'Cramdowns' may be squeezed out of stimulus bill

A proposal to change the bankruptcy code to give judges the power to slash the principal of troubled borrowers' mortgages isn't likely to be included in the economic stimulus bill working its way through Congress.

During his election campaign, President Obama advocated granting bankruptcy judges the power to "cram down" mortgage principal to prevent foreclosures. But the Obama administration reportedly wants changes to the bankruptcy code to be considered separately from the stimulus legislation because the issue could hold up the bill's passage in the Senate.

House Majority Leader Steny Hoyer, D-Md., said Obama remains committed to granting judges the power to modify mortgages but that quick passage of the stimulus bill takes precedence, The Hill reported.

Speaker of the House Rep. Nancy Pelosi, D-Calif., said Thursday that changing the bankruptcy code to allow cramdowns remains "a very high priority, and we will have it either free standing or in some piece of legislation that will become law soon."

The lending industry has opposed cramdowns, saying they will be costly to lenders and undermine investor confidence in secondary mortgage markets, making loans costlier and harder to obtain.

Republicans, who have worked to keep cramdown provisions out of previous stimulus and bailout bills, restated their opposition Thursday at a House Judiciary Committee hearing on HR 200, the "Helping Families Save Their Homes in Bankruptcy Act of 2009."

At the hearing, cramdown opponent Christopher Mayer, a Columbia Business School professor, warned lawmakers of "a catastrophe if most borrowers get the idea that they do not have to pay their mortgages."

Mayer said that while 4 million borrowers are 60 days or more delinquent, 51 million homeowners are current on their mortgages. One-third of those homeowners may owe more on their mortgage than their house is worth, and granting cramdown power to bankruptcy judges "might lead millions of additional borrowers to stop paying their mortgage."

That could overwhelm the nation's 368 federal bankruptcy judges, who handled 967,831 bankruptcy filings in the year ending June 30, Mayer said.

Mayer advocated a foreclosure prevention strategy based on $10.7 billion in incentives for loan servicers, changes to the law giving servicers the legal right to modify loans when the outcome is less costly than foreclosure, and $2.1 billion in incentives for second-lien holders to allow loan modifications. Mayer also said subsidized mortgage rates could help reduce inventories by stimulating home-buying, and help as many as 25 million homeowners refinance their mortgages.

Georgetown University Law Center Associate Professor Adam Levitin said voluntary foreclosure prevention initiatives employed so far have failed. Because more than eight in 10 mortgages have been securitized and are held by investors who have stood in the way of loan modifications, Levitin said cramdowns are "the only sure method of preventing preventable foreclosures."

Levitin dismissed claims by the lending industry that cramdowns will lead to higher borrowing costs, and said troubled borrowers are likely to file for bankruptcy only as a last resort because their credit will be damaged for up to 10 years. Many cramdown proponents say that if the threat of intervention by bankruptcy courts is hanging over their heads, lenders will do more loan modifications on their own.

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