The Wall Street Journal
December 31, 2008
Mortgage ‘Cram-Downs’ Loom as Foreclosures Mount
By MICHAEL CORKERY
Mortgage lenders who wake up Thursday with a New Year’s hangover are likely to face another headache soon: The effort to give bankruptcy judges the power to rewrite mortgages is gaining steam.
The banking industry hoped the mortgage “cram-down” measure died when Congress removed it from the $700 billion bailout bill that passed in October. But it has been gathering momentum in Democrat-controlled Washington, as evidence emerges that current voluntary foreclosure- prevention programs are falling short.
[With efforts to stem home foreclosures stagnating, mortgage ‘cram- down’ efforts seem destined to re-emerge under the new Congress. Here, a foreclosed home for sale in Lakewood, Colo., in September.] Associated Press
With efforts to stem home foreclosures stagnating, mortgage ‘cram- down’ efforts seem destined to re-emerge under the new Congress. Here, a foreclosed home for sale in Lakewood, Colo., in September.
In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it. Lenders hate it because they have to absorb the loss. Bankruptcy judges currently have the ability to modify certain personal loans and even mortgages on vacation homes, but they can not cram-down mortgages on primary residences.
Even staunch opponents acknowledge that mortgage cram-downs for primary residences are likely to be as part of Congress’s economic- stimulus package in early 2009. The National Association of Home Builders used to reject any bill with a cram-down provision outright.
Now it is saying the measure is worth a look.
President-elect Barack Obama and his incoming administration aren’t disclosing details of the much-awaited foreclosure-prevention plans, but during the campaign Mr. Obama called for closing the loophole that prevents bankruptcy judges from restructuring mortgages on primary residences. Lawrence Summers, a top economic adviser of Mr. Obama, publicly voiced support for bankruptcy reform before his appointment.
“To the extent that nothing else is working, bankruptcy cram-downs are becoming more likely,” says Rod Dubitsky, head of asset-backed- securities research at Credit Suisse.
The latest embattled foreclosure-prevention program is Hope for Homeowners, which was approved by Congress last summer and supposed to help 400,000 homeowners. Only 357 people have signed up so far for the voluntary program. The Department of Housing and Urban Development, which is administering the program, acknowledges that it has been encumbered by high fees and narrow eligibility requirements.
Another government program, FHASecure, was intended to help 80,000 homeowners who had fallen behind on their payments after their adjustable interest rates reset. It has helped only 4,100 delinquent borrowers refinance since September 2007 and will stop taking new loan applications as of Wednesday.
Mortgage lenders also are modifying tens of thousands of loans without government help. But often this hasn’t solved the problem. A report last week by the Office of the Comptroller of the Currency and the Office of Thrift Supervision found that nearly 37% of mortgages modified in the first quarter of 2008 were 60 days or more delinquent after six months.
“It is absolutely clear that voluntary modification is just not working,” says Rep. Brad Miller, a North Carolina Democrat. “Every plan that Congress has passed, we do it and nothing happens.”
Mr. Miller intends to introduce a mortgage bankruptcy-reform bill Monday, the first day of the new session. Illinois Democrat Richard Durbin plans to introduce a similar bill in the Senate.
Lenders warn that mortgage cram-downs will lead to higher interest rates and down payments, as banks seek to mitigate future losses from judicially imposed write-downs. They also are concerned that the reform measure would add to the losses they have already sustained from the housing crisis.
“Our members have modified 2.8 million loans,” says Francis Creighton, chief lobbyist of the Mortgage Bankers Association, which opposes cram- downs. “Could we do better? We are trying to do better.”
Proponents of bankruptcy reform say that previous modification efforts are falling short because they have focused on spreading out payment terms and forestalling delinquent payments. But that hasn’t cured a big part of the problem: that one in six houses is now worth less than its mortgage. Only programs that reduce principal amounts are likely to restore equity to millions of homeowners, they say.
“You have to deal with the systematic problem of underwater mortgages or you are not going to stop foreclosures,” says Harvard University economist Martin Feldstein, who has proposed his own plan to help homeowners with negative equity in their homes, which involves mortgage principal write-downs and replacing part of the original mortgage with a new, lower cost loan.
Proponents of bankruptcy reform also note that millions of troubled loans aren’t being addressed by current modification programs because they were carved up and sold to investors as securities. Mortgage servicers have been reluctant to aggressively modify these loans because they have been unsure of their legal rights.
The mere threat of mortgage cram-downs could break the standoff between mortgage servicers and mortgage investors, which has slowed aggressive loan modifications. Investors may be more willing to go along with industry-driven modifications when facing the threat that a judge could ultimately order the amounts of loan principals reduced, forcing them to eat bigger losses.
“The servicers can argue we have to give this to the borrower otherwise they will get it in bankruptcy court,” Mr. Dubitsky says.
Lenders argue that loans modified by bankruptcy judges often have high rates of default on the new payment plans. “We should be working on keeping people out of bankruptcy not pushing people into it,” says Mr. Creighton of the Mortgage Bankers trade group
Bankruptcy reform is likely to be one of many proposals that Congress considers as part of comprehensive foreclosure-prevention effort.
Another element is likely to be one that FDIC Chairman Sheila Bair has been proposing. Under her plan, the government and lenders would split the losses on modified loans that go into de
Some economists are urging the new administration to go even further.
Mark Zandi, chief economist at Moody’s Economy.com, proposes that the government subsidize the bulk of principal write-downs to the tune of $100 billion, about four times as much as Ms. Bair’s program.
—Nick Timiraos contributed to this article.