The so-called cram-down bill, which got a yes vote in the House of Representatives back in March, failed to attract enough votes in the Senate and will now be discarded from a broader housing rescue bill.
It was opposed by every Republican and a handful of Democrats, and will now be voted on as an amendment to the housing bill later this week.
It has been strongly opposed by the banking industry, including groups such as the Mortgage Bankers Association, who argue that it will lead to interest rates one-and-a-half to two points higher, making homeownership that much less affordable.
They also believe it would make it more difficult to accurately appraise property values, leading to higher down payment requirements and associated closing costs for borrowers.
However, a report from Credit Suisse Fixed Income Research found that if such legislation were to become law, foreclosures could be reduced by 20 percent, as it would prompt banks and lenders to step up loan modification efforts.
Surprisingly, the National Association of Homebuilders recently flip-flopped on its stance and now supports a temporary provision that would allow such modifications, perhaps because it could buoy sagging home prices.
Banks and mortgage lenders haven’t been too keen on offering principal balance reductions, though Wells Fargo reportedly offered them to Wachovia customers and HUD is supposedly weighing the idea as a loss mitigation tool.
Currently, bankruptcy judges can only modify terms on second homes and yachts.