U.S. House Panel Approves Mortgage Measure

By JESSICA HOLZER

WASHINGTON -- A measure to allow judges to reduce the principal amounts of mortgages for troubled borrowers in bankruptcy cleared a key hurdle Tuesday when it was approved by a U.S. House panel.

The legislation, which is progressing quickly in Congress, would amount to the most aggressive step yet by the federal government to help strapped borrowers avoid foreclosure.

Proponents contend it will act like a stick, spurring mortgage servicers to complete more loan modifications. Meanwhile, the banking industry warns that it will raise mortgage costs for all borrowers.

The measure was approved on a 21-15 vote after its House sponsor, Judiciary Chairman John Conyers (D, Mich.) agreed to changes that would narrow its scope.

"While bankruptcy reform may not provide all of the answers to this crisis, surely it provides a common sense and practical approach to helping stop the spiral of home foreclosures," Mr. Conyers said in remarks before his panel.

Under the legislation, borrowers would be eligible to have a bankruptcy judge reduce the principal balance on their home loan -- a move known as a "cram down." Current law allows cram downs for mortgages on vacation properties, but not for those on primary residences.

After stalling in Congress last year, the legislation has gained traction in recent weeks due to the shift in power in Washington and the growing perception that mortgage servicers have not done enough to help strapped borrowers.

House Speaker Nancy Pelosi (D, Calif.) said Thursday the measure was a "very high priority" that could move soon, possible as part of the economic stimulus legislation. More likely, it will be attached to other fast-moving legislation, such as a spending bill.

In key concessions to the banking industry, Mr. Conyers agreed to alter the legislation to allow court-ordered modifications only for existing mortgages and to require that borrowers contact their lender at least 15 days before filing bankruptcy. Citigroup Inc. had demanded the changes in exchange for throwing its weight behind the bill, a move that angered the rest of the industry.

In another change, the legislation will now require recipients of cram downs who resell their home within five years to share the proceeds with their lender.

The panel also added language dissuading bankruptcy judges from shrinking the principal amounts of mortgages guaranteed by the Federal Housing Administration, the Veterans Administration or the Department of Agriculture. Under current law, the government cannot guarantee or insure amounts that have been crammed down on such loans.

The panel approved a Republican amendment barring people who committed mortgage fraud from receiving court-ordered modifications.

Though banking lobbyists favor the changes, they remain staunchly opposed to the legislation. Even though it applies only to existing mortgages, they contend it will raise costs on new mortgage loans because lenders will assume Congress will extend the legislation.

"The housing market is already contracting and enactment of cram down legislation would make things even worse by injecting more risk into the mortgage market, making it harder and more costly for people to buy and sell homes," a coalition of industry groups wrote in a letter to Mr. Conyers and Rep. Lamar Smith of Texas, the panel's top Republican.

In the letter, they warned that court-ordered modifications would trigger more losses at Fannie Mae and Freddie Mac, which own or guarantee more than $5 trillion of U.S. mortgages. Those losses would flow through to the U.S. government because it has agreed to pump money into the firms to keep them solvent.

Industry lobbyists also argued that mortgage servicers would shun federally insured loans because, despite Mr. Conyers' changes, the legislation doesn't protect such loans from being crammed down by the courts.

Several GOP amendments to limit the scope of the bill failed, including language to require borrowers to complete credit counseling before receiving court-ordered modifications.

The panel rejected amendments to limit cram downs to subprime and other non-traditional loans. An amendment to limit court-ordered loan modifications just to mortgages originated during the subprime heyday also failed.

Finally, the panel voted down an amendment to impose criteria for how bankruptcy judges modify mortgages. The measure would have required them to target modifications such that borrowers' monthly mortgage payments are no less than 31%, and no more than 38%, of monthly income.

Write to Jessica Holzer at jessica.holzer@dowjones.com