Bankruptcy Cramdown Bill Takes Off

Written by: Steve Cook   Tue, January 13, 2009 Crisis Watch


Underwater homeowners could soon have a power­ful new weapon in their negotiations with lenders to modify their mortgages. New legislation on a fast track in the Senate would give judges the power to set new repayment terms for borrowers in bankruptcy court, including dramatically reducing the loan principal—known as a “cramdown.”

Court-ordered cramdowns could leave lenders with bil­lions of losses but the changes in bankruptcy law could help as many as 800,000 troubled borrowers stay in their homes and keep them off the market, according to Mark Zandi, chief econo­mist at Moody’s Econo­

Under current bankruptcy law, mortgages on a pri­mary residence cannot be restructured in bank­ruptcy, unlike virtually all other liabilities. About half of Chapter 13 filers who are in default on the mortgages aren’t able to keep paying their mort­gages, and they ultimately lose their homes because debtors often have to make higher monthly mortgage payments than they did before bankruptcy, in part because their bankruptcy re­organization plans must include the payments they al­ready missed, plus resulting financial penalties.

The goal of the new legislation, sponsored by Senator Dick Durbin (D-Ill.) and Congressman John Conyers (D-Mich.), is to give millions of homeowners whose loans are underwater new leverage to jump-start nego­tiations with intransigent lenders and

The idea has been pushed for months by bankruptcy attorneys and attorneys general from 22 states and the District of Columbia, but it took on new two weeks ago when the Jerry Howard, CEO of the National Associa­tion of Home Builders, said his group would no lon­ger oppose the proposal. Continuing home foreclosures and the economic recession have opened the group to previously off-limits ideas, he said.

In a dramatic series of events last week, the cram­down legislation took off. Citigroup, which until re­cently had fiercely opposed proposals to give bankrupt­cy judges latitude to change the terms of mortgages, met with sponsors of the bill and agreed to support the Durbin-Conyers bill. Citigroup has received $45 billion in Federal bailout money and is being closely monitored by the govern­ment—in fact it is the only bank required by Treasury to account for its spending of its bailout funds. The negotiations on the cramdown issue, say some sources, reflect the bank’s desire to “get out in front” of the growing foreclosure problem and show Democrats its willingness to be constructive.

Then Senator Charles Schumer (D-NY), chairman of the Joint Economic Committee and an original co- sponsor of the bill, indicated that he had heard from other major financial institutions interested in discuss­ing how they might lend their support to the legislation.

The Mortgage Bankers Association, however, refused to cave despite the defection of one its largest members.

“We remain opposed to bankruptcy cram down legisla­tion because of the destabilizing effect it will have on an already turbulent mortgage market. We were sur­prised by the suddenness of the announcement and are still evaluating the proposed deal, but we believe there remain a number of crucial issues that need to be ad­dressed,” said its top officers late Thursday.

Should the legislation be enacted, its ramifications could be widespread. One of the primary issues mak­ing it difficult for lenders to renegotiate loan principals is the fact that lenders don’t own the loans. Most mort­gages are securitized and sold to investors as collateral­ized debt obligations. Investors could see the value of their holdings decline, and loss of investor confidence could seriously destabilize the secondary mortgage market. On the other hand, foreclosures also result in losses for investors and they might be more costly than cramdowns since they take longer to resolve

The legislation could significantly reduce the estimated 8 million foreclosures forecast for the next three years. In addition to keeping families in their homes, keep­ing these properties off the markets will help improve the foreclosure picture and hasten the return of healthy market conditions.

Finally, there is the question of re-defaults. Reduced principals should also reduce the rate of borrowers re-defaulting after renegotiating their loans. Re-defaults exceeded 50 percent during the first quarter of 2008, but few of those loans had their principal reduced. Moreover, re-defaulters won’t be able to return to bank­ruptcy court and will avoid bankruptcy, which can be a costly process in terms of legal fees and credit rating.



Key Provisions of Durbin-Conyers Bill

• Allows bankruptcy judges to lower interest rates, reduce the principal, and shorten the terms of primary mortgages.

• Homeowners must certify that they have tried to renegotiate loan with the lender before filing for bankruptcy.

• Applies to all loans written before the date of enactment of the legislation, should it pass.


Cramdown Winners and Losers





Underwater Borrowers


Leverage over lenders

Easier terms

Stay in homes





Bankruptcy increases cost of credit and incurs attorneys’ fees







Resolve foreclosures


Losses on renegotiated terms






Preferable to foreclosures?


Losses on investments


Real Estate Markets



Fewer foreclosures leading to stabilized prices



Possible higher rates due to secondary market instability



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