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House OKs court-approved mortgage relief

The bill would allow bankruptcy judges to reduce principal amounts on loans for primary residences. It faces a stiffer test in the Senate.

March 06, 2009|Jim Puzzanghera

WASHINGTON — In an attempt to ease the foreclosure crisis, the House on Thursday approved a major change to bankruptcy law that would give judges new powers to modify home mortgages.

The revision, which was approved 234 to 191 as part of a broader housing bill, would allow bankruptcy judges to reduce, or "cram down," the principal owed on an existing mortgage for a primary residence. Before that can happen, however, homeowners would have to seek a voluntary modification from their lender and agree to share any profits if they sell the house within five years.

The legislation faces a tougher road in the Senate, although supporters there expressed optimism that the nationwide surge in foreclosures would help them pass it as early as next week.

Since 1978, judges have had the authority to reduce the principal on loans backed by almost all forms of property -- including second homes, cars and boats -- but not on primary residences.

Backers of the revision approved Thursday said it should be extended to primary homes.

"This is the same opportunity that owners of vacation homes, investment properties, private jets [and] luxury yachts have long enjoyed," said Rep. Zoe Lofgren (D-San Jose). "I think it's only fair that we offer it now to average families as well."

The measure's supporters said they hoped the threat of a court-ordered reduction in loan principal would induce lenders to voluntarily modify mortgages.

But most of the mortgage industry and many Republicans opposed the legislation. They argued that it would make bankruptcy too easy for struggling homeowners, leading to a flood of filings to reorganize debt under Chapter 13.

Opponents of the revision also said it would raise mortgage rates as lenders tried to offset the risks that existing mortgages would be reduced.

"It is a classic example of the law of unintended consequences," said Rep. Dan Lungren (R-Gold River). "When you introduce additional risk . . . you are going to jeopardize the accessibility and eligibility of these mortgages to everybody."

The House vote came as the Mortgage Bankers Assn. released a survey showing that a record 5.4 million U.S. homeowners, or nearly 12%, were at least a month behind in their payments or in foreclosure. In California, the percentage was higher, at 13.3%, or about 785,000 homeowners.

President Obama has called for the change in bankruptcy law as part of his plan to reduce foreclosures, which continue to drive down housing prices and infect the economy.

"There is broad agreement that until we stem the current tide of foreclosures . . . you will not get an end to the current crisis," said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee.

The bankruptcy law change is the most significant part of the Helping Families Save Their Homes Act.

The bill also contains new incentives for lenders to use the existing Hope for Homeowners mortgage modification program. And the legislation would permanently increase to $250,000 the amount of federal deposit insurance for each bank or credit union account.

Congress temporarily boosted the Federal Deposit Insurance Corp. limit to $250,000 from $100,000 last fall, but that higher cap is set to expire at the end of 2009. The FDIC's credit line with the Treasury also would be boosted under the bill, to $100 billion from $30 billion.

Despite the increase in foreclosures, the legislation stalled in the House last week after complaints from moderate Democrats that it was too broad.

They successfully pressed to tighten some provisions. Under an amendment to the bill that passed 263 to 164, the legislation would require homeowners to seek a mortgage modification from their lender at least 30 days before going to bankruptcy court, twice the 15 days in the original legislation.

The amendment also contains a provision that would force a homeowner to share with the lender any profit from a sale of the home within five years from the time the mortgage was revised, increased from four years.

And the legislation now would require the lender to get 90% of profits if the house is sold in the first year after the mortgage is revised in bankruptcy, 70% in the second year, 50% in the third year, 30% in the fourth year and 10% in the fifth year.

The Financial Services Roundtable, which represents large financial institutions, said the changes were "a good step," but still opposed the legislation.

"The bill makes bankruptcy a first choice and not a last resort," said the group's president, Steve Bartlett. "It will undermine ongoing efforts to modify loans."

Opponents of the legislation also argued it would reward people who stretched their finances too thin to buy houses at the expense of those who did not.

"It's legislation that really will punish those who played by the rules and lived within their means," Rep. Mike Pence (R-Ind.) said. "Rewarding bad behavior will not solve our problems, it will only worsen them."

But supporters said it would provide impetus for lenders to revise mortgages and argued it could reduce foreclosures by 20%. They also said it would not cost taxpayers any money. In fact, the Congressional Budget Office estimated the bill would generate $23 million for the government over the next 10 years, largely from an increase in Bankruptcy Court filing fees.

The budget office estimated that the change would lead to 350,000 additional bankruptcy cases over the next decade, with two-thirds coming by 2012.


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