Mortgage bonds hit by cram-down legislation advance

NEW YORK Jan 9 (Reuters) - Indexes of the riskiest mortgage bonds slumped on Friday after one of the largest U.S. banks said it will support legislation that would give bankruptcy judges the right to alter mortgage contracts.

The effort to rewrite U.S. bankruptcy law to help troubled borrowers, under some conditions, has been the focus of fierce opposition from banks for years since it increases uncertainty on the asset for lenders and investors.

Chances are that the so-called cram-down legislation could reduce the value of current investments, and force lenders to boost costs on new loans, analysts said.

If passed, the legislation would "allow a bankruptcy court, that doesn't have any real estate experience to make judgment calls" on what a property is worth, said Sadie Gurley, a managing director at Marathon Asset Management in New York. Courts could be "overstepping" in terms of reducing the value as they strip investors of control, she said.

Financial giant Citigroup Inc (C.N) on Thursday broke industry ranks and said it will support the proposal to rewrite bankruptcy laws to help homeowners avoid foreclosure. The push by lawmakers follows discouraging results from industry efforts to alter, or modify, bad loans themselves to stop foreclosure.

The top-rated portion of the ABX 07-2 subprime bond derivative index dropped about 2 points on Friday, extending a fall that came as lawmakers and Citigroup announced their agreement on Thursday.

One dealer on Friday quoted the market for the index at 38-1/2 bid, 40-1/2 offered compared with Thursday's close of 40-1/2.

The index, after hitting a record low near 32 in November, had climbed to near 45 since early December on expectations mortgage bonds had priced in worst-case default scenarios, and on confidence that federal programs to unfreeze credit markets would soon gain traction.

Falling stocks and a report showing U.S. unemployment at its highest level in nearly 16 years also depressed prices on subprime bond indexes, analysts said. (Editing by Gary Crosse)