An ambitious plan to update the Carter-era Community Reinvestment Act that supporters hope to see signed into law in 2010 comes amid charges that this legislation was responsible for nothing less than the subprime crisis and the resulting collapse of the residential real estate market.

The plan, sponsored by Rep. Eddie Johnson (D-Tex.), would close some loopholes in the original act that let non-bank financial firms operate with relative impunity. It would levy negative ratings on a much wider array of institutions that practiced predatory or discriminatory lending, and it would require that non-bank entities like mortgage providers and insurance companies comply with all CRA tenets.

[Economy1] Why this piece of legislation is still such a lightning rod more than 30 years after its introduction is something both its supporters and detractors struggle to explain from their respective camps. “The idea that this was just some sort of carrot-stick regulation that didn’t work is a perception that goes very much in hand with a right-wing agenda,” said Jose Garcia, associate director for research and policy at advocacy group Demos. Demos is one of several progressive groups seeking to have the bill, the Community Reinvestment Modernization Act of 2009, made into law.

On the other hand, Mark Calabria, director of financial regulation studies at the Cato Institute, asserts that political pressure drives CRA support. “It fundamentally gets to some very emotional issues. [Supporters] see this as an issue of racism and social justice,” he said. The Cato Institute held a forum in November that was broadly critical of the CRA, asserting that the financial models at its core are faulty.

Federal Reserve chairman Benjamin Bernanke called the CRA a “catalyst” in 2007, although he touched on the trouble already brewing in the subprime mortgage sector as an imperative to revisit the Act in the wake of significant changes in the banking industry since its implementation.

At its heart, the CRA was created to try and legislate out some of the institutional discrimination in the financial services industry. It was conceived in a very different era from today’s world of global banking behemoths. In the wake of the civil rights movement, most banks were still small, often single-branch operations. Many would operate selectively in low-income and minority neighborhoods, accepting the deposits of local residents but only writing home or business loans in more affluent communities.

Regulatory changes in banking plus an agenda embraced by Fannie Mae and Freddie Mac to boost homeownership cracked the mortgage market wide open beginning in the 1990s, and the CRA was initially credited with higher rates of homeownership among low-income and minority Americans. According to Kathleen Day, spokesperson for the Center for Responsible Lending, “The purpose of the CRA is to go into underserved areas and look for credit-worthy borrowers you overlooked because of red-lining,” she said, referring to the bank practice of categorically refusing to lend in certain neighborhoods.

The result of reckless lending practices is by now apparent to everyone, although concerns were swept under the rug in the go-go years of the mid 2000s. CRA supporters say brokers and non-bank mortgage outfits wrote nearly 95 percent of the bad loans, while the Act took the fall when these loans turned out to be unsustainable.

“Nine out of 10 of the people who got bad loans already had homes,” said the Center’s Day. “Six out of the 10 were refinances and three were selling one home and buying another.”

Often, Day adds, the unscrupulous vendors that preyed on subprime mortgage candidates cloaked their malfeasance in the language of the CRA’s mission, a sleight of hand that muddied the waters and assigned undue blame on the regulation when mortgages — and the huge numbers of securities backed by them — began to sour.

Even Lawrence White, a New York University who wants to see the CRA scrapped, says it’s not to blame for the financial meltdown. “The CRA has very little to do with the subprime lending debacle,” he said.

Aside from mortgage lending, the other goal of the CRA is to provide basic banking services to low-income and minority citizens. In these locations, “Pawnshops and the like literally became the banking services,” said John Taylor, president and CEO of the National Community Reinvestment Coalition, the organization spearheading the modernization of the CRA.

“In some communities there are no financial institutions,” asserted Demos’s Jose Garcia. Geographic impediments and language barriers create a two-tier system that leaves low-income Americans, minorities and immigrants without access to the banking and lending services the middle class takes for granted.

If the legislation were better-enforced — something the NCRC’s Taylor believes the modernization bill would facilitate — banks wouldn’t be able to do things like close branches in these communities without repercussions. But preventing closures would just be the beginning.

