Senate Democrats are attempting to push through a controversial plan to allow bankruptcy judges to modify the terms of troubled borrowers’ mortgages as part of a larger package of foreclosure prevention programs.

Allowing judges to “cram down” loan modifications over the objections of lenders could raise interest rates on mortgage loans by 1.5 percent or more, industry groups fighting the proposed changes to the bankruptcy code say.

Senate Majority Leader Harry Reid, D-Nev., has incorporated provisions of a previous bankruptcy cram down bill, S 2136, into a broader piece of legislation, the Foreclosure Prevention Act of 2008.

The new bill, S 2636, also includes several programs that lenders support — including $200 million for pre-foreclosure counseling and authorization for state housing finance authorities to issue $10 billion in additional mortgage revenue bonds to refinance subprime loans and provide mortgages for first-time home buyers.

Reid has scheduled a vote on Tuesday in which the Senate will decide whether to consider the new bill, introduced Feb. 13, without first holding hearings in as many as four committees.

Francis Creighton, vice president of legislative affairs for the Mortgage Bankers Association, said Reid’s procedural move to bypass the committee hearing process for S 2636 is reasonable — if not for the bill’s incorporation of the bankruptcy cram down language.

“The rest of the bill is great,” particularly the additional leeway for housing finance authorities to issue mortgage revenue bonds, Creighton said. “If they drop the bankruptcy language, homeowners could have these other tools — counseling, additional options for refi’s — almost overnight.”

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“This is no longer the case,” said the letter signed by groups including the AARP, the AFL-CIO, ACORN and the Center for Responsible Lending. “Preventing the modification of home loans for primary residences makes no sense in an age of subprime exploding (adjustable-rate mortgages) where the mortgage itself causes financial crisis.”

A Jan. 28 study by Georgetown University Law professor Adam Levitin, “The Effect of Bankruptcy Strip-Down on Mortgage Interest Rates” concluded that giving bankruptcy judges the power to modify the terms of mortgage loans might only increase interest rates by 10 to 15 basis points, or about one-tenth of a percent.

Giving bankruptcy judges cram down powers might provide an added incentive for lenders to conduct their own loan modifications, instead of having them imposed by a court, Congressional Budget Office researchers said in a recent report.

But Creighton said the expected increase in lending costs would offset any of the benefits claimed by the bill’s supporters. “It’s a zero sum game.” Mortgage lenders and investors who buy mortgage-backed securities won’t be reassured by language limiting the bill’s language to loans made before it is enacted, he said.

“They say it’s temporary, but what’s going to happen next year, when it’s time to extend this?” Creighton said. “What member of Congress is going to vote against it? There’s nothing so permanent as a temporary government program.”

Democrats claimed to have forged a bipartisan compromise in a House version of the bill, HR 3609, that was approved by the House Judiciary Committee Dec. 12 (see Inman News story). But Creighton said that legislation has yet to come to a full House vote because it has the support of only two Republican lawmakers and is opposed by some Democrats.

The Senate version of the cram down bill, S 2136, still awaits a vote by the Senate Judiciary Committee and could proceed independently if opponents are successful in stripping of bankruptcy cram down language from S 2636.

Without the cram down provision, Creighton said, “This is basically non-controversial legislation.”

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