Can Cramdowns Make A Comeback?

Three months after the idea met its demise in the Senate, Mike Lillis at the Washington Independent noticed that the Senate Judiciary committee has scheduled a hearing to reconsider cramdowns — a proposal to allow bankruptcy judges to modify the terms of mortgages:

Nearly three months after the Senate killed a House-passed proposal allowing homeowners to stave off foreclosure through bankruptcy, some upper-chamber Democrats are wondering if it isn’t time to revisit the issue. Leaders of the Senate Judiciary Committee, not satisfied that mortgage lenders and servicers have done enough to prevent foreclosure voluntarily, have scheduled a cramdown hearing for Thursday.

As I outlined last week, there are a number of plans circulating that would address the ever-increasing number of foreclosures and attempt to boost the sputtering administration plan to encourage mortgage modifications. The problem with the current plan is that lenders would rather wait to write down a loan’s losses or hope that a borrower makes a miraculous turn away from foreclosure, and there’s no stick to incentivize them into pursuing a modification. Cramdown was supposed to be that stick, but then it ran into the Senate.

The administration has recently started pushing lenders to voluntarily up the pace of modifications. It sent a letter to mortgage firms saying that “we believe there is a general need for servicers to devote substantially more resources to this program for it to fully succeed and achieve the objectives we all share.” Financial executives are coming to the White House on July 28 to discuss how the modification program has been implemented, and “the administration plans to grill servicers that have done few modifications or have had many complaints.”

However, all of this prodding is no substitute for a real stick, and Treasury has thus far been reluctant to endorse any other legislative remedies. “We have enough tools,” said Herbert Allison, the Treasury Department’s assistant secretary for financial stability. But Congress seems to be open to at least exploring new legislative efforts.

Cramdown does not have to be the stick that Congress settles on (and given the way that it went down last time, it probably won’t be). Right-to-rent, which would give delinquent borrowers the ability to surrender their property but rent it at market price for a set period of time, is one option. Lenders, reluctant to become landlords, might find this a good reason to modify loans.

Another option is taking away the tax advantage enjoyed by trusts that hold mortgage-backed securities “if the investors refuse to allow modifications.” And then there is mandatory mediation, a very successful program requiring that lenders and borrowers meet and try to work out an agreement before a foreclosure can proceed. In the end, the point is to incentivize modifications, and it’s encouraging to see Congress acknowledging that the current effort is falling short.