Obama’s trip West may signal power shift in bankruptcy law

February 16th, 2009 by Mike Hinshaw

Flush with a legislative victory, President Obama is scheduled to appear in Denver Feb. 17, when he will sign the $787 billion economic stimulus bill passed late in the day Feb. 13.  Hopeably, the bill’s passage on a Friday 13th won’t turn out to be a bad omen. That is, maybe some of the money and relief will actually reach people who need help this time–unlike the “bailout” funds that banks hoarded when the government made its little oopsie last fall and forgot to require even a minimum of loans targeted toward distressed homeowners.

After Tuesday’s signing at the Denver Museum of Nature & Science, the president leaves the Rockies for a Wednesday jaunt to Phoenix, where he’s expected to present his plan to stanch the hemorrhage of nationwide home foreclosures.

But Obama has a little public relations oopsie of his own: Part of the reason for the visits to Denver and Phoenix, according to a Chicago Tribune reporter, is “to refocus attention on ordinary people who might benefit from seeing the stimulus enacted.”

You know, slip out of the Beltway and mingle with the real folks… hunker down with the plebes… Well, apparently ordinary citizens got a shot at tickets to the Phoenix event, but the signing of the new bill is–according to the Denver museum–closed to the public. Posted at the museum’s Web site the day before the event, the explanation reads somewhat tersely: “This White House event is for invited guests only, and all tickets have been distributed. There are no remaining invitations.”

Oh, well, at least the hoedown for “Teachers, PTA members and school administrators” later that evening won’t get the kibosh: “Spring Educators Night scheduled for 5:30 p.m. on Tuesday evening will still go on as planned.” …whew!

Public relations gaffe aside, the event in Phoenix may well herald an historic shift in power. Since 1979, bankruptcy judges presiding over a Chapter 13 filing have not been able to modify mortgage terms on a primary residence. Astonishingly enough, using what lenders disparage as “cram down” powers, a judge can lower the amount owed on autos, boats, credit cards–and even a vacation home. But for decades, the mortgage-lending lobby has managed a white-knuckle death grip on the terms of primary residence loans.

Of course, such power is completely understandable. According to a Feb. 6 piece in the Mercury News, keeping the judges’ hands off the note, “allows lenders to foreclose on delinquent homeowners to force quick recovery of what they’re owed — part of the reason why foreclosures are so numerous.

“According to the mortgage industry data firm RealtyTrac, lenders filed for foreclosure on 2.3 million homes last year, up 81 percent from 2007 and 225 percent higher than the filing rate in 2006.”

The article posits a sea change that has been at least a couple of years in the making. “For the past two years, Democratic leaders in the House and Senate have been pushing for a change in the bankruptcy law to include principal residence loans on the list of debts that can be ‘judicially modified’ — crammed down — by the courts. They argued that banks and mortgage companies too often have been unwilling to offer delinquent borrowers serious modifications on loans because they have the option to pull the plug and foreclose.

“Lending industry groups successfully blocked those bills by appealing to Republican allies, especially in the Senate. But in the wake of the November elections, Democratic majorities are now large enough to virtually guarantee passage of cramdown legislation, maybe as early as this month.”

And the new president, the article says, “has promised to sign the legislation as soon as it hits his desk.”

Indeed, according to a Feb. 16 ABC News post, Obama is expected to unveil two more facets of a plan that already has seen some banks (finally?) agree to voluntary but temporary halts on more foreclosures. The first component is expected to be “anywhere from $50 billion to $100 billion” dedicated specifically toward home foreclosures.

The second “would lower the average homeowner’s mortgage payment, which can easily take up 38 percent of a family’s income. The goal of the plan is to lower most homeowners’ mortgages to 31 percent of their income.

A family with a household income of $50,000 will, on average, put $19,000 toward their mortgage. Under the president’s plan they’d pay $15,500 toward their mortgage for a savings of $3,500.”

The third aspect–the new, Democrat-sponsored legislation–would “allow bankruptcy judges to modify mortgages,” with the caveat that “only mortgages closed before the law is enacted are eligible.” Expected provisions might include that:

  • “lenders would also be required to write down a mortgage principal rather than interest rates, with the goal of helping to reduce the chances of default” and that
  • “Homeowners would also need to inform their lender or loan servicer in advance of their intention to file for bankruptcy protection.”

As the proposed legislation has mustered momentum, some lending industry leaders have been squealing as loudly–and predictably–as a pig trapped in a gate. As noted Feb, 6 in the Orlando Business Journal , “Modifying a loan to help a property stay out of foreclosure is common in the commercial sector, such as hotels and office buildings, as well as in some consumer sectors, such as cars.

But it’s unheard of for bankruptcy courts to modify home mortgages, said Roy Kobert, a bankruptcy attorney for Broad and Cassel in Orlando. ‘The present inability to modify home mortgages for Americans is the holy grail in consumer bankruptcy — it’s virtually impenetrable.’ ”

The party line among lenders seems to be that losing that power may cause such a backlash in lending practices that future homebuyers will pay the price. Rob Nunziata, president of FBC Mortgage LLC, an Orlando-based mortgage broker, warns that letting judges modify home loans will “introduce a whole new type of risk for lenders and investors, who would have to fear having a court judge change the amount of return the investor originally expected to get.”

Nunziata wails, “Mortgages in bankruptcy have been considered sacred, but this could change the ground rules” for lending.

Even though he concedes that “the plan is only for existing mortgages,” the article indicates that he believes “this could cause lenders to raise rates on future mortgages in fear of the law being modified to include new mortgages.”

But Chip Herron, an attorney with Wolff, Hill, McFarlin & Herron P.A. in Orlando told the Journal, “Creditors will be better off when there’s an owner who wants [to stay in a distressed home] and continue taking care of it.”

Herron envisions “a dramatic drop” both in personal bankruptcy filings and in foreclosures.

“This goes a long way to solving the real estate crisis,” said Herron. “Someone will be setting a floor to what these homes are worth instead of letting them continue to devalue.”