Roughly three months after Senate lawmakers killed legislation empowering homeowners to escape foreclosure through bankruptcy, some upper-chamber Democrats are looking to revive the corpse. They hope to pressure the White House into spending valuable political capital on a cause fallen by the wayside.
Up to now, policymakers have relied on programs that subsidize lenders and mortgage servicers who volunteer to alter loans to keep homeowners afloat. Yet those voluntary modifications lag far behind the rising tide of foreclosures. Indeed, only 160,000 homes have been propped up this year under the largest such program — a figure dwarfed by the more than 1.5 million foreclosure filings since January. With unemployment on the rise, the gap is only projected to expand. The dark trends have slowly prodded lawmakers to return to mortgage bankruptcy reform as the possible missing link to addressing the foreclosure crisis — the stick to accompany the financial carrots that have thus far failed to stabilize the housing market.
“After two years of efforts that rely on banks to volunteer to rework mortgages, it is time to admit that the programs that have been put in place thus far to ease the crisis are clearly not working,” Sen. Richard Durbin (D-Ill.), sponsor of the Senate’s bankruptcy reform bill, said Thursday during a foreclosure hearing in the Senate Judiciary Subcommittee on Administrative Oversight and the Courts. “With a simple change to the bankruptcy code … over 1.8 million families could save their homes in this country between now and the end of 2012, if the Senate could only muster the courage to help them.”
Under Durbin’s proposal, bankruptcy judges could reduce, or “cramdown,” the terms of mortgages, including interest rates and principal balances, to make the loans more affordable for struggling homeowners — a power judges have over loans for vacation homes, jewelry and other material assets, but not over primary mortgages.
Yet Durbin represents a somewhat lonely crowd. Not only is the bankruptcy-reform proposal anathema to Republicans, but the Obama administration, once a cheerleader for the change, has abandoned the legislation altogether. Without the active backing of the White House, a cramdown bill that passed the House in March was shot down in the Senate less than two months later. Still, Durbin has vowed to bring it back to the Senate floor this year. But, faced with a crowded legislative calendar, including sweeping health care and climate change reform, he’s running out of opportunities.
That erosion of White House backing, according to housing and consumer advocates, spells bad news for the nation’s homeowners, who are drowning in debt in larger and larger numbers. Indeed, more than 1.5 million homes have filed for foreclosure this year, according to RealtyTrac, an online foreclosure database. The figure represents a 15 percent jump from 2008. And the numbers are rising. In May, roughly 321,000 foreclosures were filed nationwide, RealtyTrac found. In June, the figure was more than 336,000.
The difficulty in addressing the housing crisis can be attributed largely to the shifting causes of mortgage defaults. What began as a problem limited largely to homeowners with risky, variable-rate, low-equity loans, has evolved to plague even those borrowers who took out more stable, fixed-rate mortgages with significant down payments. Rising unemployment has only exacerbated the trouble.
To tackle the crisis, the Obama administration in February rolled out its Making Home Affordable Program, which supplied $75 billion to entice servicers to tamp down mortgage payments to 31 percent of monthly income for homeowners struggling to stay afloat. The White House said at the time that the program would help between 3 million and 4 million families stay in their homes.
Yet, last week, White House officials told a Senate panel that just 325,000 modifications have yet been offered under the program. Of those offers, 160,000 are in a three-month trial modification stage — modifications that will become permanant if the homeowners can meet the new payment terms over that span.
Not only are those number insufficient to address the rising tide of foreclosures, Adam Levitin, housing expert at the Georgetown University Law Center, told lawmakers Thursday, but of the mortgage modifications that are being made, almost none involve reducing the principal balance of the loan. With the housing market falling — precipitously in some regions — even homeowners who can afford to pay their mortgages will begin to walk away if they aren’t building equity, Levitin warned.
“None of the current loan modification or refinancing efforts attempt to deal with the negative equity problem in a way that offers a long-term solution,” Levitin said.
There remains some disagreement among finance experts over why lenders and servicers have been so reluctant to modify loans, even when foreclosures are often the more expensive option. One theory posits that the servicers will be paid more from foreclosures, even if the owners of the loans will lose out.
“As long as servicers profit because homeowners are in default, they’re not going to volunteer to take a hit,” Alys Cohen, an attorney with the National Consumer Law Center, testified Thursday.
But that confusion, according to cramdown supporters, is just another reason to pass the bill. “Whatever the factors may be that are inhibiting voluntary and government-subsidized loan modifications, they are immaterial if a mortgage loan can be modified in bankruptcy,” said Levitin.
Standing in the way of the legislation are not only the banks but the banks’ supporters on Capitol Hill. Conservatives argue that empowering judges to modify mortgages would make banks more reluctant to lend money, thus exacerbating the credit freeze.
Encapsulating the GOP argument, Sen. Jeff Sessions (Ala.), senior Republican on the Judiciary subpanel, warned Thursday that the cramdown bill would raise rates on everyone. A contract’s a contract, Sessions said, and homeowners who agreed to the terms of a mortgage loan should be held accountable for the payments. “There’s no free lunch here,” he said.
Not that Washington policymakers are unaware that the voluntary efforts aren’t working as planned. The Obama administration this month has already sent letters to servicers urging increased participation in the voluntary modification program.
In another concessionary move, the Treasury this month expanded a program allowing homeowners with mortgages backed by Freddie or Fannie to refinance those loans if the outstanding balance doesn’t exceed 125 percent of the home’s appraised value. Originally, the value cap for such refinancings was set at 105 percent. The change was made in recognition of the increasing number of homeowners who are underwater as home values have plummetted. Indeed, Levitin estimates that 30 percent of all families who bought homes in the last five years currently owe more than their homes are worth.
Lawmakers and advocates alike are warning that, unless Congress steps in to address the housing crisis — which, after all, was the root of the economic downturn — the result will be a spiral of foreclosures leading to more foreclosures, and a prolonging of the larger recession.
“If we fail to act,” said Sen. Sheldon Whitehouse (D-R.I.), chairman of the courts subpanel, “I fear that we put ourselves at risk: that a vicious cycle of foreclosures, falling home values, and declining tax revenues will keep us in recession for years to come.”