WASHINGTON — For the first time since the housing crisis began, a major mortgage lender agreed Thursday that courts should be allowed to order reductions in the principal of "underwater" loans for some troubled borrowers, cracking what had been fierce and unified industry opposition.
The agreement struck between congressional Democrats and Citigroup Inc. would permit bankruptcy judges to change the terms of mortgages as part of court-ordered debt restructuring. Democrats hope to include the provision in the upcoming economic rescue legislation under negotiation between Congress and the incoming Obama administration.
The suggested change in the nation's bankruptcy laws has been repeatedly proposed -- and defeated -- in recent years.
Under Chapter 13 of the U.S. Bankruptcy Code, judges currently have the right to reduce the principal of auto, credit-card and other loans but cannot reduce the principal on a primary mortgage under any circumstances. As a result, homeowners who go into bankruptcy often wind up with mortgage payments that are even higher than the ones they had before, after skipped payments and other fees are added to the principal.
Some housing experts and many Democrats blame this unwillingness to reduce the principal on mortgages for the difficulty that many homeowners have had as they try to modify their mortgages and avoid foreclosure.
But giving bankruptcy judges the power to "cram down" mortgages has been opposed by congressional Republicans and mortgage lenders such as Citigroup, who have warned that it would make providing loans riskier and, because of that, reduce the amount of credit available to buyers.
The measure was termed a deal-breaker in last fall's $700-billion Wall Street bailout bill and was left out of the final package. But Democratic leaders said Citigroup's about-face could be the crack that breaks the banking community's dam of opposition to the idea.
"This is the breakthrough we've been waiting for," said the bill's chief sponsor in the Senate, Sen. Richard J. Durbin (D-Ill.). "They can make a big difference in convincing their fellow institutions to join us."
Last month, the powerful National Assn. of Home Builders also switched positions, removing its objections to a similar bill in the House sponsored by Rep. John Conyers Jr. (D-Mich.). That move was another signal that the bloc of industry groups lined up against the legislation is fissuring as the foreclosure crisis has worsened.
