Todd Zywicki has been warning that the mortgage cramdown provision is extremely dangerous because of the effect it could have on the credit market:
Mortgage modifications during bankruptcy will almost certainly increase the losses of mortgage lenders — and this may further freeze credit markets. The reason is that when mortgage-backed securities were created, they provided no allocation of how losses were to be assessed in the event that Congress would do something inconceivable, such as permitting modification of home mortgages in bankruptcy. According to a Standard & Poor’s study, most mortgage-backed securities provide that bankruptcy losses (at least above a certain initial carve-out) should be assessed pro rata across all tranches of securities holders. Given the likelihood of an explosion of bankruptcy filings and mortgage losses through bankruptcy, these pro rata sharing provisions likely will be triggered. Thus, the holders of the most senior, lowest-risk trances would be assessed losses on the same basis as the most junior, riskiest tranches.
The implications of this are obvious and potentially severe: The uncertainty will exacerbate the already existing uncertainty in the financial system, further freezing credit markets.
But have no fear, Congress is on the case. If mortgage cramdown would trigger the pro rata sharing provisions in existing securities, simply erase those provisions by legislative fiat! Never mind that those provisions were an integral part of a privately negotiated contract, they’re now gone “as such provision shall be contrary to public policy.” It’s hard to predict what the next domino will be, but whatever it is, surely the government can simply prohibit it from falling as well.
The end result of this will be a lessening of trust in the economy. When people can’t trust contracts to stay the way they were written, commerce becomes riskier. Interest rates (the premium for risk) go up, suppressing the economy, and some enterprises that would have been narrowly profitable simply won’t happen at all.
The good news, for Democrats, is the negative consequences of their folly will take place over the long-term, continuing long after they are out of power, so they’ll be unlikely to take the blame they deserve.
Internet Scofflaw 