However, there have been indications that the government will allow bankruptcy court judges to modify mortgage loans. The term "cram down" refers to the power of the court to force loan principals lower. For instance, if a borrower owes $125,000 on a house that is now worth $100,000, the judge can cram down the loan by $25,000 (the loan floor is the property value) to facilitate payment.
Therefore, the risk to holders of mortgage loans and mortgage backed securities will increase substantially. In addition, second lien holders are especially vulnerable because the cram down will be applied to the secondary loans first.
Perhaps the below graphs highlight the concern bankers have about this issue (as well as continued defaults):
The above graph tracks fixed rate mortgage rates. Rates have fallen to new lows (moved higher last week), but that is only part of the story.
The above graph tracks the difference between the mortgage rate and the yield on the 10 year Treasury Note. The higher this spread, the more risk averse bankers are. They would rather use their TARP money to buy government debt than risk lending to prospective homeowners.