Bankruptcy Modification and the Emperor's New Clothes [View All]

[Joanne98]

A new argument being advanced against bankruptcy modification is that it will result in trillions of dollars of losses and the collapse of the financial system. This is the "the sky will fall" argument.

Leaving aside the grossly inflated numbers, let's be really clear that these are not losses that would be caused by bankruptcy modification. These losses exist with or without bankruptcy modification. All bankruptcy modification does is force these losses to be recognized now, rather than at some point down the road. Bankruptcy modification doesn't change the underlying insolvency of many financial institutions. One way or another, there are a lot of financial institutions that have to be recapitalized.


Financial institutions want to delay loss recognition as long as possible. Maybe they're hoping that the market will magically rebound. Maybe they think that 2006 prices are the "real" prices and "2009" prices are a very short-lived aberration. But here's the crucial point: homeowners bear the cost of delayed loss recognition by financial institutions. Delayed loss recognition means homeowners floundering in unrealistic repayment plans and then losing their homes in foreclosure. Delayed loss recognition means frozen credit markets because no one trusts financial institutions' balance sheets. Delayed loss recognition means magnifying, shifting, and socializing losses. We only make matters worse when we try to pretend that these losses don't exist.

http://www.creditslips.org/creditslips/2009/01/bankruptcy-modification-and-the-emperors-new-clothes.html