In a 12-page statement, the NCRC spelled out major features of modernization. Key among them are inclusion of non-bank financial firms under the umbrella of CRA oversight, and a greater emphasis on the neighborhoods in which institutions write loans, not just the locations where their branches or offices are located. This is partially due to the rise of online and branchless financial institutions, but Taylor says the switch will also prevent companies like subprime mortgage-peddlers from operating under the radar.

Advocates also want to see enforcement of the CRA transferred to the not-yet-created Consumer Financial Protection Agency. The CFPA, as its supporters envision it, would consolidate regulatory oversight and enforcement of banking and lending activities in a single agency, rather than the patchwork of regulators some say let ruinous business practices slip through the cracks.

The modernization effort isn’t without roadblocks, though. The current House bill has yet to progress to the Senate, although Taylor says the NCRC’s goal is to have the modernization signed into law sometime this year. The CFPA doesn’t even exist yet, and might never come to fruition. Last week, Senate Banking Committee Chair Christopher Dodd (D-Conn.), the lawmaker who has championed the idea, indicated he may be willing to abandon the idea of a consumer protection agency.

In the end, it’s not clear what is ahead for the CRA. Some, like the Cato Institute’s Mark Calabria, think the need has run its course. “There was a logical raison d’être for the creation of the CRA at the time but that justification is no longer there,” he said. He admits that an outright repeal of the Act is unlikely, though. NYU’s Lawrence White also wants to get rid of the CRA, although he wants to replace it with a cap-and-trade system of credits similar to the protocol used to eliminate acid rain-causing sulfur dioxide in the 1980s.

Progressive and social-justice groups say that the CRA, while not perfect, needs to be improved, not thrown out. “We’re talking about trillions of dollars of private resources that could be available to low- and moderate-income neighborhoods,” said the NCRC’s Taylor. “We believe in banks. If we don’t have them active in these neighborhoods, it’s very unlikely they’re going to prosper. We want banks to see these neighborhoods as an important part of the economic future of this country and of their business plans.”

In the end, it might come down to that. If the notoriously profit-hungry banking industry sees economic potential in lower-income areas, this would go a long way towards keeping the predatory players out of the arena.

President Barack Obama (WDCpix)

Only a year ago, hopes were high that a big push by the government to stop foreclosures would be a great success, living up to its billing as “Help for America’s Homeowners.”

Last January started out with a foreclosure moratorium, allowing time for the Obama Administration to put the final touches on Making Home Affordable — its $75 billion signature program aimed at helping 3 to 4 million homeowners. After bailing out banks and the financial system, the administration turned its efforts to borrowers on the verge of losing their homes. The program rolled out with fanfare in the spring.

[Economy1] But as 2010 begins, it is already clear that Making Home Affordable has fallen far short of its goals, with only 31,382 permanent loan modifications completed by Nov. 30. Last year, lenders were doing far more loan modifications on their own, before the Obama plan was launched. And although foreclosures show no signs of slowing down — the total number of foreclosures is predicted to reach 13 million during the next five years — no one is expecting a dramatic turnaround in helping people keep their homes. The only way the administration will get significant numbers of loan modifications done will be to bring back failed bankruptcy cramdown legislation, or to put billions of dollars into a mass effort to rework loans — neither of which seems politically feasible.

That means 2010 will likely be another year in which only a small number of loans get modified each month, while administration and mortgage servicers continue pointing fingers at each other for the impasse, some industry experts say. The only bright spot ahead for the government’s foreclosure prevention may be that down the road, foreclosures eventually will slow of their own accord. To use the Vietnam analogy, that will allow the Treasury Department to declare victory and get out of the loan modification business for good.

“I don’t hold out a great deal of hope that the administration will do more” to complete more loan modifications, said Patricia McCoy, a University of Connecticut law professor who studies financial services regulation. “There’s just no political will for that.”

As the program falters, a move to blame borrowers for problems with the effort has grown.

