Obama Looks At Bad Loans

President Barack Obama and his economic team have signaled their intention to move quickly on the nation’s housing crisis, including the use of mortgage “cramdowns.”

Among other ideas, the White House is considering a proposal to move toxic mortgage assets off the balance sheets of financial institutions and into a “bad bank” where they can be worked out over time.

Timothy Geithner, the Treasury secretary nominee, told a congressional panel that his toolbox includes a bankruptcy provision to help struggling homeowners modify their mortgages. “We want a comprehensive housing package and this is likely to be an important part of that,” Mr. Geithner said during his confirmation hearing before the Senate Finance Committee.

The mortgage industry continues to oppose allowing bankruptcy judges to reduce or “cram down” the principal amount of a mortgage on a primary residence. But even though Mr. Geithner supports bankruptcy cramdowns, he does not want the language placed in the $825 billion economic stimulus bill which comes up for a House vote this week. The Obama economic team wants more time to craft a targeted bankruptcy provision so it will not spook the mortgage markets. “We are supportive of doing that in the most careful possible way,” Mr. Geithner testified.

Philip Corwin, a bankruptcy expert with Butera & Andrews, said he was encouraged by Mr. Geithner’s testimony. “He is clearly aware that if bankruptcy is made too broadly available it could undermine the mortgage market and recovery,” Mr. Corwin said.

The Finance Committee approved Mr. Geithner’s nomination by an 18-5 vote. As NMN went press, questions about his failure to pay payroll taxes would delay a vote on his confirmation by the full Senate.

Senate confirmation of Shaun Donovan to be the new Department of Housing and Urban Development secretary also was put on hold late last week. Cramdown legislation could cause a “substantial” surge in bankruptcy filings by consumers, including mortgagors who are currently paying their loans, according to a new report by Friedman Billings Ramsey.

FBR believes that consumers — if allowed — will go the bankruptcy route to reduce their housing debt. The firm calls it an “unintended consequence” of the language being discussed.

The investment banker also notes that banks, thrifts and other large holders of second liens “would most likely be wiped out by a bankruptcy judge in the modification process.”

Banks with large HELOC portfolios that might be hurt include Bank of America, Citigroup and U.S. Bancorp, among others.

Whether cramdown powers for judges become a reality remains uncertain. A cramdown bill passed the House Judiciary Committee but it’s unclear what major piece of legislation that bill might be attached to.

It appears that the top officials from the MBA appear ready to compromise on the issue of cramdowns if Congress proceeds with legislation that allows bankruptcy judges alter the terms of a mortgage. The Mortgage Bankers Association is lobbying to have cramdowns limited to subprime loans originated during the peak of the housing boom and that cramdown relief should be temporary.

It’s a tough pill to swallow for the MBA. Last year, the MBA made blocking cramdowns its top public policy priority. This year, in the wake of a spreading foreclosure crisis, top officials from the MBA acknowledged in a conference call that supporters of cramdowns have gained the upper hand. The MBA leaders outlined parameters they would like to see govern the extent to which bankruptcy judges could “cram down” a loan.

The bill that passed the House Judiciary Committee (by a 21-15 vote) gives bankruptcy judges broad authority to reduce or “cram down” the principal amount of a mortgage on a primary residence — except FHA and VA loans.

An amendment by Rep. Trent Franks, R-Ariz., to limit bankruptcy cramdowns to mortgages originated from 2004 through 2008 was easily defeated. The amendment also had a sunset provision.

Committee chairman John Conyers, D-Mich., said his bill exempts Federal Housing Administration, Department of Veterans Affairs and Rural Housing Service guaranteed loans from cramdowns — something MBA and other industry groups have been pressing for.

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 programs because it provides no assurance against a possible cramdown,” said Philip Corwin, a bankruptcy expert with Butera & Andrews.

But the action on the bankruptcy bill (H.R. 200) came too late and likely will not be hitched to the economic stimulus bill. This gives industry lobbyists more time to tweak the measure.

Chairman Conyers is expected to attach H.R. 200 to the next major piece of legislation moving through Congress.

Congressional supporters of bankruptcy modification have been emboldened by larger Democrat majorities in the House and Senate and by President Barack Obama’s support for changing the bankruptcy code.

Legislation should limit the discretion judges have to reduce principal, lower rates or extend terms, MBA chairman David Kittle said. He said cramdowns should only be allowed after a “waterfall” of other loss-mitigation options has been exhausted, Mr. Kittle said.