In another disheartening development on the banking front, the Senate defeated legislation giving judges the authority to modify residential mortgages in bankruptcy.

Note that the popular description is often misconstrued in short form descriptions. Judges would not have had open-ended authority to make changes. The construct is that mortgages are collateralized loans. The mortgage balance is written down in bankruptcy to the value of the collateral, and the excess is added to the unsecured creditor claims.

This is also not an arcane process. It’s used in commercial bankruptcies and lending against boats, for instance. Ever hear any complaints about this practice in Chapter 11?

It was the best hope for cutting the Gordian knot of mortgage securitizations. First, it would allow for decisions on a case-by-case basis. Second, the servicer would get paid (fees are well established for court action in foreclosure). Third, the fact that a judge could force a principal writedown would give servicers air cover to do deep principal reductions, which Walter Ross, who owns the biggest third party servicer, has found do much better (in terms of borrowers paying on time) than the shallower mods coming out of government sticks and carrots.

This is not good news at all. It bodes ill for the housing recovery (the sooner prices bottom, the better; all these phony programs and fighting to find ways to suck more income out of hopelessly underwater borrowers is anti-recovery. The history of past bank crises shows that bankruptcies and debt restructurings are a necessary step to recovery. Trying to impede that puts the interest of the banksters ahead of the collective good. But why should we be surprised? This has been the modus operandi since the crisis began.

From Bloomberg:

The U.S. Senate rejected a measure that would let bankruptcy judges cut mortgage terms to help borrowers avoid foreclosure, a victory for banks and credit unions that said the legislation would increase loan costs. The proposed “cram-down” amendment to a housing bill was defeated today in a 51-45 vote, with 12 Democrats among the 51 opponents. The measure needed 60 votes to pass over Republican objections. The House passed its version 234-191 on March 5. “These bankers who brought us into this crisis are literally shunning and stiff-arming the people who are facing foreclosure,” said Senator Richard Durbin of Illinois, sponsor of the legislation and the chamber’s second-ranking Democrat. The defeat is a setback for President Barack Obama’s administration, which included cram-down in the anti-foreclosure plan aiming to help 9 million homeowners. The mortgage industry has twice succeeded in helping to kill the proposal since Durbin first introduced it in 2007. The senator said today “this is not the last time” he will raise the issue. Democrats led by Durbin had sought a compromise on the measure with JPMorgan Chase & Co., Wells Fargo & Co., Bank of America Corp., the American Bankers Association and Financial Services Roundtable. The lenders that scuttled the negotiations are “surviving today because of taxpayers’ dollars,” Durbin said. The three banks he named received $95 billion in U.S. aid. “It’s clear that part of the mortgage industry was never interested in meeting us halfway, as negotiations went forward, they moved the goalpost back and back,” said Senator Charles Schumer, a New York Democrat.

An older trader’s saying is “little pigs get fed, big pigs go to slaughter.” In this case, the parasite is successfully sucking the life of of the host.