When dealing with consumer finance rescue options, there’s real help and there’s the illusion of it. For homeowners facing potential foreclosure, Chapter 13 presents a useful but limited range of options. Congress claims to want to do more — but some are serious and some still prefer to offer more words than action.
Senator Richard Durbin (D-IL) has proposed a robust modification to bankruptcy law in S. 2136. In opposition, Senator Arlen Specter (R-PA) proposed S. 2133. He’s certainly claiming it will do the job. And it would help. A little.
Specter has proposed that some consumers — those with “current monthly income” 150% or less than the median family income for their state — be allowed to stop or delay adjustable rate mortgage resets (increases in the interest rate) or set back resets that occurred during the prior 2-years. They could also waive prepayment penalties under their mortgages.
These are reasonable changes as far as they go. The significant area of disagreement between Durbin and Specter comes to this: Cramdown on home mortgages. That is, modifying the overall principal balance down to the current fair market value of the home.
Durbin would allow cramdown; Specter would too — but only if the lender agreed (i.e. it will never happen). Specter complains that if mortgages are subject to cramdown in Chapter 13 then future borrowers will be forced to pay more for their mortgages to adjust for the risk the lender is taking that you might file bankrutpcy and try to cramdown their loan.
Specter is correct in that mortgage lending may become riskier and therefore rates will go up. But there’s every reason to think that will happen regardless of these changes. Rational borrowers who can’t reduce highly-excessive principal balances to market will — quickly, slowly, but eventually — walk away from houses — as many are doing now and many more will in the coming year. The lenders will have to forelose and maintain the property, ultimately selling for less than the current market value in all probability. To allow a bankruptcy judge to mark down the balance of a mortgage but keep the homeowner in it and paying, is a better deal for many lenders than the alternative in fact.
So if the deal is likely to be as good as foreclosure for the lender, they would probably agree anyway, right? Unlikely. The ultimate investors in the loan — which may be a dozen institutions here and abroad — may be willing to agree but can the mortgage servicer you deal with every day get them all to agree at the same time?
A better question: Will the servicer even try? After all, a servicer may profit more by pursuing foreclosure and running up servicing costs than by pursuing a better deal for the underwriters of the mortgage. With decision-making so diffuse, profit incentives for intermediaries mismatched with the interests of the parties, and pressing time limits, it is rare for any work-out agreements (essentially what Specter proposes) to be struck.
Specter’s proposal is also limited to a 7-year period from enactment and would apply only to loans taken out before this month. Of course with such limits, future lenders will have less incentive to avoid creating another real estate/mortgage bubble like the one we are experiencing now. Durbin’s proposal does not “sunset,” and would continue to discipline lenders who are careless about their borrower’s risk profile and the underlying value of collateral.
But perhaps the most dangerous sandtrap of Specter’s bill is the requirement that it only benefit debtors with “current monthly income” (CMI) in the lower-end range of state medians.
The CMI is a unreal calculation of past income based largely on any money which came into your hands in the last six-month period. It is usually a triple irony, since it is rarely “current” or “monthly” nor includes exclusively “income.” It can change rapidly from month to month so someone who is unlucky enough to have to file when their CMI is 151% of median income receives no benefit from Specter’s bill. If next month they were 149% of median, then they could be helped. A family facing foreclosure the day before their CMI would pass under this hurdle may not enjoy the irony of their situation.
A final quirk of connecting this to CMI: As a state’s median income goes down — because, for example, fewer people have good jobs — more families may find themselves unable to avail themselves of Specter’s proposal.
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