'Cramdown' legislation gives courts authority to set mortage terms

bankruptcy judges now have the authority to set loan terms such as principal balance and interest rates

One more challenge to stabilizing the financial sector .

This cannot be a good move, and may explain the markets poor reaction this past week. If the Administration continues down a path of setting prices based on homeowners needs rather than market forces, it seems unlikely that the market confidence in mortgage backed assets will be positive, and only exasperate the housing market lending issues, and work to undermine efforts to stabilize the overall financial crisis.

US House passes mortgage debt plan
Jessica Holzer | March 06, 2009 The Australian Business

A MEASURE to allow strapped US homeowners to reduce the principal balance on mortgage debts in bankruptcy has cleared a key hurdle.

Picture: Bloomberg

The US House of Representatives has passed the bill.

The measure, if it becomes law, would give borrowers substantially more leverage in their negotiations with creditors.

Proponents, including the Obama administration, believe the change will help spark a turnaround in the housing market by encouraging mortgage servicers to modify more loans voluntarily. The banking industry says it will raise borrowing costs for all homeowners.

The measure passed as part of broader housing legislation on a 234-191 vote, after Democrats agreed to a set of changes pushed by centrists in their ranks to narrow its scope.

The changes also aimed to convince waverers that the measure was a complement to the administration's broader program of incentives for lenders to modify loans.

"This is one component of a very large effort to stabilise the housing market and limit the number of home foreclosures in California and across the country," said Ellen Tauscher, who was the lead negotiator for centrist Democrats on the bill.

A record 5.4 million homeowners were behind on their mortgage payments at the end of last year, the Mortgage Bankers Association reported. Up to 10 million US homeowners are at risk of default over the next one to two years, Moody's Economy.com estimates.

Under the legislation, bankruptcy judges would be able to reduce the principal amount of mortgage loans for struggling borrowers - a process dubbed "cramdown."

Currently, only vacation properties, and not primary residences, can be crammed down by bankruptcy judges.

The banking industry warns the change will raise borrowing costs for all homeowners and clog the bankruptcy courts, prompting judges to write off tonnes of other consumer debt just when lenders are reeling from the financial crisis.

The industry mounted a fierce lobbying campaign that made inroads with several centrist Democrats in recent weeks. A vote on the legislation was delayed last week after several began to balk at the measure.

The Obama administration argues that mortgage cramdowns should be used as a last resort, only when borrowers have run out of other options.

The measure faces a far steeper climb in the Senate, where Republicans, who largely oppose the measure, still hold a lot of sway.

It was attached to broader legislation related to the current crisis that enjoys broader support, including a measure to raise permanently the cap on federal deposit insurance coverage from $US100,000 to $US250,000.

The legislation would also boost the Federal Deposit Insurance Corporation's line of credit with the US Treasury to $US100 billion from $US30 billion.

Under the legislation, mortgage servicers would acquire a safe harbour against lawsuits from investors after they modify loans. The bill would also ease restrictions on the Hope for Homeowners program. Begun last fall to help borrowers refinance into more affordable government-backed mortgages, the program has failed to gain much traction.

The cramdown measure, introduced in the last Congress, gained momentum in recent weeks due to the change in power in Washington and the perception that lenders haven't done enough to modify loans.

Opposition to mortgage cramdown has eroded further after Citigroup agreed to back the measure after politicians offered to limit it to existing mortgages.

A host of consumer groups and borrower advocates, including the AARP, lobbied hard for the measure.

"With rising foreclosures undermining everyone's property values, this new option will not only help hundreds of thousands of homeowners save their homes, it will help keep everyone's property values from sliding further," AARP said in a statement.