When difficulties with Making Home Affordable became apparent early on, servicers began contending that borrowers were refusing to provide income verification and other paperwork to quality for permanent modifications. Under Making Home Affordable, eligible borrowers first receive a three-month trial modification. In order to convert it to a permanent modification, they need to provide servicers with pay stubs and other documentation, as well as making all their trial payments.

Before the program began, servicers voluntarily completed 120,000 permanent loan modifications per month during the first quarter of last year, according to Alan White, a Valparaiso University law professor who studies loan modifications. Once the Obama administration’s program rolled out, those totals dropped to about 70,000 per month, as servicers worked to switch borrowers into Making Home Affordable. According to Treasury Department figures, nearly 700,000 trial modifications under Making Home Affordable were underway by the end of November. But with fewer than 32,000 converted to permanent modifications, it means a net drop of permanent loan modifications since the Obama plan began.

The voluntary plans by servicers, however, were called “extend and pretend” plans by critics, who said servicers simply were setting up repayment plans with late fees and other charges rolled into them, without ever actually reducing a borrower’s debt. Re-default rates on those loan modifications have been high as a result. Making Home Affordable has been more aggressive about lowering a borrower’s monthly payment, and the government is pressing servicers to switch to using its program — one reason why Making Home Affordable permanent loan modifications are lagging behind. In addition, some borrowers simply can’t qualify for the government’s program because they are too far underwater on their mortgages.

But unless a surge of permanent loan modifications suddenly occurred in December, the New Year will begin with fewer loans permanently reworked than during the same period a year ago. Treasury officials said in November that 375,000 trial loan modifications were scheduled to expire by the end of December, but it was unclear how many would be converted into permanent plans. Then, on Dec. 23, the government announced it would order servicers to give borrowers more time to complete trial loan modifications before kicking them out of the program.

Servicers have responded to the lack of progress so far by suggesting that borrowers are refusing to turn in income and other documentation because they probably lied about their incomes to qualify for their current mortgages. Liar Loans, or loans that required no documentation of income or assets, have been cited as a major culprit in the financial collapse, as some borrowers began defaulting on them just a few payments into their mortgages beginning in 2006.

Guy Cecala, publisher of Inside Mortgage Finance, which covers the lending industry, said the mortgage firms and servicers were skeptical from the start that any loan modification plan would work. “No one ever thought seriously that this would put a dent in the problem,” he said.

Now the industry is likely to fight back against any criticism not by doing more loan modifications, but by blaming borrowers, as well as the Obama administration, for a faulty program. All this may add to a backlash and moral hazard charges of helping out homeowners who may have lied to buy bigger homes than they could afford, while other homeowners who may have lost their jobs struggle to meet their mortgage payments, he said.

“I hear people saying all the time, that all the administration is doing is offering help to the people who deserve it the least,” Cecala said.

Housing counselors and attorneys find that argument infuriating. Already struggling to get servicers on board with Making Home Affordable, they now also face dealing with a shift in a public perception toward blaming the borrower.

Diane Thompson, an attorney with the National Consumer Law Center, said the situation has gotten so ridiculous that servicers are simply looking for excuses to deny loan modifications.

“I met with a woman who oversees a counseling program in St. Louis, and she told me that the most common reason for denials now is that the borrower’s hardship isn’t permanent — surely at some point in time the borrower will get a new job,” she said. “And of course servicers continue to lose documents at an astounding rate.  Any counselor I talk to is almost seething with frustration.  I’ve had counselor after counselor in recent weeks tell me, “They’re just stalling.”

“I think there’s a bit of a face-off developing between the administration and servicers.  My impression is that servicers find the program burdensome and so would like to see it fail, but would prefer not to be held accountable for that failure.  And the administration, of course, would prefer to see the program succeed.  Whether this results in a scrapping of the program or a major reworking of it, I have no idea.”

White, of Valparaiso, thinks the situation is even more dire.

“I would give it another month or two to see if they can do any better, but if not, it is definitely time to try something else,” he said of Making Home Afforable loan modifications. “As far as blaming the homeowners, that is really sad.  From all reports I hear from housing counselors and legal aid lawyers, the servicers are losing the documentation.  It is hard to believe that 75 percent of borrowers on temporary mods are making their payments but that they can’t come up with two pay stubs and a hardship statement.  I think we are dealing with a massive failure and breach of contracts by the servicers.”

