Friday, February 13, 2009

The Very Latest on the Chapter 13 Mortgage Cramdown Legislation

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

The economic stimulus bill so dominated Congress' agenda of the last two weeks that there was no formal progress on either the Senate or House Chapter 13 Mortgage Cramdown bills since January 27 when the House Judiciary Committee debated amendments and voted in favor of amended H.R. 200. (See my prior Bulletin on that hearing and the approved amendments.) That amended bill has now been "ordered to be reported with an amendment" to the full House, but no House debate on the amended bill has yet been scheduled according to public sources.

No Action But a Lot of Talk

There has been a lot of background maneuvering and public posturing.

The Administration:

At the highest level, on Tuesday, 2/10, Treasury Secretary Timothy Geithner testified before the Senate Budget Committee in highly publicized (and roundly criticized) presentation on the financial rescue plan. He referred in his testimony to the bankruptcy cramdown legislation, saying that it “will be an important part of the president's plan." But he spoke cautiously: “At that same time, we want to do it very, very carefully, because this is a delicate situation, complicated balance. And we want to make sure we're not making the process worse as we go forward.”

Then a day later, on Wednesday, he and Housing and Urban Development Secretary Shaun Donovan met with major creditor and community representatives to discuss a $50 billion proposal which would greatly increase governmental intervention in the mortgage modification process. Already approved bailout funds would be used to buy up millions of at-risk loans directly, at a discounted price, and then refinance them to homeowners at more affordable terms. An advantage is that loans themselves are much easier to value than the mortgage-backed securities which have been virtually impossible to value.

A Proponent:

Shortly after the House Judiciary Committee passed the House version of the bankruptcy bill, its sponsor, Rep. John Conyers, wrote an op-ed column in the Wall Street Journal strongly advocating for the legislation. He directly addressed some of the criticism about it:
To those who claim that my bill will end up harming consumers by increasing the cost of credit, I would respectfully suggest that they are not taking account of the track record of the modern-day bankruptcy code.
For more than three decades, the bankruptcy code has permitted the very kind of court modification we are considering today, for every other form of secured debt, including loans secured by second homes, investment properties, luxury yachts, and jets. For over 20 years, this very kind of modification has been available for home mortgages already -- if the home is a family farm. There is no indication that this has in any way increased the cost of credit for any of these kinds of loans.
As for my legislation, we have narrowed it to apply only to existing mortgages. So it will have no effect on new mortgages and cannot impact their cost.
Finally, to those who argue that this legislation constitutes some form of "moral hazard," which will encourage reckless borrowing in the future, I would simply ask them to come to Detroit, my home town. . . .. Block after block, "for sale" and foreclosure signs feed off of each other, driving down home values, uprooting families, decimating communities, and causing local tax revenue that pays for police and firefighters to plummet. We don't have the luxury of worrying about hypothetical future moral lessons. We need to stop the bleeding today.

The Opposition:

In a competing op-ed article today also in the Wall Street Journal, Todd Zywicki, law professor at George Mason University and long-time vocal opponent of bankruptcy mortgage cramdowns argues that the legislation would increase interest rates and upfront home purchase fees, would "unleash a torrent of bankruptcies," "overwhelming the bankruptcy system," and this "surge in new bankruptcy filings, brought about by a judge's power to modify mortgages, could destabilize the market for all other types of consumer credit." But Prof. Zywicki does not seem to acknowledge that the bill is being changed to apply only to mortgages existing at the time of enactment. And his statement that "[i]n 2005, Congress eliminated the power of bankruptcy judges to modify auto loans" makes one wonder whether he has a good grasp on bankruptcy law. I suggest a reading of his article together with a highly cogent and thoroughly documented refutation of Zywicki's arguments found in the written testimony on January 22 by Adam Levitin, Associate Professor of Law at Georgetown University Law Center, before the House Judiciary Committee hearing on the bankruptcy legislation.

A Key Non-Partisan Report:

A new report was issued on January 26 by Credit Suisse entitled "Bankruptcy Law Reform – A new tool for foreclosure avoidance," which should have a huge impact on the public discussion of this issue. (Credit Suisse' Fixed Income Research group was also the source of a study on projected foreclosures whose conclusions have been constantly cited by both the press and top governmental decision makers. See my earlier Bulletin on that study: Projected Foreclosure Rates Are Increasing: the Insights in the Credit Suisse Report Beyond the Headlines.) The report starts with an excellent comparison of bankruptcy mortgage cramdown to other modification efforts such as FHA's Hope for Homeowners and the FDIC's Streamlined Modification Plan. Then the majority of the reports reviews in exhaustive detail the costs and benefits of cramdown to debtors and investors, particularly analyzing the impact on various classes of investors, the heart of the mortgage modification conundrum. Its conclusion:
Overall we think the bankruptcy reform will be a net positive in terms of foreclosure reduction, as it may be an effective way to improve both home equity and affordability. It has several attractive features relative to other loss mitigation alternatives, such as comprehensive debt restructuring, less moral hazard, and direct dealing with second liens. Though it is an important new tool in the toolkit, we can’t dismiss unintended consequences such as: (1) many more borrowers filing than who qualify, (2) bankruptcy bar ramping up its marketing machine, and (3) new defaults created by borrowers who believe (falsely or otherwise) bankruptcy will be their salvation.
I urge anybody interested in a non-partisan and competent discussion of this issue to at least flip through this (mostly) very readable report.

The Bottom Line

The ultimate question to address in the foreclosure mess is: who should bear the loss when a mortgage is larger than a home’s value? All the foreclosure prevention and mortgage modification programs wrestle with this, and many being now being considered pass on much of this loss onto taxpayers. The Chapter 13 proposal would not pass virtually any of the direct costs onto taxpayers, and the debate rages about how the costs would be passed onto the public through higher future interest rates and reduced credit availability. Some commentators, such as in an article early this morning by MSNBC's John Schoen consider it "[b]y far the most controversial proposal to break the loan modification logjam." See also this recent Forbes article from the mortgage banker's perspective bylined "Somebody has to take a hit if bankruptcy judges forgive troubled mortgages. It's probably you." Yet bankruptcy cramdown still appears to be on the Administration's list as a necessary part of the solution. Now that the stimulus wrangling appears to be done, Congress can return its attention to the apparently still worsening foreclosure crisis and to the bankruptcy bills.

The New York Times' lead editorial yesterday gives the legislators, and us, some final food for thought:
Unless the stimulus is accompanied by a successful twin effort to stem foreclosures and stabilize the banks, the downward pull of falling home prices and constrained credit will be too great to overcome.
Unfortunately, after a botched rollout this week of their bank bailout plans, administration officials will likely need another few weeks to develop a coherent proposal — and weeks thereafter to vet and implement it.
They need not, and should not, wait to start a foreclosure-prevention effort, but it’s not clear whether Mr. Obama’s team understands the scale of the effort required. Earlier this week, Treasury Secretary Timothy Geithner suggested that some $50 billion from the bank-bailout funds may be used on foreclosure prevention. That is the low end of the estimate that had been floated.
The administration also appears to be waffling in its support for passing new legislation that would allow bankrupt homeowners to have their mortgages modified under court protection. To be powerful, an anti-foreclosure effort must include both carrots, like interest-rate subsidies that would make it easier for lenders and borrowers to agree on modified loan terms, and sticks, including the option for a bankruptcy court judge to impose a settlement on lenders who aren’t doing enough to prevent unnecessary foreclosures.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
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