UPDATE:FHFA Dir:Obama Administration Working To Narrow 'Cramdown' Bill

Obama administration officials are working with lawmakers to narrow a measure allowing judges to rework mortgages for people in bankruptcy, Federal Housing Finance Agency Director James B. Lockhart said Friday.

The measure, pending before the Senate Banking Committee, could hurt Fannie Mae (FNM), Freddie Mac (FRE) and the Federal Home Loan Banks because they are large investors in mortgage securities, Lockhart said.

"We think it should be narrowed significantly," Lockhart told reporters after giving a speech at a real-estate conference in Washington. "We're advising them to be extremely careful and to narrow it as much as possible."

Under the legislation, troubled borrowers could get the principal balance of their mortgage loan reduced by a bankruptcy judge - a process known as a "cramdown." Currently, only mortgages on vacation properties and family farms - and not primary dwellings - can be crammed down in bankruptcy court.

The legislation passed the U.S. House last week, but is facing stiffer opposition in the Senate. Republicans, who still wield power in the upper chamber, are largely against the bill. In a sign that it doesn't yet have the votes to pass, Senate Majority Leader Harry Reid, D-Nev., opted against sending the legislation straight to the floor after it was sent over from the House this week.

The bill's Senate proponents are in talks with industry lobbyists on the legislation. To woo the backing of the credit union lobby, Sen. Charles Schumer, D-N.Y., has offered to attach a measure eliminating the credit union cap on business lending.

Credit unions are banned from having more than 12.25% of their loans go to businesses. Imposed 10 years ago, the cap is a bane of credit unions, which have long pushed for its elimination.

Credit unions also want lawmakers to pare back the cramdown measure so it only applies to subprime loans. The change would largely insulate credit unions from the impact of the change, since only around 2% of credit union loans are subprime.

Tweaking the legislation to incorporate the two changes would make it "extremely acceptable" to credit unions, National Association of Federal Credit Unions President and CEO Fred R. Becker Jr. said. "NAFCU would give the bill our full-on hard support," he said.

The banking lobby is also pushing to narrow the bill to just subprime loans. In addition, it wants lawmakers to prohibit borrowers who have received offers of a taxpayer-assisted loan modification from having their mortgage crammed down in bankruptcy.

"Considerable problems with the bill remain and negotiations to narrow the bill continue," Financial Services Roundtable Chairman Scott Talbott said.

The Obama administration this month began offering government payments to mortgage servicers that perform loan modifications, as long as they lower borrower loan payments to at most 38% of their income. The administration, which supports the cramdown measure, says it should be used as a last resort, only after voluntary loan modifications fail.

There is concern that the legislation could trigger large losses at Fannie and Freddie, requiring the Treasury to pump more money into the government-controlled mortgage companies. Lockhart said the legislation, in its current form, could hurt Fannie, Freddie and the 12 federal home loan banks if it caused a plunge in the value of the mortgage securities they hold.

"Certainly, if it's applied loosely and not done in connection with loan modifications it could hurt them," he said.

-By Jessica Holzer, Dow Jones Newswires; [e-mail]