The administration will handle this by continuing its current tactic of singling out for public condemnation servicers who aren’t doing enough loan modifications. But that approach hasn’t worked so far, and it’s not likely to be any more successful this year, said Kathleen Engel, a Suffolk University law professor and expert on mortgage securitization.

“A shame list may work when country club members don’t pay their dues, but I don’t think it works with servicers and lenders,” Engel said. “If it did, they wouldn’t have been making and financing abusive loans all these years.”

What might work would be a massive, multi-billion dollar effort to get loans modified on a large scale, said Cecala, of Inside Mortgage Finance. But there would be little political support for spending that kind of money on troubled homeowners. Since the Obama administration sat back last year and declined to throw its weight behind mortgage cramdown legislation that ultimately failed, the White House is not expected to suddenly turn around and once again push for legislation to let bankruptcy judges modify mortgages to keep borrowers in their homes.

And not everyone agrees on the right approach to jumpstart the program. McCoy, for example, said she considers loan modifications a “one size fits one” option that can’t be done a mass scale.

As a result, Cecala sees an entirely new direction in 2010 — lenders will enlist debt collection agencies to aggressively go after homeowners who walk away from their underwater mortgages. Or lenders will move to ensure a borrower’s credit remains impaired for a decade or more, should they walk away. In the meantime, the Obama administration will likely talk a good game, and keep criticizing servicers, while only small numbers of homeowners end up with lower payments.

In the end, Cecala said, the only thing that will become clear is that “there’s plenty of blame to go around” for a program that began this time last year with lofty expectations, and then fell painfully short.

But the Obama administration is signaling clearly that while it may be open to some new tactics, cramdown is not one of them.

Assistant Treasury Secretary Michael Barr told reporters on Wednesday that “Bankruptcy reform is an additional tool, but it’s not the focus of our efforts to keep people in their homes,”  The Wall Street Journal reported. In plain English, that basically means the administration isn’t going to support any renewed efforts to get a cramdown bill passed.

And Barr’s comments came after Treasury released a report noting that only 12 percent of eligible borrowers have started trial loan modifications under the $75 billion mortgage foreclosure prevention plan.

Supporters of cramdown say it’s necessary as a backstop to force servicers to try harder to complete loan modifications. Incentive payments to servicers for reworking loans are the carrot, and cramdown is supposed to be the stick. The administration in not only dropping the stick, but it’s increasing the carrot part of the plan. Treasury also plans this month to announce it will offer additional financial incentives to servicers to complete short sales, in which a homeowner as a last resort sells his property for less than is owed on the mortgage, and the bank accepts the discount, American Banker reported.

Under the Treasury proposal, servicers will get a $1,000 “success fee” for each short sale they are able to compete, according to American Banker.

The problem with short sales is that they have been notoriously difficult to complete, with complaints growing that banks are deliberately dragging their feet on them. Also, as Mortgage Insider blogger Matthew Padilla explains, a homeowner’s credit still can get stung by a short sale. But Treasury probably is pushing the idea because its loan modification plan clearly isn’t reaching enough troubled homeowners, Padilla said.

All this points to a simpler, quicker, and more effective solution — cramdown. But the administration clearly isn’t willing to go there. Until then, maybe some homeowners will benefit from a short sale. Maybe some more will get their loan modifications. But no doubt many will simply go on to lose their homes — something that might have been prevented by a bankruptcy judge. The administration has the power to push Congress toward cramdown, but has chosen not to. And that’s something to keep in mind each time Treasury or the White House talks about how much the government wants to help homeowners in trouble.

Flickr: respres

As bank-owned foreclosed properties pile up across the country, from abandoned houses in hard-hit neighborhoods to empty big box retail stores in failed strip malls, the fight over holding someone responsible for the brick and mortar mess left behind by the mortgage crisis continues to heat up.

