The Republican Party, defeated at the polls and bereft of ideas, managed to eke out a small but significant victory this week with the help of their friends in the banking industry by defeating a Senate bill that would've restored the ability of bankruptcy judges to write down the principal amount on home mortgages to reflect declining property values.
http://www.nytimes.com/...
The Senate Republicans prevailed by convincing eleven "moderate" Democrats to join them in sealing the fate of millions of homeowners who are unable to refinance their existing mortgages because they are "underwater" due to the dramatic reductions in the value of their homes.
"And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place."-- Dick Durbin (D-IL), April 27, 2009
http://progressillinois.com/...
The defeat of this legislation is a good example of how dysfunctional a democracy can become when powerful self-interests are allowed to trump the broader public interest through the influence of lobbyists backed by massive amounts of campaign contributions.
Somehow lost in the fog of the $12 trillion in public funds that have been dedicated to solving our banking crisis is the fact that the crisis began with skyrocketing foreclosure rates and is not likely to end until those rates come back down to normal. The "toxic assets" that are at the heart of the sickness in the financial system are toxic because the loans on which they are based are headed into foreclosure at rates far beyond what was originally anticipated.
Yet, foreclosure rates are at record levels and still climbing. With an even bigger wave of foreclosures looming on the horizon in the form of the huge number of adjustable rate mortgages written at the top of the housing bubble coming due in the next year or two, this problem will not go away on its own.
Evidently the foreclosure prevention measures that have been announced to date have not worked very well. Despite receiving trillions in taxpayer funds, mortgage lenders have not been required to rework bad loans to keep borrowers in their homes, and they have not done so voluntarily. And why should they? Even as they pursue hard-nosed strategies with borrowers that result in higher losses on each loan, they continue to receive multiple taxpayer-funded bailouts to compensate and meanwhile, they avoid having to accept even partial financial responsibility for their irresponsible lending practices.
This provision would've provided a very significant backstop against these foreclosures at no cost to the taxpayer. The concept is simple and applies in all other areas of bankruptcy law: in a bankrutpcy, a judge can reduce the principal of a debt to reflect the value of the underlying collateral, to the extent that said collateral has become worth less than the original loan amount.
For example, if a homeowner bought a house in 2005 for $250,000 with 20% down and a $200,000 mortgage. Now let's say four years later, the same house is worth $150,000 and the borrower still owes $190,000. If they can still make the payments, then great. But if they are forced into bankrupcty for whatever reason (a five-year ARM coming due for example), then the bankruptcy judge would require the bank to reduce the priciple to $150,000, so that the new loan terms will be affordable and allow the homeowner can stay in the home.
This can apply to a yacht, an investment property, or anything else, and prior to the 2005 bankruptcy reform it applied to homes. Yes, the bank takes a major loss, but consider the alternative: foreclose on the property and sell it for $150,000 minus $40-60,000 in costs related to the foreclosure process. Why not rework the mortgage to allow the homeowner to stay in the home?
This proposal was fundamental because it doesn't just affect homeowners in bankruptcy; the threat of a bankruptcy cramdown would be enough to convince many lenders to negotiate in good faith with underwater borrowers in order to keep them in their homes. In addition, the threat of cramdowns would also provide a powerful deterrent to banks making the kind of predatory, irresponsible loans (such as negative amortization loans, option ARM's, high-interest subprimes, etc.) that led to this crisis in the first place.
Amendments had been accepted to the legislation that would've limited its application to only those who truly deserved this kind of relief, i.e. provisions limiting the size the loans eligible, and requiring that the homes be owner-occupied.
Although President Obama did support this legislation during the campaign, according to the New York Times . . .
. . . the White House has done virtually nothing to move it through Congress.
http://www.nytimes.com/...
There are other foreclosure prevention measures on the table and hopefully a solution will be found. Yes, it's true that some borrowers simply bought more house than they could afford and may need to downsize into something more affordable. But the reason we have consumer laws is to prevent unscrupulous actors from using their superior knowledge and power in the bargaining process to lure people into economic arrangements that are ultimately damaging to them. This is exactly what has happned in many cases, and something should be done about it.
The wider effects of foreclosures are also a major issue. The houses often end up sitting vacant and/or abandoned, attracting crime, and bringing down the value and security of the surrounding neighborhood.
Having received literally trillions in public funds to help them through this crisis, the least that the banks should be doing right now is to come to the table in good faith with efforts to keep as many people in their homes as possible until this crisis passes. As we move forward, we must put pressure on them to make sure that they do.