Are Mortgage Cramdowns the Answer?

When mortgage lenders are forced to adjust the terms of a loan to settle a bankruptcy or help a borrower avoid foreclosure, for example, it's called a mortgage cramdown. While lenders sometimes call the cramdown a death sentence, it can be a godsend for a homeowner.

As the nation struggles to stop a devastating foreclosure crisis, more support is being voiced for mortgage cramdown strategies. "Cramdown" is used to describe foreclosure prevention plans that force lenders to modify loans whether they agree to it or not.  Their resistance to the method inspired the term, because they feel that the policy is being crammed down their throats.  Many lenders, however, think that cramdowns are a necessary and reasonable emergency step toward stopping foreclosures.

Winning borrowers, losing lenders

The American Bankers Association and the Mortgage Bankers Association (MBA) are among the industry groups that vehemently oppose cramdowns, because they involve forcing lenders to drastically rework the original terms of a loan, including reducing principal balances that are owed. The whole idea of a cramdown is to reduce debt to a level that delinquent homeowners can afford to repay.  This usually means that the investors who funded the mortgage lose money in a big way.

Rising foreclosures

Meanwhile, the MBA reported that the number of borrowers behind on their payments has continued to grow. In early March, approximately 12 percent of all homeowners in the U.S. were behind on their payments. That's up by about 50 percent from last year's levels, and represents a frightening trend toward more foreclosures, unless something extraordinary is done to stem the rising tide of defaults.

Despite objections from investors, banks, and mortgage companies, many bankruptcy judges and consumer advocacy groups are pushing for mortgage cramdowns. More than 1 million households would benefit from this type of bankruptcy protection under a cramdown policy plan, according to estimates from the Congressional Budget Office (CBO). That's why President Obama included support for the mortgage cramdown approach in his latest housing plan. And he has already asked Congress to give bankruptcy judges the authority to rework the terms of mortgages to levels that homeowners can afford.

Congress debating cramdowns

Congress is hotly debating a law that would authorize these bankruptcy court cramdowns.  After delaying its vote on the bill last month, Congress is expected to vote before mid-March. Even if the legislation fails in Congress, Chapter 13 bankruptcy filings will spike about 13 percent this year compared to 2008, according to CBO estimates. That will impact close to half a million homeowners. Chapter 13 bankruptcy lets individuals pay all or part of their debts without losing their homes to foreclosure.

Critics of the mortgage cramdown proposal argue that such a measure would not only create huge backlogs in already overwhelmed bankruptcy courts, but could wreak havoc with housing prices. They believe that giving bankruptcy judges-who aren't real estate experts-the authority to assign values to real estate would undermine the validity of pricing, creating even greater problems.