John McCain supports bankruptcy reform . . . He just doesn’t know it. His own economic plan quotes a Tom Raum article published in the Tucson Citizen:
But at the same time, McCain is calling for aggressive federal action to help keep 200,000 to 400,000 families from losing their homes. That plan has many of the elements of a proposal by Rep. Barney Frank, D-Mass., and Sen. Chris Dodd, D-Conn., requiring participating lenders to forgive part of the loan principal and then write a new loan that would be backed by the federal government through the Federal Housing Administration.
As part of his revamped economic plan, John McCain has proposed a government purchase of troubled mortgages to stem the tide of foreclosures by reamortizing the loans at fair market value. While McCain should be commended for recognizing the collapsing housing market as the major source of our faltering economy, his plan to keep the middle-class in homes will not work.
The problem is that home mortgages are pooled together by the thousands into special tax-free trusts. Wall Street sells “shares” of these mortgage-backed securities (known as “certificates”) to investors, which makes the government purchase of the underlying securitized mortgages impossible. The best Uncle Sam can do is buy these worthless certificates, which only serves to bailout investors without helping homeowners.
The securitized trusts themselves would be more proactive in modifying the mortgages within each pool, but that would destroy the tax-free status of the trusts, resulting in huge losses to the investor. The only way a securitized mortgage can be modified is if a bankruptcy judge is empowered with the ability to change (“cramdown“) the terms of the mortgage.
McCain has specifically rejected mortgage cramdown in bankruptcy, but his economic plan proposes the very same concept in a non-bankruptcy setting – these are the Barney Frank / Chris Dodd elements McCain brags about on his own web site. Why he has such an aversion to a bankruptcy solution is confusing, but his plan cannot work without it.
Opponents of bankruptcy “cramdown” argue that it will discourage lenders from writing residential mortgages. Currently, a home mortgage is the only exception to the cramdown rules, which have been in existence for decades. Cramdown has long been used on automobiles without affecting the public’s ability to get low interest loans for cars because, when it comes to automotive financing, lenders are more cautious.
There is no question that cramdown is a necessary economic mechanism to ensure banks are making wise loans. Everyone agrees that banks have been writing stupid mortgages, resulting in the collapse of the housing market. Had there not been an exception for cramming down homes, there would never have been 100% (or more) financing of homes.
In 2005, the ability to cramdown car loans was restricted by amendments to the Bankruptcy Code, and the immediate result was lenders increasing car prices and rolling negative equity from trade-ins into the new loan. Now, many more Americans are “upside-down” in their cars.
So, bankruptcy cramdown does not just help those who file bankruptcy. This mechanism ensures stability in the economy by forcing lenders to act responsibly.
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