It’s a new year in official Washington with a new Congress, a new President and a new chance for bankruptcy reform, reform which will center on the issue of what to do about unpaid mortgages.
The importance of such change is very simple: Just-released figures from RealtyTrac show that foreclosure filings were reported for 2,330,483 U.S. properties last year — that’s up a whopping 81 percent from 2007 and a more-whopping 225 percent increase from 2006. For many past homeowners, foreclosure will lead to bankruptcy and the traditional hope of a new beginning.
Unfortunately, many who have lost their homes are in for a surprise: The historic concepts of a new start and forgiveness have largely been eliminated from today’s bankruptcy rules.
The bankruptcy code we now use stems from legislation written in 1978. Under those standards borrowers could generally negotiate with lenders to settle unpaid mortgage debts. However, in Nobelman v. American Savings Bank, a 1993 Supreme Court decision, the 1978 language was re-interpreted to mean that bankruptcy judges could not modify or reduce mortgage debt.
In 2005 the bankruptcy laws were made even less friendly for consumers. Under the so-called Bankruptcy Abuse Prevention and Consumer Protection Act borrowers could not even go to court until they had first completed 180 days of credit counseling. The problem, of course, is that homes can be easily foreclosed in most states long before the required counseling period is over.
The Case for Investors
If you own mortgages then the need for strict bankruptcy rules is fairly plain: You want to protect your investment. That seems logical and reasonable, and there’s much historic precedent to support such a claim. The Fifth Amendment, as one example, says government cannot take your property without “just compensation“ — an expression which some investors argue means that bankruptcy courts cannot reduce mortgage debts unless the government pays off such claims.
And who are such investors? Well, the argument goes, they’re not just billionaires from overseas, they also include pensions that benefit individual teachers, police officers and other retirees.
A second argument concerns the potent matter of honoring contracts, a concept sometimes known as “contract sanctity.” The issue here, say investors, is that if mortgage agreements can be modified then investors around the world will take their cash elsewhere. The result would be higher costs to borrow in the U.S., a huge economic damper at a time when the economy is already in trouble.
How much higher? One answer comes from David G. Kittle, chairman of the Mortgage Bankers Association. In 2007 testimony, Kittle told Congress that loan rates could jump as much as 2 percent points if bankruptcy judges were allowed to modify loans.
The New World
While the arguments offered by investors certainly won the day in 1993 and 2005, the financial world has changed markedly since those times. The economy is at its lowest ebb since Hoover left office, foreclosures are at record levels and climbing and — perhaps most importantly — a new Congress and a New Administration have come to Washington.
“The concept of bankruptcy has long meant the forgiveness of debts and the chance for a new start,” says Jim Saccacio, chairman and CEO at RealtyTrac.com, the country’s largest source of foreclosure listings and information. “You can find references to the forgiveness of debts going back to Deuteronomy and Leviticus in the Bible. Today, with foreclosure levels high and going higher, it should be fairly clear that regardless of what the rules may say, investors are not going to be able to collect anything from people who after bankruptcy have no assets, no cash and too often no job. It’s time we looked at the realities of the marketplace and tried to create a new and better system that salvages as much as possible for all parties.” Even
In the Senate, the “Helping Families Save Their Homes in Bankruptcy Act of 2009” (S. 61) has been introduced by Sen. Richard Durbin, D-Ill. The Durbin bill would allow bankruptcy judges to modify loans if a home had been foreclosed, the loan violated the Truth in Lending Act or to reduce or eliminate fees and charges if the lender failed to give adequate notice.
Usually the reaction to such legislation would be absolute opposition from the lending industry, but in this case something unusual happened: Citigroup is widely reported to have said that it would not oppose the measure. Translation: The largest bank in the U.S. by revenue is breaking ranks with other lenders and giving political cover to Washington lawmakers.
Why did Citigroup not oppose modification legislation? One possible answer is this: Citigroup has received billions from the Treasury Department under the $700 billion bail-out legislation. It may also need more money, cash it’s unlikely to receive without a more flexible position on modifications.
And it’s not just Citigroup. Other major banks depend on Washington not only for bailout cash but also for friendly regulation. With a change of administrations the new reality is that banks have to evolve.
In response to the Citigroup news, the American Bankers Association said “it was not a participant in the recent agreement between Citigroup and Congressional proponents of mortgage cram-down legislation. ABA is opposed to the agreement because it will leave in place overly broad mortgage cram-down authority and other provisions that will harm thousands of banks across the country that have made, and continue to make, good loans.”
The term “cram-down” in the industry code word for mortgage modification.
The reaction to Citigroup from the Mortgage Bankers Association was both similar and different. The Association put out a statement saying “we remain opposed to bankruptcy cram down legislation because of the destabilizing effect it will have on an already turbulent mortgage market. We were surprised by the suddenness of the announcement and are still evaluating the proposed deal, but we believe there remain a number of crucial issues that need to be addressed.
“Any agreement needs to protect FHA and VA guarantee programs. Today’s announced agreement does nothing to solve that important issue. In addition we believe that this legislation ought to be limited only to subprime loans. We would also want to see a sunset date that limits how long judges would be granted this extraordinary power.”
The MBA statement allows that mortgage modifications might, in fact, be acceptable to them for subprime borrowers. This is curious because the taking clause of the Fifth Amendment has no special provision for subprime borrowers. Also, investors overseas would plainly be impacted by subprime modifications, yet somehow worries about higher rates seem to have disappeared. In effect, the absolutist arguments barring loan modifications are now in the “let’s bargain” stage.
The problem for lenders is that they have few chips. Their friends in the old Administration are going or gone and the new Administration came to office preaching a mantra of change. It doesn’t make sense that loans on second homes, yachts and planes can be modified in a bankruptcy court but not homeowner loans.
There’s also another matter tugging at those who deal with the borrowers, the companies and banks we sometimes call lenders. Most often so-called lenders are not lenders at all, they are instead “servicers” who represent the investors who actually own individual mortgages.
Servicers are actually agents of mortgage owners and are restricted in the modifications they can make. In fact, servicers are often not authorized to make any modifications. Already Countrywide is being sued by investors who object to its proposed $8.4 billion mortgage modification plan . Rather than deal with enraged investors it might actually make sense for servicers to favor more flexibility for bankruptcy courts — that way loans could be modified by judges and servicers would have little or no liability.
In the end lenders and investors have no hope of winning public support. Why? Because people don’t like to see pictures of families with their goods on the sidewalk — especially if such pictures are from down the street.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.