Cramdown on its way

Nancy Pelosi thinks that responsible people should subsidize deadbeats:

The leader of the U.S. House of Representatives said on Monday lawmakers expect to begin debating legislation this week that would let judges erase some mortgage debt for borrowers who file for bankruptcy.

U.S. House Speaker Nancy Pelosi said Democratic leaders hope to bring mortgage bankruptcy legislation known as the “cramdown” bill to the House floor on Thursday.

(Via the Corner.)

Interest rates are lower on secured debt (such as mortgages) than unsecured debt (such as credit cards) because secured debt can be recovered by foreclosure even in bankruptcy.  Once mortgage cramdown becomes a reality, the advantage of secured debt goes away.  Consequently, mortgage rates will go up.  The net effect is people who pay their mortgages will subsidize cramdowns for those who don’t.

The idea is even worse for existing mortgages, if that’s possible.  For existing mortgages, the effect is to depress the values of those mortgages.  The financial sector is still reeling from a financial crisis that came about because of a crash in the value of mortgages and mortgage-backed securities.  Damaging those assets further is just about the stupidest possible thing to do.

UPDATE: Mortgage cramdowns could also hurt some of the people they are intended to help (in addition to responsible borrowers, banks, and investors).  The possibility of a cramdown gives banks an incentive to foreclose whenever it suspects a bankruptcy might be coming, even when the banks might otherwise have preferred to be lenient.  It’s a terrible idea all around.

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