The Coming Cost of Mortgage "Cram-Downs"

Yesterday's Wall Street Journal reported that, thanks to the severe credit crunch, current recession, and imminent control of both Houses of Congress and the Oval Office by Democrats, even mortgage lenders are bracing for some sort of "cram-down" legislation in the coming months.

The TARP bill originally had such a provision, but it was struck on the threat of veto.

In the past, all bankruptcy law modifications have carefully avoided violating residential mortgages on primary residences, since it was understood that introducing such risk into mortgage finance would lead to higher rates and probably downpayments, as well.

Welcome to the new world of mortgage finance. What investor will want to own mortgage-backed securities which are vulnerable to any small-town bankruptcy court judge's whims? It may not be a matter of higher rates or larger downpayments. Much of the mortgage-backed securities market might just vanish if such legislation passes.

Like it or not, the issue boils down to people being responsible for the obligations under contracts into which they freely entered.

Using cram-downs now, of course, rewards those people who engaged in excessive borrowing. And those who can now claim to have been coerced.

But the signal this sends for future contracts is very disturbing. Essentially, we are slowly evolving contract law into a scheme in which, if you don't get your desired result from the contract, somebody in a bankruptcy court will let you void the contract.

How can we, as a society, continue to function economically amidst such a legal vagueness in the most basic of all advanced economic systems?