Bad policy is not improved by limiting it to certain situations.
The Helping Families Save Their Homes Act (H.R. 1106) would allow
bankruptcy judges to reduce the principal owed on a mortgage, a
practice often referred to as a "cramdown." Judges would also be
able to reduce interest rates or lengthen the term of the mortgage.
This is a huge policy mistake that will help only a few people
while raising the cost of borrowing for thousands of
moderate-income and first-time homebuyers.
Although supporters claim that this is a limited provision that
applies only to existing mortgages, the cramdown language can
easily be amended to make it permanent at a later date-which would
then be priced into future mortgages. In addition, the House bill
even lacks many of the targeted limitations designed to make sure
that bankruptcy is a last resort-limitations that were included in
President Obama's poorly considered housing plan. It even weakens
language passed earlier by the House Judiciary Committee that was
designed to keep those who filed fraudulent mortgage applications
from taking advantage of cramdowns.
Problems with Cramdowns
Allowing bankruptcy judges to modify mortgages would:
- Raise mortgage costs. Cramdowns would add additional
risk that mortgages will not be repaid as the contract requires.
Lenders must charge for that added risk, and experts estimate that
the additional costs would raise mortgage rates by as much as two
full percentage points or substantially increase required down
These added costs would fall hardest on moderate-income and
first-time homebuyers, who have a higher risk of defaulting on a
mortgage. This will price many families out of the housing
- Further undermine the value of mortgage-backed
securities. Banks and other investors are already facing heavy
losses because mortgage-backed securities have lost much of their
value because of uncertainties about whether the mortgages will be
paid. The language in H.R. 1106 increases this uncertainty.
Investors will be at risk of both foreclosure and cramdowns that
reduce the earnings of these securities. Many cramdown mortgages
will later go into foreclosure. Since investors have no idea what
this new provision will do to the value of their securities, prices
will drop further.
- Fail to help many homeowners. Only one-third of all
Chapter 13 filers complete the process successfully and get the
fresh start that bankruptcy promises. The other two-thirds "pay
court fees, pay attorney's fees, pay fees to the bankruptcy
trustee, invest time and money to restructure their financial
affairs, and then wind up with nothing more than temporary relief.
It is therefore not surprising that a substantial number of Chapter
13 filers-nearly one-third-go on to file for bankruptcy again."
Other Provisions in H.R. 1102
The Helping Families Save Their Homes Act also contains a
mixture of other housing and financial provisions, including a vain
attempt to "fix" the failed Hope for Homeowners program that
Congress passed last summer. These include:
- Liability waivers for mortgage servicers that modify
mortgages. Mortgage servicers receive payments from mortgages
and forward them (after fees) to the owners of the mortgages. As
the main contact with homeowners, mortgage servicers should be able
to refinance or alter mortgages in order to ensure that the owners
get the best possible return, but many fear that unhappy mortgage
owners would sue them. The legislation provides these servicers
with a safe harbor so long as they act within certain specified
boundaries. This is a needed change.
- Making $250,000 FDIC and NCUA deposit insurance levels
permanent. Last fall, Congress increased deposit insurance
coverage by FDIC and NCUA to $250,000 until December 2009. This
bill makes that change permanent and also increases the agencies'
borrowing authority to cover their losses. Borrowing authority is
used only if the deposit insurance fund runs out.
- Trying to fix the Hope for Homeowners program. Last
summer, Congress created Hope for Homeowners, an FHA-based program
that it originally claimed would help up to 2 million homeowners.
To date, according to the FHA, it has actually helped about 500.
The legislation makes a number of changes that will raise the cost
of it by $2.3 billion but is unlikely to otherwise improve it. This
would throw good money after bad.
- Keeping predatory lenders from taking advantage of FHA
programs. Section 203 of H.R. 1106 makes it easier for HUD and
the FHA to prevent predatory lenders from underwriting
FHA-guaranteed home loans. This is a needed reform.
Making the Problem Worse
Mortgage cramdowns would further destabilize an already damaged
housing market while increasing mortgage costs for future
borrowers. This is the essence of bad policy at the wrong time, and
it should be avoided at all costs. Adding a couple of good
provisions to a huge policy mistake does not make it better.
Changing the bankruptcy code in this manner is extremely
David C. John is Senior
Research Fellow in Retirement Security and Financial Institutions
in the Thomas A. Roe Institute for Economic Policy Studies at The
Show references in this report
Obama housing plan suffers from many policy errors that will be
detailed in a forthcoming WebMemo.