Hand-wringing over bankruptcy billAdvisers laud, lenders slam proposal that would allow judges to stop foreclosures
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A battle is heating up over proposed federal legislation that, if passed, would give bankruptcy judges unfettered power to modify mortgage loans in an effort to stop the surge in foreclosures sweeping the nation.
The Mortgage Bankers Association of Washington and other banking trade groups came out swinging last week, saying that the House bill, HR 200, and its Senate companion, S 61 — dubbed the "cramdown" legislation — would be a disaster for consumers in the long run and push the battered mortgage market into an even deeper downward spiral.
But financial advisers and other advocates applaud the bill, calling it a badly needed move to stem the tide of foreclosures and stabilize the housing market.
Under the proposed legislation, a bankruptcy judge could change the terms of a mortgage loan by cutting the interest rate, extending the term of the mortgage or lowering the loan balance to make the monthly payments affordable to the homeowner.
The term cramdown refers to the judge's ability to lower the value of the secured debt to the current appraised value of the home. Under the proposal, any homeowner who sells the home within five years after the principal is lowered would have to share profits from the sale with the lender.
About 10 million homeowners are at least 30 days behind on their mortgage payments, according to Gus Faucher, an economist with Moody's Economy.com in West Chester, Pa. He estimates the proposed changes in the bankruptcy rules could prevent as many as 800,000 families from losing their homes.
Initially, the bill was slated to be tacked onto the Obama administration's economic stimulus package, but was pulled at the eleventh hour to become a stand-alone.
The proposed legislation now appears to be on a fast track: An amended version of HR 200 passed through the House Judiciary Committee last week. Plans are now in the works to add it as a rider to the omnibus spending bill that will fund federal operations for the rest of fiscal 2009, which must be passed by March 7, according to a person familiar with the situation.
The omnibus bill will also contain other anti-foreclosure measures, including one that would allow lenders to modify securitized loans without facing legal problems from bondholders, the person said.Banking groups aren't happy.
"Allowing judges to unilaterally alter mortgage contracts will do significant harm to consumers and further destabilize an already unstable mortgage market and consumers will end up paying the price," said David Kittle, chairman of the MBA's Vision Mortgage Capital LLC unit in Washington.
If judges start changing mortgage terms, it will introduce risk into the process and likely lead to "higher down payments, higher fees and higher mortgage interest rates for all borrowers going forward," he said.
Then there's the seven- to 10-year black mark that would appear on the homeowners' credit reports after they file for bankruptcy, Mr. Kittle said. This would hurt their ability to buy their next home, find employment, get a credit card or even rent an apartment, he said.
A coalition of 10 banking groups, including the American Bankers Association and the Financial Services Roundtable, both of Washington, fired off a letter to Congress last week expressing similar concerns. The bill would inject risk into the mortgage market, "making it harder and more costly for people to buy and sell homes," the coalition wrote.
GAINING MOMENTUM Despite their objections, consumer and political support for the proposed legislation appear to be mushrooming.
"I think the momentum is very strong on the legislation right now," said Peter Peyser, a principal at Blank Rome Government Relations LLC, a lobbying firm in Washington.
"There's a perception that the industry has done very little to address the foreclosure issues, and with the election adding to the Democratic majorities on both sides and putting a supporter of the legislation in the White House, I think it's looking more and more likely that this will happen."
Geoffrey VanderPal, a certified financial planner at Elite Financial Planning Group of America Inc. in Las Vegas, agrees.
"I think it would be a good start," said Mr. VanderPal, whose firm manages more than $100 million in assets. "If you can restructure someone's debt in such a way that it gets them through these hard times, and the mortgage company and the creditor end up getting a piece of it as well, then I think everyone comes out ahead."
Additionally, "it might slow down foreclosures long enough to let the rest of the housing market recover," said Tony Proctor, a CFP at Proctor Financial in Wellesley, Mass., who manages $190 million in assets.
Rick Sharga, vice president of marketing for RealtyTrac Inc. of Irvine, Calif., dismisses suggestions that the proposed legislation will lead to tougher home-buying conditions for consumers.
"The skeptic in me wonders how much harder we can possibly make it than the current market conditions, because the lenders just aren't making loans anyway," he said.
"As much as the lenders might wring their hands over this, it's really the government's frustration at the industry's inability to do anything to stem the tide of foreclosures."
Lenders don't seem to be motivated, Mr. Sharga said.
"We haven't seen the same kind of creativity from the lending community in coming up with loan modifications and loan workout programs that we saw in the origination process that got us into this mess."
Even the nickname — " the cramdown legislation" — speaks volumes, about the industry's attitude, he said.
"Why do we call something that's aimed at keeping people in their homes cramdown legislation — and the last time we changed bankruptcy laws in favor of the lenders, we called it consumer protection?"
Many advisers said they wouldn't hesitate to recommend the program to clients who are in danger of losing their homes, even though it means filing for Chapter 13 bankruptcy protection.
"I would probably tell them that they need to do whatever they need to do to make sure they have a home to live in, so I wouldn't be that concerned about the black mark on their credit record," Mr. Proctor said. "I think lenders in the future are going to discount the problems that they see on people's credit reports during this time frame."
Still, Mr. Proctor said he'd like to see Congress amend the bill to ensure that any credit blemishes occurring during this recession would be wiped off credit reports within three years. "Having a black mark on their credit report for 10 years seems a little bit harsh in these times."