Will Debt Forgiveness Follow Mortgage Modifications?
Jan 10th, 2009 | By Rob | Category: housing
Various news outlets reported on Thursday that Democratic Senators and Citigroup had reached an agreement to allow bankruptcy judges to modify the terms of mortgages for homeowners in the bankruptcy process. The financial industry has previously opposed the procedure, known as “cramdowns,” which force mortgage modifications on debt holders. The hope is that bankruptcy judges will be able to fashion new loan terms that will be a win for both homeowners and the investors in the mortgage debt. By rewriting the home loan for those near foreclosure, the individual can keep their home and pay an affordable amount monthly, while investors will receive more money than they would have if they had foreclosed on the home.
This is not the first program to help homeowners avoid foreclosure. Efforts to date have focused on voluntary loan modifications, where troubled borrowers apply to their lender in order to rework the terms of the mortgage before the lender is forced to foreclose on the home. Despite encouragement by state and federal officials, the securitization of home loans among multiple investors has made receiving approval from the various debt holders to modify the mortgage difficult. It’s also unclear just how successful the voluntary mortgage modifications have been at their primary purpose - avoiding foreclosure.
Last summer, Congress passed the Hope for Homeowners program, which when implemented in the fall, was supposed to help hundreds of thousands of homeowners replace troubled mortgages with mortgages backed by HUD. But just a few months into the three year program, it is now regarded as a failure by the head of HUD (in an interview with the Washington Post).
The Congressional bailout bill last fall was expected to aid in the loan modification effort, as the government was expected to modify the terms of some of the subprime mortgages which the Treasury Department purchased as part of the TARP. But as the Treasury Dept. pursued the direct injection of cash into financial institutions rather than purchase mortgage debt, government officials have looked for new ways to encourage mortgage loan modifications.
One program that has been regarded as a success (for the moment) has been the FDIC’s Indymac loan modification program. It will be interesting to see if the program is successful at avoiding foreclosures in the long run. Even Fannie Mae and Freddie Mac have extended a voluntary suspension on foreclosure sales and evictions in order to give homeowners and mortgage holders more time to work out loan modifications.
Now, the government is backing the bankruptcy loan modification program. My understanding is that the program has a few limitations. First, the homeowner must have contacted the lender about a mortgage modification at least ten days prior to filing for bankruptcy. Second, the program will apply only to existing loans, meaning those originated prior to the passage of the bill, and not loans made in the future.
The hope is that the loan modification program will be the stick that encourages lenders to implement voluntary mortgage modifications before homeowners are forced into bankruptcy. Several analysts have indicated that passage of the bill in some form is highly likely.
Although other financial institutions have not come out in favor of the program, and the American Bankers Association is opposing the program on the same grounds as it did the recent Federal Reserve’s credit card legislation (it will make credit more expensive and less available), Citigroup’s support for the proposal suggests that the government has finally got some leverage for its investment in the nation’s third largest bank, even though this may mean that Citibank’s endorsement has less meaning that it would otherwise.
As the government begins to reach a solution to the mortgage modification problem, it will be interesting to see whether it includes, or follows it up with, a modified credit card debt forgiveness program. Late last year, the government rejected a plan proposed by credit card organizations to give increased viability to the current partial debt forgiveness program. While to some extent the government will be reluctant to modify the current system because credit card debt is already handled by the bankruptcy system, the desire of both individuals and lenders to avoid bankruptcy may mean that a new system to handle debt is put in place. If it is handled at the same time as mortgage modifications, it could be the additional carrot to the financial institutions (who receive little money from unsecured debt through bankruptcy) to support a comprehensive debt modification proposal. I’ll have to think more about my own opinions on how consumers and lenders might deal with debt modification outside of bankruptcy before forming any firm opinions, so if you have any thoughts, be sure to drop me a comment! Thanks.