More than two years into the crisis, local authorities still are slapping banks, servicers and speculators with fines ranging from $30,000 to even $90,000 for ignoring orders to take care of foreclosed and vacant properties under their control. The continuing punitive measures come as servicers already find themselves under fire for failing to complete more loan modifications under the Obama administration’s Making Home Affordable program – an effort that includes $75 billion in taxpayer money as incentives for the lending industry to rework loans. And it also comes as some realtors and lenders are mounting challenges to local anti-blight ordinances, and promoting the use of a mortgage database to track down servicers. Some housing advocates fear the industry will go beyond lobbying for the use of its mortgage system to push for getting rid of local vacant property laws altogether.

Illustration by: Matt Mahurin

The end result: Some of the same servicers the Obama administration is urging to complete more loan modifications still are walking away entirely from vandalized homes, or failing to fix broken windows, get rid of junked cars, clear trash, repair damaged roofs and gutters, or even demolish a condemned house, all of which can be violations of local housing codes. And housing courts keep hearing persistent arguments from servicers that they’re merely temporary custodians who can’t alienate investors by spending money to bring properties up to code.

“They may think it’s unfair, but the law provides that if you have ownership of a property, you take care of it,” said Cleveland Housing Court Judge Raymond Pianka, who regularly fines lenders $5,000 a day for properties that don’t comply with city codes. “There’s no provision to exempt corporations. I’m not going to treat them any differently than the individual property owners who come into my courtroom in wheelchairs and walkers.”

And while the lending industry contends its working more cooperatively than ever with local authorities, not everyone sees it that way.

“For every one vacant property owner who wants to work with the local government, there are five other property owners who are gaming the system,” said Joseph Schilling, a Virginia Tech urban affairs professor and co-founder of the National Vacant Properties Campaign. “My sense is the industry is also overwhelmed, almost as much as the code departments, and properties still fall through the cracks.”

Controversies over vacant properties are one sign of how the aftermath of the mortgage crisis may be as complicated to address as the initial waves of foreclosures themselves.

As TWI reported recently, the volume of REOs, or bank-owned foreclosures, is growing at an alarming rate, exacerbating the foreclosure crisis by sticking hard-hit neighborhoods with vacant and sometimes vandalized homes that drive down property values. REOs are foreclosed properties that lenders take back after they don’t sell at foreclosure auctions or sheriff’s sales. They keep the homes in inventory until they can be sold again.

RealtyTrac, an online foreclosure database, predicts that REOs will total 1.5 million this year, up from 160,000 just a few years ago. And a significant percentage of those REOs still haven’t been listed for sale. That means a glut of bank-owned foreclosed homes remains in limbo in many communities. Some banks hire property managers, but others let houses fall into disrepair. Neighborhoods in Cleveland, Detroit, and other cities with weaker housing markets have been stung by growing blight from REOs. In once-hot areas, like Atlanta, “zombie” subdivisions that were half-built and then abandoned mar the suburbs.

Speculators who buy REOs in bulk over the Internet, then fail to fix them up or abandoned them, have added to the crisis. And more loan defaults are expected, with 9 million foreclosures predicted by 2012, according to the Center for Responsible Lending. On top of all this, the bust in commercial real estate means communities also are increasingly stuck with empty big box retail stores, closed-down car dealerships, and vacant strip malls – more blight, and more problems.

For its part, however, the lending industry contends that it’s doing more than ever to solve the problem, stepping up to work more closely with state and local governments, and promoting a mortgage database that local officials can use to track down servicers and notify them of violations.

“There was a disconnect a few years ago, but we’re moving forward,” said Robert Klein, CEO of Safeguard Properties, a company that maintains vacant homes nationwide for mortgage servicers and banks. “There’s been tremendous progress made between code enforcement officers and lenders and servicers around the country. I think we’re all on the same page now.”

Empty houses with code violations resulting in stiff fines usually are the result of years of previous neglect, or cases in which servicers can’t be found to be notified of problems, he said. That situation is happening with far less frequency than in the past.  “The $90,000 fines are an exception to the rule,” Klein said.

