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Straight Story: Stripping down

Chris Farrell Apr 25, 2008

Straight Story: Stripping down

Chris Farrell Apr 25, 2008


Tess Vigeland: Our economics editor Chris Farrell is here for the audio op-ed we call the Straight Story and Chris, home foreclosures, as we know, are at record levels these days and of course, the timing couldn’t be worse because about three years ago, Congress changed the rules to make it harder for people to get debt relief by declaring bankruptcy.

Chris Farrell: Well, you’re absolutely right, Tess, and you know what? I think it’s time for a mortgage strip-down.

Vigeland: Oh my goodness, Chris, get off the pole. I’m afraid you’ll have to define your own terms here.

Farrell: All right, a strip-down — otherwise know as a cram-down — is when a bankruptcy judge modifies the interest rate or principal payments on household debt. Here’s the straight story: Foreclosure is costly to homeowners and society, so we need to start paving the way for mortgage strip-downs now.

Vigeland: Chris, why should people be able to just simply write-off mortgages that they themselves should not have gotten in the first place?

Farrell: All right, let’s get away from the blame game. OK, is it the homeowner’s fault or is it the lend institution’s fault? Let’s throw them in the same pot and say “a curse on both of you,” but here’s the reason why I’d like to move the system over toward bankruptcy: the judge modifies the terms; the homeowner stays and he or she maintains the property so the neighborhood does better. There are a bunch of homeowners out there because of fraud or greed carrying too big of mortgages who are doing these voluntary workouts that aren’t working. The bankruptcy system is designed to deal with exactly this situation, so let’s tap into that expertise and keep the homeowners in their place.

Vigeland: But there are those who would argue that “Hey, what does that mean for the people who are responsible and waited because prices were simply too high?”

Farrell: They have a good balance sheet, they have cash, home prices are coming down; they’re going to be able to buy a home, so I think they’re protected that way. Now when someone goes into foreclosure, you know the house falls about a third of its value and then it has all the spillover effects into the neighborhood and the local economy, so to me, it makes a lot more sense to put these people through bankruptcy.

Vigeland: Why do bankruptcy instead of foreclosure? What’s the benefit there?

Farrell: Two benefits. First of all, judges are really experienced. They’re able to deal with the situation. They look at a lot of debts, so they’ll modify the terms of the loan and they’re not going to let people get away with too much, but we have this safety net that’s been around for a long period of time. Why do we keep creating, coming out of Washington, you know the “hope this” and the “hope that” and the “hope free” and “hope for…”

Vigeland: “Hope now,” I believe it is.

Farrell: “Hope now.” I mean you’ve got a bankruptcy system. It exists and they’re used to dealing with people who have taken on too much debt. Let’s tap into that expertise and let’s stop this nonsense of hope this and hope that.

Vigeland: The response of the mortgage banking industry, of course, would be then that’s going to raise mortgage rates overall. They’re going to tighten up down payment requirements and closing costs are going to go up for everybody.

Farrell: OK, you can go to the Mortgage Bankers Association’s web site and they have this section called “Stop the Cram-Down” and it will show how your rate will go up by 1.5 percent if we have this change. Now, I can also show you a brand new study of Georgetown University Law Center arguing it would have no impact on the mortgage market, so we can argue that forever. I’m not convinced that if we make this change that means we’ll pay a higher interest rate for our mortgages or we’ll have to put more money down for a down payment, but those changes are coming anyway. We’re moving toward a posture of more financial conservatism when it comes to home ownership and that’s a good thing.

Vigeland: All right. Chris Farrell with the Straight Story. Thanks, Chris.

Farrell: Thanks.

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