By James Edmund Datri - 12/20/07 06:42 PM EST
Something happened on Dec. 12 in Chairman John Conyers Jr.’s (D-Mich.) Judiciary Committee that could easily get lost in the shuffle of the Iraq war, the upcoming presidential primaries and the holidays. But it was a very significant event, and, in a nation where homeownership plays such a central role in the economic life and social fabric of American families, it is one we should all be following. That’s because if the mortgage bankruptcy legislation passed by the Judiciary Committee that day ever becomes law, it could have a very significant, negative impact on the residential mortgage market. And for my party, which controls the Congress, what sounds on the surface like a political no-brainer could create a storm of controversy among the vast majority of Americans who acted responsibly in taking out a mortgage, are living with the consequences (good and bad) of their decisions, and are paying their mortgage bills on time.
What did Mr. Conyers’s committee do? It passed legislation that would apply to all subprime and nontraditional mortgages (regardless of whether or not they were predatory) made since the year 2000, allowing bankruptcy judges free rein to adjust payments, penalties, and interest rates on those loans — even allowing a judge to artificially reduce the amount of a mortgage to reflect a home’s current value (for those who bought homes at the housing market’s height) — all while allowing the borrower to keep their home.
Like I said, on the surface, this sounds great, like a no-brainer: Helping out those in trouble to stay in their homes. But there are big problems with this approach.
First, this effectively treats all subprime and nontraditional borrowers as victims of predatory lending. In fact, to define all subprime and nontraditional loans as “predatory” is the equivalent of saying that it is impossible to make a home loan to a higher-risk borrower without it being predatory. That is nonsense. There are many higher-risk, but credit-worthy borrowers, who got an absolutely fair deal from their lender, but who made bad economic decisions, like incurring too much consumer debt, or assuming that housing prices could only go up. Others were investors without much cash who, quite knowingly, bet the farm on the real estate market. These investors did and would have reaped the benefits when and if the market had gone their way; they should not be bailed out in this way when their decisions placed them on the losing end, any more than those who made bad, but informed, decisions in the stock market should be reimbursed, without penalty, for their losses. In addition, it has been reported that a Treasury report to be released in January will show that there has been a significant amount of mortgage fraud by borrowers, resulting of course in more loans that should not have been made.
The problem is this bill lumps all those people in with the true victims of predatory, deceptive lending practices.
It’s not hard to imagine the stories of abuse of the system that this kind of mass bailout will inevitably produce: some people getting a free ride while the vast majority of Americans act responsibly, take out a home loan they can afford, and pay their bills on time. And it’s not hard to imagine the political ads appealing to those who “play by the rules” while others unfairly get a free pass. If you’re going to give this kind of a huge break, you had better fine-tune it to be sure you are targeting the assistance only to those who truly need it — which this bill does not.
Of course the next logical question is: If we drafted a better bill that more carefully targeted the assistance to the group of individuals we want to help, would the bankruptcy code be the place to provide that help? The answer there is a resounding “no.”
There is a reason the Congress originally prohibited the alteration of mortgage terms in bankruptcy: It was to make mortgage credit widely and reliably available. It has worked by providing lenders the assurance that their extension of credit would be fully and predictably secured by a home. That’s a big reason the average credit card interest rate is much higher than the average mortgage interest rate: lenders know that with credit card debt, as unsecured credit, if a problem arises, there is no property secured there for the lender to recoup some of the losses.
This bill sends the very dangerous message to lenders that mortgages may now be treated more like unsecured credit, which takes away the very thing that makes the mortgage market different.
Bottom line: The “fix” proposed in this legislation is far worse than the underlying problem, and — make no mistake — there will be losers with this “fix,” and lots of them. Taking away predictability in the mortgage market from lenders will drive up rates for everyone, and will make it harder for future first-time buyers, and higher-risk but credit-worthy borrowers, to get a home loan. This in turn will reduce the number of potential buyers, which could further depress the real estate market, hurting all current homeowners.
And when that happens, the blame game will begin.
The mortgage bankruptcy bill passed by the Judiciary Committee is bad policy and bad politics and should be stopped.
Datri, former executive director of the House Democratic Caucus, is a partner at McDermott Will & Emery and has clients in the financial services industry.