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Lowdown on Cramdown: The Power of Bankruptcy Courts

In light of the sour economy and high rate of distressed homeowners marching to bankruptcy court, many see a serious need for some decisive legislative action.

Well, action that accomplishes something, instead of proposed legislation that keeps dying in Congress. But in the current political climate, is the prospect of bankruptcy law reform dead? 

Will bankruptcy judges ever be given more power to help the masses of distressed homeowners flooding their courtrooms? 

President Barack Obama has repeatedly promised the introduction of legislation intended to help distressed homeowners. But every time President Obama has proposed a brilliant plan, the bank lobby groups seem to reply with their own brilliant plans.

And their brilliant plans often involve large dollar figures and extreme lobbying directed at the legislators. There have now been two recent futile attempts to give bankruptcy courts "cramdown" powers.

As discussed in a previous post, "cramdown" refers to giving bankruptcy courts the power to adjust the terms of mortgages held by those who declare bakruptcy. Last May, the Senate blocked legislation that would have given the courts such power. As one Senator said:

"The banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place." 

The measure was re-introduced later in 2009, but was defeated again in December.

The passage of this bill would have been great news for struggling homeowners. It could have have provided lenders with added incentive to negotiate.

Or rather, a looming threat if they didn't negotiate.

You see, no lender would want the terms of their loan to fall under the gavel of a bankruptcy judge. Lenders would be more willing to negotiate the debt and modify loans on their own terms, if they knew that the alternative could be a debt negotiation on the court's terms.

And a bankruptcy court with such power could very well allow for the principal of a loan to be reduced greatly, which would send panic alarms ringing in the banking industry.  

Unfortunately for many distressed homeowners and bankruptcy petitioners, their only two choices remain either debt negotiation of bankruptcy. Debt negotiation is not always the most optimistic choice these days, since banks are being frugal and often, just reducing the interest rate by a few percentage points.

If judges are given the power to "cramdown" on mortgages, there might be a greater influx of debtors headed to bankruptcy court. If not, distressed homeowners might continue finding themselves drowning with their underwater homes.  

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