Cram it

Message on my answering machine this morning:

"The Mortgage Bankers Association will get raked over the coals [Thursday] in a new study published by Georgetown University Law professor Adam Levitin. The new study will show the MBA is misleading Congress and the news media when it claims that fixing the mortgage foreclosure crisis by tweaks to bankruptcy laws will result in significantly higher interest rates. This is a significant finding, in that nearly all of the MBA's argument against the plan to save 500,000 American families from mortgage foreclosures rests on a bogus claim about a spike in mortgage interest rates."

Wow. The rhetoric is really heating up over a proposal to give federal bankruptcy court judges the power to modify the terms of bankrupt borrowers' mortgages -- including reducing loan principal if a home in a declining market has lost much of its value.

The banking industry -- the MBA and the American Bankers Association -- really dislikes two bills that would do this, S 2136 and HR 3609. The Mortgage Bankers Association has even devoted a special section of its Web site to fighting the bills.

Rather than being mere "tweaks" to the bankruptcy code, industry groups say, allowing judges to rewrite the terms of mortgages after the fact would undermine investors' confidence in the ability of lenders to collect payments. With credit markets already in disarray, allowing bankruptcy courts to do "cram downs" could push interest rates on mortgage loans up by 2 percent, the industry maintains.

Poppycock, say those who support the idea, including former HUD Secretary Jack Kemp, Mark Zandi, chief economist of Moody's Economy.com, and a bunch of consumer and civil rights groups that have banded together as the "Alliance to End the Foreclosure Crisis." The groups include the Center for Responsible Lending, the Consumer Federation of America, the Leadership Conference on Civil Rights, the National Association of Consumer Advocates, the National Association of Consumer Bankruptcy Attorneys, and the National Consumer Law Center.

HR 3609 "will not increase interest rates, negatively affect secondary markets, or lead to abuses" the groups claim in a recent press release. The compromise House bill would limit judges' cram down powers to existing nontraditional and subprime mortgages, and the bill would not apply to loans made after it became law (see Inman News story). 

"This removes any concerns that could reasonably be raised about the bill’s impact on the cost or availability of future credit," AEFC claims. "While the bill has changed, the industry’s talking points against it have not caught up with those changes."

The study the groups will publicize Thurdsay, "The Effect of Bankruptcy Strip-Down on Mortgage Interest Rates" was published on Jan. 28. According to an abstract of the paper, it analyzes data from the 1980s and 1990s to "explore whether mortgage interest rates and origination rates changed as a result of federal judicial rulings on residential mortgage strip-down -- the bifurcation of an undersecured mortgage lender's claim into a secured claim for the value of the collateral property and a general unsecured claim for the deficiency."

Is that abstract enough for you?

According to the summary, the study's initial results "suggest that permitting strip-down has no effect on origination rates and increases mortgage interest rates by only 10-15 basis points" although there was some evidence that there's a larger impact on interest rates where Chapter 13 fillings are more common.

With 1.3 million subprime ARM loans scheduled to reset this year -- including more than 350,000 loans in the third quarter of the year -- backers of bankruptcy cram downs say there's no time to lose. 

Just having such a law on the books is might provide an incentive for lenders to conduct their own loan modifications, rather than have them imposed on them by a court, Congressional Budget Office researchers said in a recent report.

As noted here yesterday, FDIC chair Sheila Bair recently warned Senate lawmakers that lenders aren't engaging in workouts fast enough to slow the pace of foreclosures. A new survey of bank loan officers suggests that simply freezing the interest rates of ARM borrowers facing resets may not be enough to keep some from walking away from homes that are worth less than the balance of their mortgage. Bair said lenders are going to have to start writing down principal on some loans, too.

In some cases, loan servicers may be wary of modifying loan terms because it could open them up to lawsuits by investors who could claim they've violated the pooling and servicing agreements (PSAs) governing loans that are bundled up and sold as collateral for mortgage-backed securities. 

Another bill, HR 4178, would protect loan servicers who engage in workouts under the bill's criteria. But Bair has testified before lawmakers that while the intent of that bill may be "laudable," such legislation could be challenged on Constitutional grounds because it would override existing contracts (see Inman News story).

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