A bipartisan compromise bill in the U.S. Senate (S.2636), which closely aligns with a similar House bill, would allow bankruptcy courts to modify existing subprime mortgages to help families save their homes from foreclosure.
Under the terms of the Foreclosure Prevention Act, a borrower can qualify only if it can be proven that he or she cannot afford the subprime mortgage. If eligible, a bankruptcy judge could (a) reduce the balance owed on the house to the current fair market value and (b) convert the mortgage to a 30 year note with a fixed rate of interest no lower than prime plus a risk premium. If the family sells their home within five (5) years of the modification, any increase in the market value of the home, up to the original mortgage amount, would be given back to the lender.
The government must step in because the banks are powerless to modify the deluge of non-performing loans. The banks sold these subprime loans to investors on Wall Street as part of a pool of loans, known as a securitized trust. That trust is a contract between the bank and the investors to provide a certain rate of return.
If a bank voluntarily agrees to “freeze” interest rates on a subprime loan, it is breaching its contract with the investors. The investors, who are already angry with the irresponsible underwriting by bank, will have a perfect lawsuit. However, investors cannot sue the banks if the law forces them to take lower monthly payments. The reduced payments will actually increase cash flow to the banks and investors since borrowers can actually afford the payment. After all, is it not better to be paid a slightly reduced monthly payment that to lose tens of thousands of dollars by foreclosing on a home?
According to the mortgage bankers own data released in January, lenders are initiating foreclosures 13 times more frequently than they are modifying problematic adjustable-rate subprime loans. According to the Center for Responsible Lending, only 3% of homeowners with adjustable-rate subprime mortgages are likely to receive a streamlined loan modification from their lender.
The American Bankers Association argues this bill will raise the cost of credit to future borrowers by injecting uncertainty into the markets. However, since the compromise language excludes all future loans from bankruptcy consideration altogether, there is no way S. 2636 would raise the future cost of credit. If the credit markets were so sensitive to changes that Congress might make, the markets would already have accounted for all sorts of such “risks.” The credit markets are already in disarray not because of Congress, but because of the banks’ irresponsible lending practices.
The Foreclosure Prevention Act is a perfect solution to the current housing crisis which, according to Wells Fargo CEO, John Stumpf, rivals the Great Depression. The legislation will absolutely reduce foreclosures, which in turn, will stem the flood of houses in our already depressed housing market.
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