WASHINGTON (Reuters) – A plan to let bankruptcy judges erase some mortgage debt will help lower foreclosures by 20 percent and stabilize the troubled housing market, a Credit Suisse report concluded on Monday.
The possibility that judges could lower, or ‘cram down,’ a loan amount will give mortgage companies an incentive to modify more failing loans on their own, the investment bank’s researchers said.
“We expect the new bankruptcy reform will increase loan mods, particularly principal reduction mods, as it is likely to both pressure and also give justification to servicers to more actively pursue principal reduction mods,” the report from Credit Suisse Fixed Income Research stated.
A two-year-old housing downturn has pushed foreclosures to record levels as more families struggle to make payments on properties that are slipping in value.
Many of those sour loans were bundled by Wall Street into complex securities that are difficult to modify.
Advocates for mortgage “cram-down” argue that bankruptcy judges are uniquely able to cut through mortgage contracts and rewrite loan terms.
Late last week, Democratic leaders who control the White House and Capitol Hill agreed to push a cram-down bill early this year.
“A large percentage of delinquent borrowers could benefit from cram downs,” the report states. “We expect the bankruptcy plan will provide about a 20 percent reduction in foreclosures.”
A separate report on Monday warned that redrafting bankruptcy rules could scare more lenders away from the housing market and damage banks that specialize in mortgage second-liens.
“(Cram-downs) will create long-term problems for the housing market through higher mortgage rates and reduced affordability, which will likely further destabilize home values and wreak havoc on second-lien and consumer lenders,” the report from Friedman, Billings, Ramsey & Co said.
Second-lien holders would likely be wiped out by a bankruptcy judge, the report concludes, and lenders that specialized in those loans will be hurt.
Many troubled consumers will be enticed by the possibility of getting relief through the courts, and increased bankruptcy filings will mean more write-offs across the sector, the investment bank stated.
“A spike in bankruptcy filings would also cause a surge in credit card losses, as lenders are required to charge off the account upon receipt of the bankruptcy notice,” the report states.
(Reporting by Patrick Rucker; Editing by Kenneth Barry)