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Will Cram-Down Make A Comeback?

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by Faiz Shakir, Amanda Terkel, Matt Corley, Benjamin Armbruster, Ian Millhiser and Nate Carlile

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In April, the banking industry and its allies in Congress successfully defeated a bankruptcy law reform that would have allowed bankruptcy judges to lower -- or "cram down" -- mortgage payments for troubled homeowners. The change was an integral part of the Obama administration's plan for stemming the foreclosure crisis, and while it initially passed in the House of Representatives, it garnered only 45 votes in the Senate. The banking industry spent $42 million on lobbying to defeat cram-down in the first quarter of 2009 alone, leading Sen. Dick Durbin (D-IL), the bill's sponsor and most outspoken proponent, to conclude that the banks "frankly own the place." Since then, the mortgage modification effort has fallen short, and during the first six months of 2009, "a record 1.53 million properties were in the foreclosure process." One in 84 homes received a foreclosure notice in that period, and thus an interest in cram-down has been renewed. The Senate Judiciary Committee held a hearing on the measure last month, and both House Financial Services Committee Chairman Barney Frank (D-MA) and Durbin have indicated they will revive the bill.

A SLOW PACE:
When the Obama administration initially released its housing plan, titled Making Home Affordable, it set the goal of having mortgage servicers modify 3 to 4 million mortgages. The plan was based upon providing companies with financial incentives for completed modifications, while the threat of a cram-down would give servicers a reason to keep homeowners out of foreclosure, and avoid having a bankruptcy judge alter the mortgage in court. But without cram-down to round out the package, the modification effort has sputtered. Thus far, just 200,000 homeowners nationwide are on track for a modification, with 108,000 of those having mortgages owned by Fannie Mae or Freddie Mac, both of which are actively encouraging modifications. Privately-held mortgages constitute less than half of the modification effort, even though they account for 55 percent of delinquencies. The mortgage industry claims that it is attempting to keep up with the demand for modifications, but that it simply doesn't have the capacity. But the New York Times noted that "many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans."

THE SHAME GAME: Last week, the Obama administration brought 25 mortgage company executives, including representatives from Bank of America, Citigroup, and JP Morgan Chase, to the White House for questions regarding the slow modification progress. Today, the administration released a report on the modification effort, including the names of those companies that are lagging behind. As the Associated Press reported, "by publishing the names of companies that are lagging behind in the government's plan to ease the housing crisis, officials are counting on public outrage to get the industry on track." Publishing the names also helps reveal whether the program as a whole is faltering, or whether specific servicers that are behind the curve. "No one wants to be on the bad side of that list just because of the public scrutiny that comes from it," David Sisko, the head of default management services for Deloitte & Touche, told Bloomberg News. But the program's troubles don't end there. As Andrew Jakabovics, the Center for American Progress' Associate Director for Housing and Economics, pointed out, "The lack of transparency in the program makes it difficult to determine where the points of failure lie." He noted a Government Accountability Office report that found "the lack of adequate documentation and specification of the assumptions makes it difficult to assess the reliability of Treasury's estimates and, going forward, may hinder efforts to evaluate how well the program is meeting its objectives."

IF NOT CRAM-DOWN, THEN WHAT?: "People in the servicing industry and in the broader financial industry must understand that if this last effort to produce significant modifications fails, the argument for reviving the bankruptcy option will be extremely strong," said Frank. But Durbin told The Progress Report in an interview that, ultimately, "I think we're going to be forced into alternatives." One alternative option is taking away the tax advantage enjoyed by trusts that hold mortgage-backed securities "if the investors refuse to allow modifications." There is also mandatory mediation, a very successful program requiring that lenders and borrowers meet and try to work out an agreement before a foreclosure can proceed. Congress could also "temporarily change the rules on foreclosure to give people facing foreclosure the right to rent their homes" at the market price, giving banks an incentive to modify mortgages, in order to avoid becoming landlords. Finally, Jakabovics suggested allowing the Treasury Department "to buy out (at a discount) the servicing rights of underperforming servicers or even acquire them outright in exchange for some of the outstanding warrants" that Treasury acquired under the TARP program. "Treasury could then resell those rights to the servicers who have demonstrated capacity to do modifications," he wrote.