Waving a White Flag on Cramdowns

The mortgage industry's opposition to "cramdowns" has been steadfast and unyielding over the years. Just about a year ago, the Mortgage Bankers Association made blocking any legislation that would allow bankruptcy judges to reduce the secured portion of a mortgage loan its highest public policy priority. But today, the MBA seems ready to accept the likelihood that cramdown legislation may be enacted in the coming months.

To be sure, the MBA's official position remains the same - bankruptcy cramdowns will spur more consumers into bankruptcy, increasing losses for mortgage lenders and investors. That will force them to raise the price of mortgage loans for all Americans through tougher lending standards, larger downpayment requirements and higher interest rates.

But in a recent conference call with reporters, top MBA officials expressed a willingness to compromise on the issue if, as expected, Congress proceeds with bankruptcy reforms. The MBA acknowledges that supporters are gaining momentum and the trade group has outlined parameters it would like to see included in any legislation that allows bankruptcy judges to reduce the secured portion of a mortgage loan.

The MBA representatives said any legislation allowing cramdowns should limit the discretion judges have to reduce principal, lower rates or extend terms on a mortgage. MBA chairman David Kittle said that if Congress does pass a bankruptcy measure, cramdowns should only be allowed after a "waterfall" of other loss mitigation options have been exhausted, including repayment plans, loan modifications, an extension of terms and principal deferral.

He also proposed that cramdowns should be limited to subprime loans originated during the peak of the housing boom and that cramdown relief should be temporary.

"We need to set a permanent sunset date after which judges will no longer have this extraordinary power to alter the terms of a mortgage," Mr. Kittle said, noting that two-thirds of bankruptcy repayment plans fail, in which case the borrower typically loses their home to foreclosure anyway. Steve O'Connor, the MBA's senior vice president of government affairs, acknowledged that "clearly there is political momentum" favoring supporters of cramdown relief. "We recognize the realities of the landscape. And if in fact cramdowns are implemented, we think there should be some constraints to limit damage to the marketplace."

Despite the momentum in favor of cramdowns, the MBA is not alone in highlighting potential unintended consequences. FBR Capital Markets recently issued a report saying the proposed legislation will "create long-term problems for the housing market" and may depress the already weakened equity prices for mortgage and home-equity lenders.