Hand-wringing over bankruptcy bill

Housing crisis Foreclosures are sweeping the nation.

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.

LENDERS LEERY

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. read more