But in remarks to a recent Mortgage Bankers Association mortgage servicing conference that continue to be passed around on housing and community development listerves, Cary Sternberg of American Home Mortgage in Irving, Tex., went further. Sternberg, the firm’s senior vice president of Real Estate Owned (RE0) properties, contended that servicers increasingly are caught “in the cross hairs of disgruntled and cash-strapped local governments” looking to drum up revenue. The local governments often don’t understand the legal and other constraints under with servicers operate when it comes to REOs, he said.

“They need to look for ways to keep their cities going,” Sternberg said. “It’s a difficult problem to deal with and servicers like us are dealing with cities and municipalities all over.”

In Chula Vista, Calif., Realtors and lenders complained this summer that the city’s landmark anti-blight ordinance, which includes fined of up to $1,000 for lenders that ignore code violations, was driving away new business. Chula Vista’s 2007 ordinance became a national model, with more than 200 other communities adopting similar rules. The city has issued a total of $1.3 million in fines. Realtors asked the city to lessen fines and give firms more time to repair properties. The city is reviewing possible changes to the ordinance.

While servicers and code enforcers have made real progress sharing information through the mortgage database, the huge volume of REOs and continuing foreclosures continues to swamp the resources of everyone involved, Schilling said.

And in some places, problems run even deeper..

“From my experience, servicing of properties in the inner city, particularly in African-American neighborhoods is either non-existent or erratic,” said Kermit Lind, a Cleveland State University law professor who specializes in housing and foreclosure issues. And, he added, “servicers have testified under oath that they receive instructions to stop maintaining properties and walk away. Servicers have complained that they cannot afford to bring their properties up to code and still make money selling them, and that their investors will not allow them to comply with local laws.”

Lind had little sympathy for the plight of servicers, noting archly that “any reasonable person should see that compliance with local building and housing codes protecting the health, safety and welfare of taxpaying neighbors should be subordinated to the duties and responsibilities of servicing and pooling agreements concocted on Wall Street.”

But Christopher Oswald, a lobbyist with the Mortgage Bankers Association, which launched the mortgage database project, said lenders hit with huge fines only face additional obstacles getting foreclosed properties on the market and into the hands of new owners. Communities may once have needed to levy punitive fines to get the attention of servicers, but that problem has been addressed by the mortgage database, known as MERS, he said.

The industry database was expanded to allow its use by local governments. Enter an address, and up pops the name and contact information for a servicer or property management firm.

“We’re both after the same thing – to make sure the properties are maintained,” Oswald said.

The MBA introduced database in a handful of pilot cities more than a year ago, and the effort has been so successful the group plans to expand it nationally, he said.

Schilling said the industry outreach has been particularly successful in the West, in fast growth markets, and in some individual cities such Dayton, Ohio. But there are still problems elsewhere. At a recent housing conference in Kansas City, Schilling said he “got an earful” from housing and code officials throughout the state about how hard it was to find and work with mortgage servicers.

The mortgage database itself has drawbacks. It covers many, but not all, mortgage loans. It has no data at all on commercial real estate owners. And in some cases, a property contact shifts once a house moves from foreclosure to an REO. “There are gaps,” Schilling said.

An even bigger concern is that the lending industry will lobby state and local governments not just to use the database, but to also get rid of their local vacant property ordinances. Communities still need those regulations on the books as a powerful tool to make sure servicers and lenders take care of their properties, Schilling said.

The MBA isn’t actively lobbying against any anti-blight measures, Oswald said. But it makes sense for some towns to realize they may not need anti-blight ordinances if they can track down owners through the database instead. Communities can then avoid having to issue large fines that may delay transferring properties to new owners, he said.

“Anything standing in the way of getting servicers to put properties back on the market would be of concern to us, and should be of concern to local code officials too,” Oswald said.

Some local officials already have plenty of concerns about getting foreclosed homes back on track.

