One benefit of visiting the nation's capital is the chance to see a Congressman. My most recent sighting was of Congressman Brad Miller (Raleigh, North Carolina), who has recently been active in proposing ways not just to solve, or at least ameliorate, the mortgage and banking crisis, but also to keep bankers from causing another one. Today I heard him talk about a proposal he made several years ago to restrict the worst kinds of subprime lending (a proposal that unfortunately didn't pass) and some proposals he's making now to clean up the Augean stables of the financial world.
One of the things I learned from his speech is that a bankruptcy court can rewrite most loan agreements between a bankrupt borrower and the unhappy lender if the value of the security is less than the amount owed on the debt, except for agreements secured by the borrower's principal residence (i.e., home mortgages). In bankruptcy lingo this is called a cramdown: let's say the borrower pledged an office building that used to be worth $3,000,000 as security for a loan of $2,500,000, but the building is now worth only $2,000,000. The bankruptcy court can, to a degree, disregard the security provisions of the mortgage and treat this as a secured loan for $2,000,000 (today's value of the collateral) and an unsecured loan for $500,000. The lender gets priority to recover the $2,000,000 from the building if it's sold, but has to wait in line with the bootless and unhorsed unsecured creditors to recover anything on the remaining $500,000.
But there's an exception for a borrower's principal residence. "Why," he asks, "can a bankrupt borrower cram down a loan on a vacation house, or even on a yacht, but not on the house where they actually live?" It's a good question. I don't know the answer. I did enjoy his description of how financial executives explain the meltdown. Mr. Miller likened what they are now saying to what he calls the "other dude" defense (he describes himself as a recovered trial lawyer). The "other dude" defense is when the defendant in a criminal case, let's say a street robbery, says that he was just standing around, minding his own business, when this other dude -- who was about the same height and weight, and looked kind of like him, and even wore the same clothes -- came along and committed the crime, then ran away before the police got there. Banking executives, he says, are using the "other dude" defense: they were just standing around, minding their own business, making safe and boring loans, when these other dudes came along and created the subprime mortgage meltdown.
Mr. Miller didn't believe in the "other dude" defense when street criminals used it, and I got the sense that he doesn't believe it when bankers use it today.