Lenders Win Fight Against Mortgage ‘Cramdowns’

Published July 1, 2009

Mortgage lenders breathed a sigh of relief at the end of April when the U.S. Senate rejected legislation that would have allowed U.S. bankruptcy judges to cut mortgage terms to help borrowers avoid foreclosure.

The so-called mortgage “cramdown” legislation would have changed the foreclosure process dramatically, resulting in tighter credit and higher loan costs, according to lenders.

The bill needed 60 votes to pass the Senate but received only 45, with 12 Democrats among the 51 senators who voted to oppose the bill. A House version passed in March.

The Senate’s rejection represented a victory for the mortgage industry and a defeat for the Obama administration, which made the cramdown measure a part of the White House’s plan for combating the housing crisis.

Fears of Industry Instability

The plan faced stiff opposition from the financial community because cramdowns would have destabilized all current mortgages and raised the rates for future ones because the added risk to the lender would have been priced into the loan.

President Barack Obama and Senator Dick Durbin (D-IL), who drove the Senate legislation, want to force cramdowns because they believe doing so will slow the rate of foreclosures. Mortgage defaults have continued to rise in the aftermath of the housing bubble, and many believe the financial crisis will not end until the housing market gets back on track.

The bill offered some protection for lenders. Homeowners would have had to go through a qualifying process before a judge could cramdown a loan, and the authority would have ended in 2014.

The legislation also provided direction for judges on how much they could adjust a loan, and lenders would have received the financial benefit of any property value increase for four years on any mortgage adjusted by a judge.

First Losses to Lenders

But in addition to the rewrite authority, the bill required lenders to absorb the first losses on a default, creating an incentive for banks to renegotiate loans instead of just seizing a foreclosed home and selling it to recoup their losses. That did not sit well with banks or investors.

Attempting to compromise with lenders, Durbin tied the bill to an increase in FDIC borrowing authority, but chief cramdown opponent Sen. Jon Kyl (R-AZ) scoffed at the insurance sweetener. He said, “Democrats have tried to strike a compromise with some in the banking community by holding FDIC borrowing authority hostage to passing cramdown. Fortunately, the industry has politely declined.”

From the lender’s point of view, their contracts would have become worthless pieces of paper if the government could simply sweep in at any time and change them to protect the homeowner from defaulting. This might have led to lenders charging higher initial rates, hurting the prospects of recovery in the housing market.



Anthony Randazzo ([email protected]) is a policy analyst at Reason Foundation.