In Cleveland, Judge Pianka said some banks and servicers finally are catching on, showing up in his courtroom to answer to violations and repair properties. He’ll often forgive the big fines if a firm cleans up its property. (Court records show Pianka reduced a $30,000 fine for U.S. Bank to $3,000, after the bank brought a house into compliance.) But a recent court docket also gave a glimpse of continuing disputes, from the speculator from Dubai, who bought six properties, sight unseen, off Craigslist, and hasn’t fixed them up, to a real estate company that purchased REO worth only $1,000, and already has racked up $50,000 in fines.

Pianka recently spoke to a conference of property management contractors sponsored by Safeguard, showing photographs of graffiti-scarred, abandoned homes, and letting the lending industry know he’ll hold them accountable for their foreclosures. Klein, of Safeguard, said the judge’s talk was well-received – another small step in a continuing battle over cleaning up after the foreclosure mess.

“It frustrates me when I see the government looking to the servicer for the solution, because it will never ever happen,” said Margery Golant, a Florida lawyer who defends homeowners against foreclosure and who worked in the law department of a major mortgage company, Ocwen Financial. “I don’t think they’re motivated to do modifications at all. They keep hitting the loan all the way through for junk fees. It’s a license to do whatever they want.”

As I explain in my story today about loan modifications, servicers are also still including waivers that require borrowers to sign some of their legal rights away in order to obtain a loan modification — a practice that lawmakers, including Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, told them to get rid of more than a year ago.

Frank apparently is so fed up with the slow process of loan modifications that he’s now threatening to bring back legislation to allow federal judges to cramdown, or modify, the terms of a mortgage for a borrower in bankruptcy.

At The Atlantic, Daniel Indiviglio points out how little this means:

Democrats have an easy time passing pretty much whatever they want in the House. Not so for the Senate. In fact, when cramdown legislation was offered in the Senate last spring, it failed miserably. Only 45 Senators voted in favor — no where near the 60 necessary. In other words, the Senate would have at least as difficult a time passing cramdowns as passing national health care reform and cap and trade.

But the climate for passing cramdown legislation has changed: now it’s even less likely. Unlike last spring, the economy and housing market are showing signs of stabilization. That should make moderate Senators even more unlikely to change their votes in favor. These days, the Senate has all the power. Frank can threaten all he wants, but unless he knows of some way to sway moderate Senators, those threats may fall on deaf ears.

Frank’s threats aren’t the only ones to carry little weight. As any five-year-old knows, there isn’t much incentive to change your behavior if there aren’t any consequences for bad behavior. Servicers may get summoned to Washington for a public flogging about their lack of progress in modifying loans — but so what? There are no real financial penalties, or retribution, for failing to rework the loans — or for creating non-compliant modification agreements, like the ones with legal waivers. Housing counselors might catch some problems and try to correct them,  but they can’t do much about the incentive of junk fees that make foreclosure a more profitable option. So nothing really changes.

The Treasury Department could do more. It could treat servicers as government contractors, spot check contracts and quit paying firms that violate the program’s guidelines. It could levy penalties. It could get serious about cleaning up the sloppiness in its signature foreclosure prevention program. In short, it could do what it hasn’t done, up until now: Make loan modifications a priority.

And there are other options. If real efforts to promote loan modifications don’t pay off, then it’s time to rethink foreclosure strategies. The White House could actually put its clout behind cramdown this time around. It could push innovative rental policies to ease foreclosures. But whatever it does, the lesson here is to apply the fundamentals to any reforms, especially those involving a lending industry that continues to prey on troubled borrowers. If things don’t get done, there should be consequences.

The lack of progress in getting loan modifications completed has highlighted why the failure of cramdown was so disastrous for foreclosure prevention. Cramdown was the veiled threat, the end of the line if lenders didn’t modify loans. Now there’s nothing to deter them, except for the occasional lecture from administration officials or lawmakers. The business of making money from foreclosures just goes on as usual, long after the news cycle ends.

Six thousand American families are due to lose their homes in foreclosure today.

Many more American families are going to be grist for the foreclosure machine unless Congress acts to help them. But, as of today, it appears that any bailout of the financial institutions that are now in trouble after years of reckless, making predatory loans is not going to include help for homeowners.

