WASHINGTON — Key congressional Democrats on Thursday reached an agreement with financial giant Citigroup Inc. on a proposal to make it easier for bankruptcy judges to adjust the terms of home loans and possibly forestall many foreclosures.
Citigroup, said Assistant Senate Majority Leader Richard Durbin, D-Ill., is the "first major financial institution to step forward and to say, 'We understand this is a crisis in America.' "
The breakthrough agreement boosts the chances that Democrats can push new laws through Congress that direct bankruptcy judges to rework mortgage terms by writing down the principal on the millions of homes that now are worth less than the mortgages they carry.
Democrats have argued that lenders must accept a "cram down," essentially modifying a home loan to reflect a property's current value.
Thursday's agreement with Citigroup is important because it gives lenders a strong incentive to modify the terms of distressed mortgages before homeowners opt to seek bankruptcy protection.
"It's a really big deal," said Michael Calhoun, the president of the Center for Responsible Lending, a homeowner advocacy group that's been calling for more aggressive steps to modify mortgages and minimize foreclosures.
"It's a major milestone in passage of the bankruptcy reform, and I think it'll break the logjam we have seen to date. It's the first financial institution to come out and endorse the bankruptcy legislation."
There are strings attached. The bankruptcy change would apply only to existing mortgages, and the homeowner must have contacted the lender at least 10 days before filing for bankruptcy. Durbin termed those provisions "eminently reasonable."
Lenders have long warned that such a legal change would drive them to raise lending rates and would encourage homeowners to file for bankruptcy when they otherwise wouldn't.
"We remain opposed to bankruptcy 'cram down' legislation because of the destabilizing effect it will have on an already turbulent mortgage market," John Courson, the president of the Mortgage Bankers Association, said in a statement late Thursday. "We were surprised by the suddenness of the announcement and are still evaluating the proposed deal, but we believe there remain a number of crucial issues that need to be addressed."
Housing advocates don't think the legislation would spur more bankruptcies. Anyone agreeing to this special bankruptcy "cram down," Calhoun said, would have a new mortgage with an interest rate that's a full percentage point above market norms. The homeowner also would enter into a five-year agreement in which all his or her disposable income is used to pay off debts.
Senate Banking Committee Chairman Christopher Dodd, D-Conn., and others — including President-elect Barack Obama, have argued that it made no sense for judges to be barred from giving homeowners breaks on their principal residences since that's already allowed for second homes and vacation properties.
"I don't know how you can possibly justify excluding vacation homes, boats and the like from the effects of a bankruptcy proceeding," Dodd said, "and not be able to protect a primary residence."
The lawmakers hoped to attach the bankruptcy legislation to the economic stimulus plan that Congress wants to pass by mid-February, but conceded that it's controversial enough to derail the entire effort.
Lawmakers hope that other lenders will follow suit soon.
Citigroup, Durbin said, "had a chance to reflect on what's happened" in recent months and was willing to change its view. Citigroup had no comment Thursday.
Sen. Charles Schumer, D-N.Y., said he thought that other lenders were opposed "for solidarity purposes," but have now "realized that being against this is hurting the whole financial system and the economy."
MORE FROM MCCLATCHY