ABC News’ Z. Byron Wolf reports: Democrats were almost giddy this afternoon when they hastily called a press conference on Capitol Hill to announce that one of the country’s largest banks, Citigroup, had agreed to support a long-stymied proposal to give bankruptcy judges the ability to change mortgage terms.
Critics, which include both Democrats and Republicans, call the practice "cramdown" because it forces mortgage holders to accept the terms and some say it would drive up interest rates. Judges already have the cramdown power for second homes, yachts, and other big-ticket items, but notes on primary residences cannot be rewritten by bankruptcy judges.
Generally, this type of major shift would be useful for consumers in trouble, but bad for the banks and investors who hold the mortgages. It also could lead to a significant jump in write-downs they would be forced to take, and might make them very reluctant to make future mortgage loans.
About 4.6 million people –- one in 10 American homeowners –- are either delinquent making payments or in the foreclosure process.
"Most Americans do not have vacation homes. Most Americans, today, in trouble, are desperately trying to hold onto their primary residence," said Senate Banking Committee Chairman Sen. Chris Dodd, D-Conn., who chairs the Senate Banking Committee. "The notion here is to create the environment for negotiation so that those who are holding the mortgages will not wait until bankruptcy, that they’ll sit down ahead of time with the prospects that they’re going to have this mortgage rewritten in bankruptcy and say, ‘Let’s see if we can do it before they go to bankruptcy court.’ It creates a more positive negotiating environment."
But the cramdown agreement between Democrats and Citigroup does not insure that actual legislation will pass the Congress — something Sen. Dick Durbin, D-Ill., admitted at this afternoon’s press conference.
"We have some work to do," Durbin added.
Sen. Charles Schumer, D-N.Y., said more banks are likely to sign onto the bill in the coming days and with support from banks, Republicans and Democrats who oppose the measure are sure to follow.
"Citigroup’s action has broken the dam," said Schumer. "My office has now been called by heads of the — of most of the major banks in the country, saying they want to hop on board. And I’m now hopeful that we can get the banking industry to be supportive of this provision — at the very least, [to] not oppose it."
Not all Republicans would necessarily agree though. One Republican aide said he did not immediately detect a shift of support to the bankruptcy provision.
When Senators voted on Durbin’s bankruptcy reform provision in April 2008, without support from Citigroup and the banking industry, only 36 senators supported it.
But supporters today, who were joined at the Capitol Hill news conference by Rep. Brad Miller, D-N.C., said they hope to attach the cramdown measure to the stimulus package.
At their press conference, Durbin, Schumer and Dodd said they have gotten Citigroup to support their cramdown provision in exchange for three tweaks to the original cramdown bill.
According to Durbin’s office, these include:
1. Only existing mortgages would be eligible;
2. Homeowners would be required to certify that they attempted to contact their lender regarding loan modifications before filing for bankruptcy;
3. Only major violations of the Truth in Lending Act (TILA) would invalidate creditor claims in bankruptcy, rather TILA violations of any size.
An expert told ABC News on Wednesday that allowing bankruptcy judges to change terms of existing mortgages could have the unintended effect of raising mortgage rates for new buyers and refinancings.
He said if banks believe that the negotiated terms of a note could be modified and cost them money down the road, they’ll simply raise rates across the board to compensate for the potential losses.
– ABC News’ Dan Arnall contributed to this report.