Economists at the Federal Reserve Bank of Cleveland have weighed in on the long-running debate over whether to let bankruptcy judges modify home mortgages, saying evidence suggests the strategy helped stem farm foreclosures in the 1980s.
During that crisis, which the economists Thomas J. Fitzpatrick 4th and James B. Thomson called "a typical boom-bust scenario," farmers faced a predicament similar to that facing many homeowners today: the outstanding balance on their mortgages exceeded the current market value of their property.
Not unlike today, foreclosure moratoriums proved to be ineffectual, the economists wrote in an Aug. 3 research paper.
So Congress passed legislation to allow what was then known as a stripdown (and is now commonly referred to as a cramdown) for farm loans. The balance of the mortgage was reduced to the current market value of the farm, and the remaining balance was converted to an unsecured claim that received the same treatment as other unsecured debts in the bankruptcy.
Opponents of stripdowns in the 1980s made arguments similar to those made more recently, Fitzpatrick and Thomson said — namely that such a change would flood the courts with bankruptcy petitions and could lead to higher interest rates on mortgages.
But "the effects of that stripdown provision, in place for more than two decades, on the availability and terms of agricultural credit suggest that there has been little if any economically significant impact on the cost and availability of that credit," the economists said.
Data also suggests that the legislation "worked without working," the economists said, in the sense that it actually led to an increase in private loan modifications.
Of course, the whole discussion may be academic.
A bill introduced by Sen. Dick Durbin, a Democrat from Illinois, proposing such a change has been held up in Congress since the beginning of last year.
Durbin's three previous attempts to pass this type of reform have failed in the face of opposition from the mortgage industry and Republicans.