Bankruptcy Relief for Homeowners at Risk of Foreclosure

The United States Senate will likely take up a housing bill next week. The so-called "cram-down" provision -- allowing bankruptcy courts to restructure mortgages, including reducing the principal -- should be embraced as a relatively simple, tax-free and absolutely essential component.

Since 1971, when my company launched the nation's first socially responsible mutual fund, investors have increasingly embraced the notion that corporations and markets will produce better environmental, social and financial outcomes if they focus more on the long term. In the speculative run up to the current financial crisis, however, a large share of the market, and in particular the mortgage market, turned away from this approach. Speculative bubbles, before they inevitably burst, are fundamentally the triumph of short-term thinking over long-term thinking, and of short-term investors over long-term investors.

Nowhere was this more the case than in the subprime mortgage disaster -- the proximate cause of today's global financial crisis. Wall Street bankers were only too eager to snap up mortgages bereft of the most basic due diligence or underwriting standards, including even verification of income. Why? Because there was short money to be made. And if these large institutional investors hadn't been willing to purchase these loans, very few lenders would have been willing to make them.

Now, after the banks that caused the crisis have received billions of dollars in taxpayer bailouts, there are still millions of Americans in danger of losing their homes. It is high time to help these Americans, and a key part of that effort must be to allow qualified homeowners, as a last resort, to restructure their mortgages through the bankruptcy courts.

But short-term thinking will not go gently into the night. The bankers who helped create this crisis, and who have been lavished with billions of taxpayer dollars, have now set their lobbyists to work trying to derail bankruptcy relief for ordinary homeowners. In fact, the House recently passed a bill which, although including provisions to allow bankruptcy judges to restructure mortgages, added onerous conditions for homeowners at the behest of banking industry lobbyists.

Bankruptcy relief -- which should apply to all borrowers, not just subprime borrowers -- is a common sense solution:

Foreclosures are a problem for everyone. In 2009 alone, some 73.4 million families neighboring the 2.4 million expected foreclosures will see their home values drop an additional $435 billion as a result of their neighbors' misfortunes - and that amount could more than triple over the next three years to nearly $1.5 trillion. [Source: State Foreclosure Prevention Working Group, "Analysis of Subprime Servicing Performances," September 2008]

Voluntary efforts haven't worked. Credit Suisse reported in October that only 3.5 percent of delinquent subprime loans received modifications in August 2008 - and in many cases these "modifications" actually increased the borrower's monthly payments. [Source: Credit Suisse Fixed Income Research, "Subprime Loan Modifications Update," October 1, 2008] The State Foreclosure Working Group of Attorneys General and Banking Commissioners found that nearly eight out of ten seriously delinquent homeowners are not on track for any loss mitigation at all.

The legislation will make a difference for those who need it most. The Senate legislation provides that the option would only be open to homeowners who have unsuccessfully sought to obtain loan modifications from their lenders and who meet strict income requirements. (If a wealthy homeowner is underwater, the legislation won't help them.)

Analysts estimate that allowing the courts to participate in loan modifications will prevent up to a million foreclosures. Can anyone doubt that this will make an enormous difference to the economic recovery that we all fervently hope for?

A strong housing bill is essential if economic recovery is to proceed. The Senate needs to resist ever more short-term thinking from the banking industry, and rise above short-term political concerns as well, and embrace court-supervised workouts that will not only keep millions of Americans in their homes but be a good long-term investment for the nation as a whole.

Comments

[dnpvd51]

I rent and so do 100 million other people in this country.

Why should renters want home prices to remain high?

[californiadreamer]

Opposition to the principal reduction component by a judge in a bankruptcy proceeding has been ingenuous at best. The most popular is one that could be summarized as: Why should he get to do that and I can't? Seems like a lot of sour grapes by homeowners with good fixed rate mortgages who still have equity and don't want to see financial mistakes awarded. Yet not allowing a judge to reduce the principal balance on a mortgage makes the whole bankruptcy a joke. That is the big debt, the escalating mortgage cost. And the threat of a borrower going to the extreme of bankruptcy should encourage lenders to make more modifications. Investors will lose but that is part of the gamble. Those forced into bankruptcy will lose also in many ways, but they will not lose everything and will have a right to rebuilt their lives and their credit. I believe the American people will be watching this vote very carefully. They will want to know who's on their side and who's not. Obama seems to have pulled back from any use of the bully pulpit on this one. We shall see if the vote even gets to the floor.

[outnow]

The bankruptcy amendments to force conversion to Chapter 13 for many otherwise appropriate bankrupts and the elimination of "cram downs" formed one of the pillars of the current sub prime mess. The bankers wanted to eliminate these avenues of escape from the real estate mortgages in a down market while the banks reaped the upfront fees while bundling the risk off their balance sheets.

More air would be let out of the real estate bubble but the real economy would be much better off since these homes would be occupied and owners could stay put. If the real estate market has 25 - 330% more to go down and massive unemployment continues, I don't see good news for the derivatives being evaluated at high levels, but the banks need quantitative deleveraging. The bankers will fight in the Senate to prevent any moves to change the bankruptcy law they engineered.

This will be an interesting fight in the Senate where debtors and creditors must have an either-or outcome. There can not be a compromise. yanking the pillar out of debt bondage policies is not what the creditors want.