Tuesday, February 24, 2009
Let bankruptcy courts modify the terms of home mortgages, says President Obama and legislation now before Congress. Banks don't like the idea, but it's a good one, possibly even for them.
We are talking about Chapter 13 bankruptcies, in which troubled borrowers reorganize their debt, not walk away from it (that's a Chapter 7 bankruptcy). Judges can already restructure loans for vacation homes, boats and business properties. Doing the same for a primary residence seems reasonable.
The idea is to make monthly mortgage payments easier to meet and thereby keep more people in their homes. This can be done by lowering the interest rate, extending the length of the mortgage or cutting the principal amount owed.
Banks can already modify loans, but, notes Kathleen Day of the Center for Responsible Lending, "it's a voluntary system with no repercussions if you don't do it."
Consumers now have somewhere else to go for a loan modification. Knowing that borrowers have that option in bankruptcy court might spur banks to make more of their own revisions.
Foes of such changes warn that they would unleash a new wave of bankruptcies and reward the irresponsible. Scammers able to pay would try their luck with a judge for easier terms. Spendthrifts who borrowed recklessly would get a break in court without having to give back the RV or Mediterranean cruise. Meanwhile, the cost of mortgages would rise to compensate lenders for the risk of having a bankruptcy court possibly change the terms.
Some or all of the above may happen, but let's discard the notion that bankruptcy is a neat way for the indebted to save a few bucks. A bankruptcy seriously impairs one's ability to borrow for 12 or more years. Bankruptcy is a particularly irrational choice for high-income people who can afford their monthly payments. They'd still have to repay the written-down part of the mortgage balance out of income earned for up to five years, to the extent possible, after paying back secured debt.
As for banks, the prospect of a court-ordered change in mortgage terms -- inelegantly called a "cram-down" -- would prompt them to focus on loan applicants' ability to repay their debt. They would check a borrower's income and require a reasonable down payment -- like they used to.
A bill to allow mortgage modifications does offer protections to lenders, setting many limits on what judges may do. And if someone still in bankruptcy sells a house that has appreciated in value, the law guarantees lenders a piece of the gain for the first four years.
The point of this exercise is to stabilize the housing market for the benefit of homeowners and lenders alike. A foreclosure is usually more expensive to lenders than a loan modification. And boarded-up houses depress real-estate values all around.
This logic makes sense to giant Citigroup, which has parted ways with most other banks by backing the legislation. Vikram Pandit, Citicorp's CEO, wrote to several senators that "we support its swift passage."
A moment of silence for all you members of the rule-obeying, mortgage-paying public. Many of you oppose helping the imprudent, and your displeasure is respectfully noted. But there's really no choice right now but to subsidize a variety of foolish or bad actors. Perhaps next time we'll have regulations to rein in the excesses, so bailouts will not be needed.
Empowering courts to change the terms of a mortgage may indeed mean higher mortgage interest rates and fees for everyone, but I see the tradeoff as follows: Borrowing costs may go higher, but future housing markets won't crash, taking our jobs and 401(k)s with it.
If that's the deal, there's only one response: Where do we sign?
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