As lenders continue to resist mortgage principal reduction, homeowners are beginning to ask why they cannot be given the same debt forgiveness extended to big corporations such as General Motors (GM) and Chrysler. In an editorial citing the 2009 bankruptcy of the two companies, the New York Times delves into the inconsistent behavior of lenders when it comes to cramdowns.

Lenders’ willingness to compromise depends on exactly who is asking for a break. When GM and Chrysler filed for Chapter 11 bankruptcy, billions of dollars of debt and liabilities were wiped off their plates. Homeowners and individuals also have the option of claiming bankruptcy, but they will not be welcomed back into the open arms of lenders as quickly as those corporations.

So the question being asked is this: Why are banks so willing to forgive the debt of large corporations, but completely refuse to work on the compromise with homeowners? The New York Times suggests appointing officers to evaluate the specific circumstances surrounding each mortgage default and make a smart decision that helps everyone. Homeowners would get another opportunity for a refinance or cramdown, and lenders would benefit from another chance to get a new loan instead of another home to add to their shadow inventory.

first tuesday take: The reason why lenders refuse to cut homeowners a break, but willingly forgive billions of dollars of debt from big corporations is simple: politics. Unfortunately, lenders are doing what they do best by extending mercy to business giants, which ultimately protects them from the political cold-shoulder. In the long run, it is more lucrative to stay in the good graces of politicians and business executives, and that makes forgiving their debt an easy decision. However, agreeing to a cramdown for one homeowner means agreeing to a cramdown for all homeowners, and that is just too much lost profit. [For more information regarding cramdowns, see the January 2010 first tuesday article, Cramdowns, cramdowns, cramdowns!]

The government has emphasized the importance of homeownership as a moral issue for decades. Lenders have jumped on the bandwagon by excusing their unwillingness to forgive principal with the notion that homeowners are morally obligated to pay back what they owe. However, the grey area of a seemingly black and white issue becomes evident during economic peaks and valleys. If lenders knowingly originated thousands of subprime, Alt-A or adjustable rate mortgages (ARMs) during the Millennium Boom (2004 to 2007) — risky mortgages with high interest rates, balloon payments and great disregard for a homeowner’s risk of default — are they not then morally responsible for the thousands of resulting foreclosures? By originating those loans in the first place, lenders essentially catalyzed the foreclosure crisis themselves. Why, then, is all the blame directed at the homeowner?

Eventually, they will be stuck with no choice but to agree to loan modification and principal reduction, since roughly 250,000 foreclosures are started throughout the nation each month. Until then, it’s not difficult to figure out why lenders favor those with wealth and power.

Re: “What’s good for G.M. is good for homeowners” from the NY Times