Illustration by: Matt Mahurin

The basis of the bailout plans now under discussion is the government’s purchase of hundreds of billions of dollars in mortgage-backed securities, or MBS. Purchasing MBS alone, however, will not solve the foreclosure crisis because it will not give the government the legal ability to modify loans and keep families in their homes.

This is because of the complicated structure of most of the troubled loans. Many are held by securitization pools, each of which was carved up into highly complex securities and sold to tens of thousands of investors around the globe.

MBS are debt securities — essentially bonds. A bond is a right to a steam of payments. It is not a right to direct management decisions. So an MBS holder has no more right to direct the management of the mortgage loans than corporate bondholders have to direct the management of the corporation.

The decision to do loan modifications rests with the mortgage servicer, which manages the mortgages on behalf of the MBS holders. For most securitization deals, the servicer’s instructions cannot be changed without the consent of two-thirds of the MBS holders.

So, in order to modify the underlying mortgages, the government would have to reassemble more than two-thirds of the tens of thousands of pieces of each of the carved up MBS deals. Many pieces have themselves been pooled and securitized, sometimes multiple times, which makes the government’s Humpty-Dumpty problem even more difficult.

The task is further complicated because many borrowers took out second or third mortgages, the pieces of which also have to be reassembled by the government in order to prevent foreclosure.

Even if the government could reassemble the pieces needed to change the servicer’s instructions, it could still not modify the mortgage loans without the consent of all MBS holders earning income from the affected MBS. So bailing out financial institutions is unlikely to provide relief to the millions of Americans facing foreclosure.

To date, efforts to help financial distressed homeowners keep their homes have relied largely on the financial services industry’s voluntary efforts. These have been ineffective at best — and harmful at worst. It seems no longer possible to trust the industry to set the terms of the public policy debate about the mortgage crisis.

First, the financial industry insisted that there would be no mortgage foreclosure crisis. It was wrong. Then it insisted the crisis would be “contained,” with minimal harm to homeowners and the economy. Wrong again. Today, as foreclosures continue to dwarf the number of voluntary loan modifications, threatening the entire U.S. economy in the process, the industry is still arguing that a limited solution — Federal Housing Admin.-guaranteed refinancings — will take care of the problem.

Given the industry’s track record, can the public gamble on their assurances — especially when mortgage servicers, who make the decisions about how to manage loans, often have a financial incentive to foreclose on distressed mortgages rather than modify them?

The only way to ensure that help is available for homeowners is to supplement the Wall Street bailout with help for consumers. One answer might be bankruptcy relief for mortgage debt, which has been the primary mechanism for resolving consumer financial distress for more than a century.

The bankruptcy system, however, is incapable of handling the current home mortgage crisis because of the special treatment due residential mortgages. Unlike virtually every other type of debt, mortgages on single-family primary residences may not be modified in bankruptcy.

This means that a family can write down credit card debt, car loans, medical bills, payday loans, loans on yachts, jewelry, and household appliances, even mortgages on vacation homes or rental property. But if they cannot make their original single-family home mortgage payments, right down to the last penny, they lose their home.

Permitting modification of mortgages in bankruptcy does not require the lenders’ consent. Bankruptcy provides a solution when lenders are unwilling, or incapable, of making a deal with homeowners. Bankruptcy relief would help homeowners keep their homes with no cost to taxpayers, would not be available for speculators, would spread losses between lenders and homeowners, and would be immediately available — unlike government programs that can take months to set up.

The financial services industry has argued that permitting bankruptcy modification of mortgages would result in a constriction of mortgage credit, higher prices for consumers, and instability in the market. These are serious concerns. But the industry has presented no evidence to support this, and all available research indicates that there would be little effect on mortgage credit availability or cost.

Widespread financial distress among homeowners lies at the base of this financial crisis. Without resolving this, a bailout of financial institutions will not right the economy. A bailout of the financial services industry could come with an explicit price tag: relief for homeowners now and serious regulatory reform later. Otherwise, the financial crisis will continue — which means Congress is just signing a blank check.

Adam J. Levitin is an associate professor of law at Georgetown University Law Center, where he teaches bankruptcy and credit transactions.