Bankruptcy Reform Meets Unlikely Foe

President-elect Barack Obama (WDCpix)

Congressional Democrats hoping to use the economic stimulus package to force lenders to refinance troubled mortgages have met an unlikely opponent: President Barack Obama.

Many Democrats, including Obama, have long-supported the strategy of empowering bankruptcy judges to alter the terms of primary mortgages to prevent foreclosures. But White House officials have said they don’t want the bankruptcy provision in the stimulus bill for fear of alienating Republicans, most of whom oppose the change.

Illustration by: Matt Mahurin

Bipartisan cooperation was a central theme of Obama’s 2008 presidential campaign, and he wants his first legislative victory to hinge on something other than a party-line vote. Last week, Obama and Democratic leaders agreed instead to attach the bankruptcy provision to a large spending bill that Congress is expected to consider later this year, according to reports.

That stance has piqued some Democrats, who are beginning to wonder if the push for bipartisan agreement is worth the cost of waiting. For each day that Congress dallies, these lawmakers say, thousands of Americans lose their homes to foreclosure.

“I believe the ‘fierce urgency of now,’ requires us not only to pass this out of committee, but to pass it in the stimulus,” Rep. Steve Cohen (D-Tenn.) said last week, according to The Hill. “Because we know the stimulus is going to pass.”

The debate arrives as the nation’s economy continues to sink and Washington lawmakers are growing bolder in their efforts to intervene. Yet, while lawmakers have stepped in to provide enormous bailouts to the finance and auto industries, they’ve done almost nothing to tackle the foreclosure crisis that was the root of the turmoil. A $300 billion program enacted in July offered lenders government guarantees on troubled mortgages if the lenders agreed to absorb a 10 percent loss. Only a few hundred homeowners have benefited.

House Democrats, with much input from the Obama administration, introduced legislation this month to spend roughly $550 billion on infrastructure projects and aid to states over the next two years, while providing another $275 billion in tax credits to individuals and businesses.

The proposal also contains provisions addressing the housing crisis, including $4.2 billion to help hard-hit communities buy up foreclosed homes “and reduce neighborhood blight.” But the proposal leaves out the changes in bankruptcy law.

The House is expected to vote on the stimulus bill Wednesday. The measure is likely to pass easily, though Republicans continue to criticize the plan for what they consider to be a dearth of tax cuts.

Housing advocates have long-pushed to empower bankruptcy judges to reduce, or “cram down,” the balance of primary mortgages, as well as other terms of the loans, to keep homeowners from suffering foreclosure. That legal avenue is currently available for loans on commercial property, yachts, vacation homes — almost anything but primary mortgages, which were singled out for exception under bankruptcy law.

The Center for Responsible Lending, a consumer advocacy group, estimates that 2 million homes have been foreclosed on since 2007, with 2.2 million more sub-prime mortgages projected to fail this year. The latter figure represents 6,000 foreclosures every day of the week.

A report released by Credit Suisse on Monday estimates that the change in bankruptcy law would reduce foreclosures by 20 percent.

“Everyday that goes by, thousands of people are losing their homes,” said Kathleen Day, a spokeswoman for the Center for Responsible Lending. “We’ve waited long enough.”

Last week, House Speaker Nancy Pelosi (D-Calif.) said the bankruptcy change falls “very high” on her to-do list this year.

“Enacting bankruptcy legislation is a very high priority, and we will have it either free standing or in some piece of legislation that will become law soon,” Pelosi told reporters at the Capitol Thursday. “The more time that goes by, more people lose the opportunity to stay in their homes. It is urgent.”

House Judiciary Committee Chairman John Conyers (D-Mich.), who held a hearing on cramdown legislation last week, has scheduled another meeting Tuesday to move the bill through the committee.

Democrats found some unexpected support earlier this month when Citigroup, which has accepted billions in bailout funding from Washington in recent months, bucked most others in the industry and endorsed the cramdown proposal.

Still, the larger finance industry has been a fierce opponent of the bankruptcy change, arguing that forced mortgage renegotiations for troubled loans would lead to interest rate hikes for everyone.

John Jackson, president and CEO of Lending Cycle, a Kentucky-based lending software company, said the change would “put the banking system in a situation that’s not viable.”

“This creates a whole new burden which just exacerbates the problem,” said Jackson, the former executive vice president at First Bank in Louisville. “It removes the profitability of that loan for banks.”

But housing advocates and many Democrats dispute that claim. David Berenbaum, executive vice president of the National Community Reinvestment Coalition, called the industry argument “a smokescreen,” pointing out that, for the past eight years, bankruptcy judges have been appointed by the industry-friendly Bush administration.

“There is actually no reason to believe that that a judge will just blindly side with a homeowner,” Berenbaum said.

Berenbaum also warned that bankruptcy reforms alone would not solve the problem. Without additional changes prohibiting the predatory lending practices that contributed to the crisis, he said, there’s nothing preventing it from recurring.

“Unless we address the underlying issue that got us into this economy,” Berenbaum said, “this could all happen once again.”

It’s not the first time the debate has surfaced. The House passed anti-predatory lending legislation in November 2007, but it was never taken up in the Senate. That bill takes steps to ensure that borrowers can afford loans before they take them out. It also bans the financial incentives that led many lenders to steer consumers to sub-prime and other more costly loans.

Heather Wong, spokeswoman for House Financial Services Chairman Barney Frank (D-Mass.), said the House intends to consider similar anti-predatory lending legislation again this year.