Sen Richard Durban, D-Ill.

A top Democrat on Monday warned the nation’s banks that, unless they get more aggressive in modifying mortgages to prevent foreclosure, Congress will renew previous efforts to empower families to keep their homes through bankruptcy. But Sen. Richard Durbin (Ill.), the upper-chamber’s second ranking Democrat, also gave the banks three months to comply with his ultimatum — a span over which roughly 1 million new homeowners are projected to enter foreclosure.

Congress and White House officials have created a series of programs designed to entice mortgage lenders and servicers to modify troubled loans voluntarily, but those efforts haven’t kept pace with an ever-rising number of foreclosures, which have already topped 1.5 million since January. The issue has plagued lawmakers, who have spent hundreds of billions of dollars propping up the nation’s banks, but have provided little in direct help for families caught in the swirl of the housing crisis, which was at the root of the current recession.

Durbin is the sponsor of legislation to alter the bankruptcy code to allow judges to trim, or “cramdown,” the terms of primary mortgages to keep people in their homes — an option current law doesn’t permit. The Senate killed the proposal earlier in the year, but it could resurface if foreclosures continue to rise and the banks continue their reluctance to cut mortgage rates on their own. Durbin, for his part, thinks the bankruptcy change can’t come soon enough.

“The voluntary efforts by some banks to slow the foreclosure crisis and stabilize America’s housing market have not worked,” Durbin said during a housing forum at the Center for American Progress Action Fund. “Whether the bankers and mortgage servicers are failing because of intransigence or incompetence doesn’t matter … They have to do much better.”

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Durbin’s new initiative is raising the hopes of cramdown proponents. At Creditslips, University of Illinois law professor and credit expert Robert Lawless called Durbin’s revival “hopefully an indication there may be some interest in moving the legislation forward.”

There have been increasing reports (e.g., here) recently that lenders are not doing voluntary mortgage modifications in the numbers that need to happen. Yeah, I know — who could have possibly foreseen the possibility that a solely voluntary system would not work? There need to be carrots that encourage lenders to do the modifications. The change in the bankruptcy law is the missing piece — the stick that makes the program work.

A renewed interest in cramdown may have less to do with a sudden acknowledgement of its merits than the shortfalls of Making Home Affordable, the Obama administration’s program to encourage loan modifications.

The goal of that program is to rework loans for 3 to 4 million borrowers. But a new report by the General Accounting Office calls that estimate too optimistic. It also says the administration needs to do more to make sure servicers are equipped to participate – and that they follow the rules, CNN Money reports.

The GAO also critiqued the administration for not having the controls in place to properly monitor the program. Specifically, the agency is concerned that Treasury is not evaluating servicers’ capacity to meet the plan’s requirements and guidelines. Also, the agency has failed to fully staff the Homeownership Preservation Office, which is responsible for overseeing the modification program.

And, though Treasury has hired Freddie Mac to review servicers’ performance, it has not put established procedures to address those servicers who don’t comply.

Already, reports have surfaced that financial institutions are not adhering to the program’s rules. At a Senate Banking Committee hearing last week, a consumer advocate said some servicers are violating the guidelines by demanding upfront payments, denying borrowers not in default and initiating foreclosures while borrowers’ applications are being reviewed. Senator Christopher Dodd, D-Conn., has asked the administration to look into these allegations.

Given those drawbacks, it’s little wonder that tactics like cramdown are being revived. The Obama administration plans to meet with servicers July 28, to pressure them to modify more loans. But with rising unemployment contributing to a record 1.5 million foreclosures just in the first half of this year, a strategy that involves more than just a carrot may be called for. The Obama administration stood on the sidelines before, as cramdown failed, and has openly abandoned the idea. But unless it can get servicers to not only write down loans but to reduce loan balances as well — something that hasn’t happened so far – it may be forced to rethink that decision and take a second look at cramdown, the missing stick in its strategy so far.

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