Banks change their tune on mortgage cramdowns. It's about time

Justin Fox
Time Magazine

In what strikes me as a pretty major change of heart, Citigroup has signed on to Illinois Democrat Dick Durbin's effort to give bankruptcy judges the power to rewrite the terms of mortgages. Reports the WSJ:

The cramdown bill would apply to all mortgage loans, including but not limited to subprime loans, written any time prior to the bill's date of enactment.  It allows judges the ability to lower principal or interest rate, extend the term of the loan, or any combination of the three. "Cramdown" refers to the ability of judges to lower a mortgage principal so that it is equivalent to the current market value of a home.

The banking industry thwarted such efforts by Durbin in 2007 and 2008. The WSJ portrays the deal as partly a PR effort on the part of Citi, which needs good PR these days. I'd like to hope that it also might mark the beginning of a realization on the part of bankers that being tough on bankruptcy law isn't always good business for them. Banking industry lobbyists slipped the provision restricting judges' ability to modify mortgages into the big bankruptcy reform act of 1978, and had argued in recent years that changing the law would result in a big rise in mortgage rates.

But the available evidence actually doesn't back this up. As I wrote a couple of weeks ago:

Georgetown Law professor Adam Levitin and Columbia economics graduate student Joshua Goodman gathered this evidence recently by taking advantage of a quirk in judicial history. Between 1979 and 1993, about half of all federal judicial districts interpreted bankruptcy law to mean that judges could modify first-home mortgages, while the other half interpreted it to mean they couldn't. The Supreme Court put an end to this in 1993 by ruling that the latter approach was what the law called for. Levitin and Goodman examined mortgage data from before then, and concluded "that mortgage markets are largely indifferent to bankruptcy modification outcomes." The reason for this, they contend, is that "lender losses in foreclosure would be greater than in bankruptcy, and so permitting bankruptcy modification as an alternative to foreclosure would, if anything, benefit lenders."

The bankers seem to be learning this lesson. They're still insisting that the bill only apply to past mortgages, not new ones. But it's a step forward. Maybe next it will begin to dawn them that, as some economists argue, the tougher personal bankruptcy rules they pushed through Congress in 2005 made the current financial crisis worse.

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