Industry Recoils at Citi's Mortgage Deal
Banks Seek More Limits on Bankruptcy Judges' Authority to Rework Mortgages

By Renae Merle and Binyamin Appelbaum
Washington Post Staff Writers
Saturday, January 10, 2009

Citigroup's support for a plan to let bankruptcy judges modify the terms of troubled mortgages and help borrowers avoid foreclosure left its banking industry counterparts on the defensive yesterday, insisting that the plan would do more harm than good.

After years of failed attempts, congressional supporters of the proposed law are cautiously optimistic about its prospects. And privately, banking executives acknowledge that some type of legislation is likely to pass, but they said they want to limit the loans eligible to be modified.

The major banking trade groups held a conference call with members after the Citigroup announcement Thursday, and all of the banks affirmed their opposition to the deal, according to a person on the call. Industry groups including the Financial Services Roundtable, the American Bankers Association, the Mortgage Bankers Association and the American Securitization Forum have all issued statements opposing the deal.

But, according to a congressional aide, two other large banks are actively negotiating with Sen. Richard J. Durbin (D-Ill.) to be included in the agreement.

This comes as more borrowers are being swept into a deepening foreclosure crisis despite government and industry efforts to help. Under the legislation being considered, a bankruptcy judge could change the terms of a loan by reducing its interest rate, extending its length, or lowering the principal or loan balance, known as cramdown provisions. The law would apply only to existing loans and not to loans made after the law passed. Currently, judges are allowed to modify the terms of a mortgage for a second or vacation home but not a primary residence.

In its agreement with Senate leaders, including Durbin and Sen. Charles E. Schumer (D-N.Y.), Citigroup won some concessions. The agreement added a requirement that homeowners contact their lender at least 10 days before filing for bankruptcy.

The industry wants to limit the cramdowns to subprime borrowers or to homeowners driven into bankruptcy by an unaffordable mortgage.

"The fix doesn't go far enough to address all of the problems. It's a good first step, but there is a lot more to be done to make the bill targeted," said Scott E. Talbott, senior vice president for government affairs at the Financial Services Roundtable. "We are continuing to work to limit the negative effects, to make it the least worst way to do the wrong thing."

While the agreement limits the impact of the provision to existing mortgages, many investors assume Congress will extend it, amplifying the potential losses to lenders, they said. If the borrower sells the home after the modification and reaps a profit, lenders should be able to secure a share, they maintain.

"Anything that is so broad, even if limited in time, is a grave concern," said Floyd Stoner, executive director of the American Bankers Association. "We always believe this economy will recover. As it does, real banks are the engine of the recovery. We need to make sure that we don't do things that make it more difficult for them to participate in that recovery."

Such a change could also cause problems with loans insured by the Federal Housing Administration, an FHA official told a congressional panel yesterday. The government does not have legal authority to reimburse lenders for any losses caused by a cramdown, creating a disincentive for lenders to do business with the agency, said Phillip Murray, who handles all single-family business for the FHA.

Durbin thinks the current version of the agreement is fair, but he is open to further discussions, said Max Gleischman, his spokesman.

The industry groups "will be the last to come out for this proposal because they work by consensus," Schumer said in an e-mailed statement. "But we expect more individual banks to be for this."

Supporters argue that the benefit of the provision, which they estimate could help 600,000 to 800,000 homeowners, extends beyond borrowers in bankruptcy. Lenders are more likely to attempt aggressive modifications when they can still control the terms, rather than allow a judge to set the limits, they say.

"We really let industry dictate what the solution would be up until now, and there is a growing recognition that that is not working. This [foreclosure] problem exploded under these voluntary programs," said Maureen Thompson, legislative director for the National Association of Consumer Bankruptcy Attorneys, which supports the change.

The Citigroup deal strengthens the position of cramdown proponents, according to Brian Gardner, a policy analyst at the investment bank Keefe, Bruyette & Woods.

"The deal between Senate Democrats and Citigroup over bankruptcy cramdown legislation probably ensures passage of the bill -- something that we already thought was highly likely," he wrote in a note to clients yesterday.

The deal came as a surprise to many in the industry, though Citigroup, Bank of America and J.P. Morgan Chase have spoken with Schumer's office about the bankruptcy provision, according to sources familiar with the talks. Bank of America and J.P. Morgan declined to comment. Schumer's and Durbin's aides declined to confirm which other firms have discussed the bankruptcy bill.

Staff writer Dina ElBoghdady contributed to this report.

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