The proposal passed the House but failed in the Senate in 2009. The Obama administration said they supported it but they didn’t fight for it.
President Obama’s Treasury Secretary, Timothy Geithner, was “lukewarm” about the legislation, according to Politico at the time. Years later, however, Geithner said not having it was a top policy constraint to addressing the housing crisis during the Great Recession.
President Obama’s Chair of the Council of Economic Advisers in 2009, Christina Romer, said in 2012, “Ultimately, we didn’t push for it as much as perhaps we should have… And so it’s something I wish we could do now. Again, the financial industry fights it like crazy.”
A recent study estimated that if the legislation had passed, roughly 500,000 fewer U.S. homes would have been foreclosed on during the Great Recession.
This legislation was the “cramdown” legislation which would have allowed bankruptcy judges to lower the amount of money bankrupt people owe on their primary homes to the fair market value of their homes at the time of the bankruptcy. When house prices fell in the 2000s, many people owed more on their houses than their houses were worth.
Bankruptcy judges could write down a lot of loans, including mortgages on vacation homes, but bankruptcy judges could NOT write down the mortgage amounts owed on the houses the owners actually lived in!
The financial industry got a ton of bailouts from the government during that time but the banks also fought hard to prevent Congress from giving bankruptcy judges the authority to lower mortgage debt to the fair market value of the primary residences of bankrupt homeowners. The result was the United States and the U.S. financial industry got 500,000 more foreclosures.
In addition, no doubt many or most of those foreclosures were dumped on the market and sold for less than fair market value which drove down house prices even further, including driving down the value of all the other houses the banks would end up foreclosing, owning and selling. But the financial industry considered defeating cramdowns a big victory for their lobbying.
It seems like it would be hard for homeowners to abuse a cramdown policy because it only applies to people after they go through bankruptcy court. Bankruptcy judges would only approve cramdowns for people who are legitimately bankrupt according to the law. People aren’t going to go bankrupt just to get their mortgage amounts lowered to fair market value.
500,000 Fewer Foreclosures
A 2022 study compared Chapter 13 bankruptcies from 1989 to 1993 that included cramdowns to those that didn’t. That was before the Supreme Court disallowed all such cramdowns in 1993. They found that cramdowns lowered foreclosures after bankruptcy by more than 20 percentage points. If mortgage cramdowns had been allowed in bankruptcy court, their “back-of-the-envelope” calculation estimates the U.S. would have had 500,000 fewer foreclosures from 2008 to 2013.
Over 5 million foreclosures were completed in the U.S. from 2008 to 2013. If the cramdown legislation had passed, it would NOT have stopped the crash in house prices but it would have made the crash smaller. House prices would have fallen less which would have helped the financial industry, and roughly 500,000 distressed American families would have avoided losing their homes to foreclosure.
More Economic Growth
Today foreclosures are extremely low, although they’re growing fast. A major reason for the great depth and length of the Great Recession was the huge number of foreclosures that tanked house prices, family wealth, family spending, and the U.S. economy. More foreclosures led to lower house prices which led to more foreclosures and so on in a negative feedback loop.
The U.S. had an unnecessarily high number of foreclosures, and an unnecessarily long and deep recession during the Great Recession, in part because the Senate chickened out in 2009 and didn’t allow mortgage cramdowns in bankruptcy court.
Someday the U.S. will have another housing bust. Hopefully, not soon. But now, before the next crisis hits, would be the ideal time to change our bankruptcy laws to reduce the number of unnecessary foreclosures in the next housing bust to help stabilize U.S. house prices, U.S. family wealth, the U.S. economy, and also the U.S. financial system.
The authors of the study mention 3 reasons why their estimate of 500,000 fewer foreclosures may be too LOW.
1. They studied the impact of cramdowns from 1989 to 1993 (S&L correction). Since house prices fell more during the Great Recession, they may have underestimated the impact of cramdowns on the number of foreclosures during the Great Recession.
Nationally, real house prices fell 13% in the S&L correction and 37% in the Great Recession. Makes sense that cramdowns during the Great Recession would have reduced foreclosures by a lot more than 500,000.
2. If cramdowns existed during the Great Recession, perhaps more people would have applied for bankruptcy, which would have increased the number of cramdowns, and decreased the number of foreclosures even more.
3. If cramdowns existed during the Great Recession, the possibility that more home owners might declare bankruptcy and get a cramdown might have caused the banks to modify more mortgages themselves which could have decreased the number of foreclosures as well.
Me. I think there’s a negative feedback loop where more foreclosures lead to lower house prices which lead to more foreclosures.
So, lowering the number of foreclosures by 500,000+ would have created a positive feedback loop where fewer foreclosures lead to smaller price declines which lead to fewer foreclosures and so on.