Following the trends of bankruptcy law over the last year the subject of “cramdowns” has made some lenders tremble and others, like me, anxious to see what our legislature will do to empower homeowners nationwide. If this new legislation makes it in to the senate and passes, I’m hoping President Obama will sign the new bankruptcy amendments in to law.
These new powers would allow bankruptcy judges to eliminate portions of a borrowers principle balance during bankruptcy proceedings. If passed, this ability will enhance American citizen’s ability to stay in their homes and I’m all for it. Perhaps these powers will increase the willingness of lenders and servicers to modify loans before borrowers get to the point of bankruptcy. Important developments in the story came from Reuters and the Washington Post today.
The U.S. House of Representatives is expected to vote on a bill on Thursday that would let bankruptcy judges rewrite home loans and shield mortgage servicers who modify loans from bondholder lawsuits.
The legislation, which aims to ease a deep U.S. housing slump, would also strengthen the ability of the Federal Deposit Insurance Corp to deal with bank failures and make permanent an increase in the insured deposit limit to $250,000.
“Hopefully Thursday,” House Speaker Nancy Pelosi told a reporter when asked when the bill would come to the floor.
The House bill would permit bankruptcy judges to erase some principal from troubled home loans, just as they are able to adjust other consumer debt. President Barack Obama called for such a measure in a housing rescue plan he released last week.
The so-called mortgage “cramdown” provisions should prod mortgage companies to loosen home loan terms on a scale that they have not done before, House Financial Services Committee member Rep. Brad Miller told Reuters.
“We have provided carrot after carrot to encourage them to modify loans,” the North Carolina Democrat said. “With the possibility of facing losses in bankruptcy, the mortgage servicers should have a justification for easing some terms.”
The bill also contains a “safe harbor” provision that offers liability protection to mortgage servicers who modify loans to help distressed borrowers stay in their homes.
Any measures that pass the House would also need to clear the Senate before Obama could sign them into law, and the Senate has yet to take up a similar bill.
Washington Post:
When President Obama touted reform of the bankruptcy code while unveiling his foreclosure prevention program earlier this week, it wasn’t much of a surprise. He had advocated allowing judges to modify troubled loans several times before, including during the presidential campaign.
But in the fine print of Obama’s proposal were restrictions that some of his fellow supporters of bankruptcy reform said could blunt its impact. Opponents, meanwhile, have said they viewed the president’s version of the proposal as a move in the right direction.
For one, the Obama initiative would cap the value of mortgages that could be revised in bankruptcy court. It would also pertain only to loans originated in the “past few years,” according to a summary of his proposal.
How the administration chooses to define several parts of its plan will impact whether tens of thousands of homeowners are excluded, said Henry Sommer, a past president of the National Association of Consumer Bankruptcy Attorneys. “It could affect a lot of people or very few people, we don’t know,” he said.
The details will ultimately be hammered out on Capitol Hill, where lawmakers have been wrangling with the financial services industry for years about allowing bankruptcy judges to lower the principal owed on home loans. Now, bankruptcy judges are precluded from modifying mortgages on primary residences, a practice known as cramdown. The House, where bankruptcy reform has already been approved in committee, could take up the measure as soon as next week, a Democratic aide said.
Republicans and the financial services industry fiercely oppose the measure, complaining it could drive up mortgage rates and increase losses to lenders. But some financial industry sources have said they expect some version of the legislation to pass and are working to limit its scope.
“What the administration put out was encouraging, because it looked at bankruptcy as a last option rather than a first option,” said Francis Creighton, chief lobbyist for the Mortgage Bankers Association.
Scott DeFife, senior managing director of government affairs at the Securities Industry and Financial Markets Association, said that his industry “saw the president’s proposal as improvements to the bankruptcy cramdown debate.”
The provision will also be a key part of a housing package being put together by Congress to codify changes to housing policy called for by Obama, a congressional aide said. The administration has designed a program to lavish incentives on lenders that modify mortgages. The incentives are the carrots to encourage more modifications, and bankruptcy reform is seen by the administration as the stick lenders would face for failing to comply.
Democratic congressional leaders aim to have the legislation passed within the next month, the aide said.
Nearly three-quarters of homeowners in Chapter 13 bankruptcy — which allows borrowers to restructure their debt — have unaffordable home payments, said Katie Porter, a University of Iowa law professor who has studied the bankruptcy process. About 20 percent of homeowners spend at least half of their income on their mortgage. Having an unaffordable mortgage can be a major stumbling block to completing the bankruptcy process successfully, she said.
Obama’s plan would limit bankruptcy cramdown to mortgages written in “the past few years” — a restriction advocated by industry officials.
Moe’s Commentary:
Whether or not the courts should be empowered to reduce the principle balance of a mortgage during bankruptcy proceedings will be a hotly debated topic. My thought is that if the philosophy driving recent policy maintains its momentum, we will see judges awarded the authority to reduce the principle balances of borrowers in the near future. I predict that a line of demarcation will be set, perhaps 3 years in to the past, from which judges will be able reduce these balances and that “cramdowns” will not be allowed on investment properties, only on primary residences.
There is, however, one thing to take in to consideration that the Post and Reuters did not touch on. For example, a new flood of bankruptcy fraud could begin with unqualified bankruptcy service companies offering to do BK’s on the cheap with no results. These BK service companies may take advantage of a great deal of consumers by promising far more than they can really deliver.
In the best of worlds, this new legislation will simply provoke lenders to be more proactive in modifying the terms of loans. I’m sure that if this legislation passes, corporate bean counters will easily find a way to fast track loan modifications on the loans they feel are most likely to go to bankruptcy court in an effort not to lose their shirts. Perhaps it takes the threat of severe losses to get these banks to do the right thing.
Sources:
Washington Post
Extent of Bankruptcy Reform Hinges on Details
Mortgage-Aid Tiff May Portend a New Wave of Class War
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