Mortgage Lenders Win Battle over Bankruptcies

Article excerpt

WASHINGTON -- In a big victory for home lenders, the Supreme Court ruled Tuesday that borrowers who file for bankruptcy cannot reduce their mortgage debt to the current value of the property.

The decision, which settles conflicting rulings from lower courts, apparently will stop a practice that the mortgage industry had feared would lead to big loan losses.

In recent years, bankruptcy courts have increasingly permitted borrowers to reduce the value of home loans to market value, known as a "cramdown."

For example, a $170,000 loan might be chopped $100,000 if local housing prices had dropped sharply. The remaining $70,000 becomes an unsecured debt, which a lender is much less likely to recoup.

While figures on the number of cramdowns and resulting losses are not available, the practice has been a significant worry for lenders in California, the Northeast, and the Oil Patch, according to a spokesman for the Mortgage Bankers Association of America.

The Supreme Court's unanimous ruling was warmly greeted by the mortgage industry. "This is an excellent decision," said Phil Corwin, director of retail banking at the American Bankers Association.

Warren Lasko, executive vice president of the Mortgage Bankers Association, said that preventing borrowers from walking away from their debts would avoid major losses.

Mr. Lasko said that "the vast majority of borrowers" will also benefit from the decision. The reason: Lenders will be able to reduce their provisions for loan losses, enabling them to offer lower interest rates.

Conflict Resolved

The decision resolved conflicting sections of the U.S. Bankruptcy Code. The court rules that a provision of Chapter 13 of the code prohibiting cramdowns overrides a more general section that permits debtors to modify some of their debts.

"This will probably make moot" a cramdown provision in the bankruptcy reform bill now pending in the Senate, said Roger M. …