Congress to Ponder Crucial Bankruptcy Law Change as White House’s Role in Financial Meltdown Emerges

December 23rd, 2008 by Mike Hinshaw

As the role of the Bush administration in the economic crisis continues to emerge, a bill slated for a January unveiling may address a long overlooked facet of personal bankruptcy.

A recent installment in a New York Times series about the financial crisis paints a bone-chilling picture of the Bush administration’s role in fueling the meltdown while a Dec. 23 Time magazine article describes a long-overdue reform that would allow bankruptcy judges to order loan modifications for mortgages on primary residences.

In its Dec. 20 article, the Times reviews the administration’s housing policy, citing both items of public record and “interviews with dozens of current and former administration officials.” What emerges is a “series of piecemeal policy prescriptions that lagged behind the escalating crisis.”

By mid-September, the March fire-sale of Bear Stearns to JPMorgan Chase (aided by $30 billion funneled through the Federal Reserve) had become stale news amid reports of record waves of home foreclosures. On Sept. 16, President Bush signed on to a deal that channeled another $85 billion toward the foundering insurance giant, AIG. On the heels of that deal, Bank of America had followed JPMorgan Chase’s lead with a last-minute “rescue” of Merrill Lynch, and Lehman Brothers had choked on the dead money of its own bad loans. On Sept. 18, says the Times, Bush and his economics team listened as Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson reported, in turn, a nationwide credit panic that, overnight, had banks refusing to lend, followed by the conclusion that in order to avoid disaster Bush would have no choice but “to sign off on the biggest government bailout in history.”

Taking a moment to ponder the news, an apparently befuddled Bush offered his reaction:

“How did we get here?”

How we “got here,” the article continues, comprises a mix of headstrong belief in a free market unfettered by regulation, a failure to compromise over tighter oversight of the so-called “Government Sponsored Entities” Fannie Mae and Freddie Mac, and a bent for appointing pals to crucial positions coupled with the tendency to disregard serious warning flags as early as 2006, flags waved both by those inside the White House and out.

“Lawrence B. Lindsey, Mr. Bush’s first chief economics adviser, said there was little impetus to raise alarms about the proliferation of easy credit that was helping Mr. Bush meet housing goals.

‘No one wanted to stop that bubble,’ Mr. Lindsey said. ‘It would have conflicted with the president’s own policies.’ ”

As the crisis continues amid reports of more waves of foreclosures on the horizon as “Alt-A” and “option ARM” loans begin to reset, Time magazine reports that new federal legislation may offer some relief for consumers who hope to save their homes by filing person bankruptcy. Sen. Dick Durbin (D-Ill.) and Rep. Brad Miller (D-NC) reportedly are set to introduce the bill on the first day that the new Congress convenes.

Previous proposals have not had much success. So, says Time, “. . . lawmakers will reconsider another, bolder plan: letting bankruptcy judges force lenders into modifying mortgages. It might actually work.”

The measure has been considered before, but “was thwarted by opposition from Republicans and the banking industry. Now, however, the banking industry and its lobbyists have lost a lot of sympathy . . . ” plus, some proponents have emerged in the mortgage industry itself.

Oddly enough, according to Time, current bankruptcy law does not allow for loan modification of one’s primary residence (sometimes termed a “first home), but–astonishingly–does indeed do so for second houses, apartment houses, and other property–including yachts. “In those cases, a bankruptcy judge has the power to force forgiveness of some of the debt as part of a repayment plan.”

As might be expected, issues await, and clear sailing for the bill is not assured. For one, banking interests and some scholars fret that lenders “will demand bigger down payments and higher interest rates to compensate them for the added risk.” Furthermore, even though the bill is intended to bring permanent change, pressure from the mortgage industry may result in only temporary changes or even applying “only to mortgages extended before the bill” is passed.

What is clear is that the currently allowed mix of parties involves a bewildering array of homeowners, primary mortgage lenders, secondary loan servicers, investors and Wall Street products that results in competing agendas and adversarial relationships. As the Time piece concludes: In more orderly times “. . .before 1979, lenders were generally banks and thrifts that held onto the loans they made. If modifying a mortgage loan would result in less of a loss than foreclosing on it, they would modify. Today the gridlocked mortgage markets that securitization has wrought don’t seem capable of making such rational economic decisions. Bankruptcy judges may need the power to do it for them.”