Would Cramdowns Cut Foreclosures?

Washington-Congressional supporters of bankruptcy cramdown legislation found vindication in a recent report by Credit Suisse that says bankruptcy reform could make a sizable dent in foreclosures.

"We expect the bankruptcy plan will provide about a 20% reduction in foreclosures," the Credit Suisse research report says.

The CS analysts also concluded that passing a bankruptcy reform bill that allows judges to reduce or cram down the principal amount of a mortgage would put "pressure" on servicers to modify more loans.

"We expect the new bankruptcy reform will increase loan mods, particularly principal reduction mods, as it is likely to both pressure and also give justification to servicers to more actively pursue principal reduction mods," the CS report says.

Democratic members of the House Judiciary Committee frequently quoted liberally from the Credit Suisse report while the committee considered amendments and passed a bankruptcy bill by a 21-15 party-line vote. The bill (H.R. 200) eliminates a longstanding exemption that protects mortgages on a primary residence from being modified in bankruptcy.

The committee rejected an amendment by Rep. Trent Franks, R-Ariz., to limit bankruptcy cramdowns to mortgages originated from 2004 through 2008. The Franks amendment also had a sunset provision, which the mortgage industry believes is critical, so the cramdown authority expires after a few years.

As MSN went to press, House speaker Nancy Pelosi was working on bringing H.R. 200 to the floor for a vote, despite strong opposition by the financial services industry.

Industry groups claim the bill will encourage homeowners to file for bankruptcy, undermine private efforts to modify troubled loans and increase the cost of mortgage credit going forward.

Industry lobbyists say the bankruptcy bill does not have enough support in the House to pass as a standalone measure.

However, House leaders plan to put the bankruptcy bill in a larger housing package that could garner more support.

The House Financial Services Committee recently passed three bills that will be part of the housing packages.

These bills revamp the Federal Housing Administration's Hope for Homeowners refinancing program, shield servicers that engage in loan modifications from investor lawsuits and strengthen the Federal Deposit Insurance Corp.

Committee chairman Barney Frank, D-Mass., noted that bankruptcy should be a "last resort." He said a more effective Hope for Homeowners program and other loan modification programs will provide homeowners with a "series of alternatives to bankruptcy."

The powerful committee chairman has not been a supporter of the bankruptcy changes. But he has been disappointed by servicers' loan workout efforts.

"Lenders had a chance to kill bankruptcy," Rep. Frank said, by voluntarily pursing more aggressive policies to reduce foreclosures.

The Center for Responsible Lending is reporting that 46,000 foreclose starts are initiated every week and there could be 2.4 million foreclosure starts in 2009.

"As long as we see this rate of foreclosures, economic recovery will remain out of reach," CRL president Michael Calhoun said.

If the industry can't stop the bankruptcy bill, their lobbyists will be working to narrow its scope. One of their goals is to make sure servicers have a chance to modify troubled loans before the homeowner files for a Chapter 13 bankruptcy.

H.R. 200 only requires homeowners to certify that they called their lender/servicer 15 days before filing for bankruptcy.

The Mortgage Bankers Association and other industry groups also want the FHA, Department of Veterans Affairs and the Rural Housing Service guaranteed loans to be exempt from cramdowns, because failure to do so could leave lenders exposed to additional losses despite the government guarantee.

There is language in H.R. 200 that appears to be an exemption. But industry lobbyists claim the exemption language does not go far enough and amounts to little more than guidance to the bankruptcy courts.

"If this bill is enacted, lenders will no longer participate in these government loan programs because it provides no assurance against a possible cramdown," said Philip Corwin, a bankruptcy expert with Butera & Andrews.

Under current law, the government cannot reimburse FHA, VA or RHS lenders for losses due to bankruptcy cramdowns.

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