, the servicer and investor must get the MI provider to sign off on any loan modification — how likely will the MI provider be to do so, when they just push losses directly onto the investor via a borrower bankruptcy?

Housing Wire points as I am fond of noting as well that there are always unintended consequences. The more complex the issue, the more likely that those consequences will be significant.

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