As the economy and the housing and job markets worsen, middle-class households continue to lose equity in their homes and are less able to afford their mortgage payments. The difficulty is compounded for those locked into predatory mortgages with high interest rates. The federal government and the mortgage industry's continued failure to address the foreclosure crisis adequately could result in as many as 8.1 million foreclosures by 2012. Despite widespread calls for action to confront the crisis, foreclosures increased 81% in 2008. Voluntary mortgage modifications by lenders and banks, encouraged by policymakers in place of comprehensive federal action, have failed to make mortgages more affordable and prevent widespread foreclosures.
The Senate had an opportunity to address the foreclosure crisis yesterday by adopting the Helping Families Save Their Homes in Bankruptcy Amendment, which authorizes federal bankruptcy courts to modify the terms of mortgages on certain primary residences. Influenced heavily by the banking industry, they balked.
Bankruptcy law currently bars modifications on primary residences, while allowing modifications for vacation homes, family farms, and yachts. The amendment would permit bankruptcy courts to restructure the debt on home mortgages by reducing the principal owed, extending the repayment period, and reducing interest rates. Under the bill, eligibility is limited to homeowners with mortgages originated before 2009 that are worth less than $625,000, 60 days delinquent, and subject to a notice that a foreclosure may be commenced.
Extending the same bankruptcy protections to primary residences that currently apply to luxury yachts and vacation homes is not only fair, but would reduce foreclosures by about 20%, according to Credit Suisse, and benefit about 800,000 households, according to the Center for Responsible Lending. Strengthened bankruptcy protection is also beneficial to middle-class families who are not themselves facing foreclosure: the 2.4 million subprime foreclosures that the Center for Responsible Lending predicts will occur in 2009 will result in a $352 billion decline in property values for homes in neighborhoods surrounding those foreclosures, with an average decrease in property value per home of $8,667.
Preventing foreclosures in those neighborhoods will keep property values up, benefiting all homeowners. Indeed, an analysis by the Center for Responsible Lending found that similar legislation would avoid 600,000 foreclosures and thus maintain $72.5 billion in wealth for families not facing foreclosure. Modification of mortgages in bankruptcy will help maintain property values, while keeping middle-class families in their homes, limiting the self-reinforcing spiral of foreclosures and falling home prices.
Critics of modifying primary mortgages in bankruptcy worry that interest rates will rise as a result, that the federal government is bailing out irresponsible borrowers, and that the provision will encourage bankruptcy, overwhelming bankruptcy courts. None of these criticisms is valid.
Restricting eligibility to current mortgages in danger of foreclosure means that future mortgages will not qualify for modification. Thus, lenders will not raise interest rates on future mortgages based on the risk of modification in bankruptcy. Indeed, research demonstrates that mortgage markets (and interest rates) are not, in fact, influenced by the risk of bankruptcy modification. Further, the bankruptcy modification provision will protect all homeowners from the current housing crisis by mitigating house price declines. Foreclosures affect not only the families who lose their homes but entire neighborhoods, as property values decline with the appearance of unkempt properties, abandoned homes, and increased crime. Finally, concerns that the modification provision will incentivize bankruptcy are exaggerated. Not only is the provision limited to mortgages at risk of foreclosure, but bankruptcy itself is unpleasant, damaging credit and subjecting living expenses to court review.
Still, modification of mortgages in bankruptcy will not solve the housing crisis. Further action to address widespread foreclosures - including a moratorium on foreclosures and a mechanism to require modification of mortgages outside of bankruptcy - is necessary. President Obama's Homeowner Affordability and Stability Plan is an important component of such a comprehensive approach, but one whose efficacy is not yet proven.