February, 2009:

A vote on HR 1106 was delayed Thursday as conservative Democrats tried to reduce the number of mortgages impacted by the legislation.  When I looked at the composition of the Blue Dog Democrats and The New Democrat Coalition, I’m amazed at the number of Northern California Congressmen in those groups.

These Northern and Central California Representatives are members of those groups of Democrats:

• Baca     District 43
• Cardoza   District  18
• Costa   District 20
• Thompson   District  1
• Tauscher   District 10
• Capps   District 22

Having heard some of the rhetoric in the floor debate, it seems to me that the debate has been gotten so focused on the merits or demerits of the individual borrower that the effect on all of us has been forgotten.

Foreclosures are dragging down neighborhoods and the national economy.

Voluntary mortgage modifications are not working, so the available options seem to be either foreclosures or judicial mortgage modification.  The narrower the application of the bill the less likely it is to solve our national economic.

He was a little old man, standing alone before the bankruptcy judge in Oakland yesterday.  The lender on his home sought the judge’s permission to foreclose on his house.

He told the judge that he had been working with the lender on a loan modification since September and had just gotten papers to complete in January.  The loan modification people told him not to make any further payments until the modification  went through.

Only some other department at the lender asked the judge for permission to auction off his house.

Under bankruptcy law as it is today, the judge was powerless to assist or compel a modification of the loan.  That’s because a special exception for home lenders in the Bankruptcy Code enacted in 1984  prevents a judge from changing any loan secured by a  family home.

President Obama is pushing the Helping Families Save Their Homes in Bankruptcy Act which would eliminate the special exception for home lenders.  If it passes, the judge at yesterday’s hearing could have taken a meaningful role in solving the man’s problem within the guidelines of the new law.  But not yesterday.

I have hopes of a happy ending to yesterday’s drama.  The judge continued the hearing on relief from stay for 90 days (an extraordinarily long time in the circumstances)  to give the parties a chance to work it out without his help.

The emotional opposition to efforts to keep individual families in their homes  through government intervention talks about homeowners who bought more house than they could afford.

My experience, as a bankruptcy specialist, is that far more of the troubled loans I see are refinances.  These are people who “bought” the idea that equity in their home that wasn’t “working” was equity wasted.  They mortgaged the home they already owned toward some other end.

That was the message of lenders who peddled loans to pay off other debt or enable investment.  You were a chump, according to the marketing, if you didn’t borrow against the value in your home.

These were not people greedy for a grander home than they could afford:  they were victims of the idea that improving your financial condition was dependent on leveraging your home to fund investment.

Unfortunate, but not “greedy”.

Opponents to legislation to allow bankruptcy judges to modify home mortgages scream that such a prospect would raise the cost of everyone’s home loans in the future.  If contract isn’t sacrosanct, they argue, lenders will have to raise the interest rate to cover the risk.  Pretty scary stuff, if true.

But the claim is wrong on two scores.  First, the bill reported out of the House Judiciary Committee applies only to loans on the books when the law is enacted.  It will have no application to loans made in the future.

Second, an academic study last year looked at the impact of bankruptcy loan modification in the period when it was permitted and found very slight impact on interest rates.  “Mortgage markets are largely indifferent to the risk of bankruptcy modification.”

Remember that the risk of judicial modification already exists for lenders on vacation homes, rentals, and commercial buildings.  Those credit markets seem to have survived and prospered (before the current debacle) in the face of possible modification.

Then, I suppose, we have to ask what is the cost to future homebuyers if we don’t stop the collapse in the housing market.

One of the arguments against judicially supervised mortgage modification is that we should not “reward” those who took loans they cannot now afford.  We should not rescue borrowers who overbought, goes the charge.

I see both policy arguments and personal observations for why we should care, and act,  to make it possible for some of those families to keep their homes.

The  stories I hear from my bankruptcy clients about how they got into loans that  are now devouring  them have common themes.

• Their realtors assured them that in a year or two they could get a better loan or sell at a profit.
• They believed that homeownership was the road to middle class stability.
• They refinanced on whatever terms were available to pay other bills.
• They did not understand the loan terms

The borrowers in these scenarios don’t  lack moral integrity.  They may have been  overly trusting of  the real estate “professionals” advising them or overly optimistic about the market or their personal prospects, but not “greedy” or “dishonest”.

The policy arguments center around the fact that we are all in this together.  My neighbor’s foreclosure will lower the value of my house.  The crash of  the real estate market in Florida impacts the economy of California.  I benefit from the health and strength of those around me.

Todd Zywicki, who notoriously  testified that the bankruptcy reform bill adopted in 2005 was “perfect” as written, constructed a scenario in his Wall Street Journal article intending to show how an overspending homeowner might profit unfairly  from a modified mortgage.

While he picks sensational facts for his example, the idea  underlying his tale is that the homeowner might see a recovery in the value of his property in the future.  Isn’t that what we, as a country, are hoping for?  That is fundamentally unfair?

Even assuming that there are those who individually might be “unworthy” of our help, just how far are we willing to go in rejecting a solution that works for the vast majority for fear that it isn’t perfectly just?  Isn’t opposing a solution on these grounds akin to cutting off our collective noses to spite our face?

Then there is the “sauce for the goose” aside: Congress has been willing to throw billions of our dollars at  the banks who engineered all of these bad loans to make a profit.  What possible fairness argument applauds the rescue of banks with  taxpayer dollars, yet rejects a bill that costs taxpayers nothing and provides immediate and meaningful relief to families?

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