As Iowa Attorney General Tom Miller continues his leading role in negotiating a massive settlement with the nation’s largest mortgage servicers this week, he is guided in part by an episode that played out in his state a quarter-century ago.

In testimony on Capitol Hill, in news conferences and in numerous interviews, Miller repeatedly has singled out the response to the Iowa farm crisis of the 1980s as a model of how he hopes to overcome the often-adversarial relationship between lenders and borrowers, and restore a measure of stability to the country’s struggling housing market.

But that approach, which Miller has called a “precedent for success,” involves a controversial element that banks so far have dismissed as both unequitable and unworkable: forgiving part of the loan balance, or principal, for borrowers who are struggling to make payments.

“Principal reduction is a tool in the toolbox that’s been underused,” Miller said in a recent interview. “We had principal reduction in Iowa during the farm crisis and it worked very well. By reducing the principal, the farmer then — the homeowner today — can make the payment . . . [and the] payment is greater than what the investor would make on foreclosure. That’s a win for everybody.”

Miller had been in office for years when the farm crisis peaked in the mid-1980s. Thousands of farmers had become overleveraged in the preceding years, taking advantage of booming property values and low interest rates to take out more loans and buy more land and equipment.

Roger Escher of Washington, Iowa, was a victim of the farm crisis of the mid-’80s. The state’s banks worked to help farmers pay their loans. (ROGER BURDETTE/ASSOCIATED PRESS)

When double-digit interest rates arrived and the value of the farmers’ land and crops began to tumble, many found themselves unable to pay their bills. A wave of foreclosures swept across the state and devastated many communities.

“Things began to spiral downward,” said Alan Tubbs, a veteran Iowa community banker who headed the agricultural division of the American Bankers Association. He worked with the Agriculture Department on programs to help mitigate the crisis. “It was an emotional time as well as a difficult economic time.”

As part of widespread efforts to ease the upheaval, Miller teamed with the Iowa Bankers Association and other groups to encourage the state legislature to pass a law requiring mediation between borrowers and lenders before foreclosure.

The goal, Miller said, was to find “the sweet spot,” in which the farmer could remain on his land and the bank received more in payments than it would from foreclosure, even if writing off a portion of the loan was necessary.

“Some of the banks weren’t too thrilled with having to do that at the beginning,” Neil Milner, then head of the Iowa Bankers Association, said of the mediations. But in time, he said, “everybody gave a little. The farmer could walk away with something to get started again; the institution got the issue resolved.”

Mike Thompson headed up the Iowa farm mediation program beginning in 1985, an effort that has handled more than 35,000 cases. Since 2007, he has run the state’s mortgage foreclosure hotline, which he said was inspired by the farm crisis.

Thompson said he sees parallels between then and now, including the reluctance of lenders to lower loan balances.

“It took 21 / 2 years before a lot of the farm lenders really got to the point that they could acknowledge loss,” he recalled. But then, he said, they discovered “that they were in this together. They figured out, ‘Let’s don’t make this adversarial,’ ” and that’s when they began to seek common ground with many troubled farmers.

For whatever reason, he said, such a cease-fire has yet to arrive in the foreclosure crisis, marked by distrust and animosity on both sides. “We’re still in the fight model,” he said.

Banks have lowered interest rates for some homeowners and have suspended payments temporarily, but they have been reluctant to embrace principal reductions on a large scale.

“Such programs could be harmful to consumers, investors and future mortgage market conditions, and should not be undertaken without first attempting other solutions, including more targeted modification efforts,” JP Morgan Chase executive David Lowman told lawmakers in a House hearing last year, estimating that broad-based principal reductions could cost the industry nearly $1 trillion. 

Of course, there are fundamental differences between the Iowa farm crisis and the housing predicament.

While troubled homeowners often must navigate the impersonal bureaucratic maze at behemoth servicers such as Bank of America, lenders during the Iowa farm crisis were overwhelmingly local.

“This was going on in your community,” said Tubbs, the longtime Iowa banker. “You’re dealing with neighbors and people you go to church with and see all the time.”

In addition, the settlement talks continuing this week in Washington grew out of revelations last fall about extensive problems within the mortgage servicing industry — from forged foreclosure documents to conflicting and contradictory information provided to struggling homeowners. Such problems were not part of the crisis in the 1980s.

Those scandals gave federal regulators and state attorneys general, led by Miller, leeway to try to force sweeping changes within the industry, as well as to potentially establish a multibillion-dollar fund that could be used, among other things, to prevent foreclosures.

Miller acknowledges that loan reductions aren’t right in many situations. But he remains convinced that history holds an important lesson, one worth repeating.

“I think the underlying principle is just so similar,” he said of today’s crisis. “When people got together, particularly with skilled mediators, it worked in so many cases and really kept, I believe, the fabric of rural Iowa together.”