The House of Representatives approved a measure Thursday that would give bankruptcy judges the authority to modify the mortgages of homeowners filing for bankruptcy.

The bill, which could be approved by the Senate as early as next week, was voted on just as the Mortgage Bankers Association released a survey showing that a staggering 5.4 million U.S. homeowners – nearly 12 percent – were at least one month behind in their mortgage payments or already in foreclosure (“House OKs Court-Approved Mortgage Relief,” Los Angeles Times, March 6, 2009).

Judges already have the authority to reduce the principal on loans backed by other assets, including second homes, cars, and boats, but supporters of the bankruptcy law change – a provision of the House’s Helping Homeowners Save Their Homes Act – say that allowing bankruptcy judges to “cram down” the mortgage principal a homeowner owes on their primary residence would help more families to keep their homes.

“This is the same opportunity that owners of vacation homes, investment properties, private jets [and] luxury yachts have long enjoyed,” says Rep. Zoe Lofgren, D-Calif. “I think it’s only fair that we offer it now to average families as well.”

Supporters also believe, the threat of a “court-ordered” reduction in loan principal could induce mortgage lenders to voluntarily perform more mortgage modifications – modifications that financial institutions have largely been unwilling to make despite lender incentives offered through the government’s Homeowner Affordability and Stability Plan.

But opponents of the cramdown bill contend that it could make the mortgage crisis worse. The measure could make filing for bankruptcy too easy for homeowners and could lead to a flood of Chapter 13 bankruptcy filings.

“The bill makes bankruptcy a first choice and not a last resort,” says Steve Bartlett, president of the Financial Services Roundtable, a coalition of large financial institutions.

The measure would not only undermine ongoing efforts to modify loans but also “punish those who played by the rules and lived within their means,” says Rep. Mike Pence, R-Ind. “Rewarding bad behavior will not solve our problems, it will only worsen them.”

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