Consumer Law

MBA & CRL duke it out on Bankruptcy reform

By Alan White

by Alan M. White

The Mortgage Bankers Association issued a press release yesterday denouncing the Center for Responsible Lending for misstating facts about foreclosures and loan modifications in its reports. Both groups are trying to influence the bankruptcy legislation being considered in Congress at a hearing today.

According to MBA, bankruptcy reform is not the answer. MBA asserts that many foreclosures are ?avoided? not just by loan modifications, but also by repayment plans and short sales. If Congress gives bankruptcy judges power to modify mortgages, interest rates will rise and refinancings will be curtailed, says the MBA.

Let?s examine the MBA?s facts.

First, is CRL painting too bleak a picture by ignoring foreclosure alternatives other than loan modifications? While repayment plans can in some cases yield the same benefits as loan modifications for homeowners and investors, a short sale will not. In a permanent loan modification, the lender will reschedule unpaid payments, and sometimes, but not always, reduce the interest rate, or forgive some interest and fees (and on rare occasions, reduce the principal.) A loan modification can result in a lower monthly payment, or a higher monthly payment, but it allows the homeowner to resume payments without having to scrape together a large lump sum to pay arrears.

A repayment plan, on the other hand, usually calls for significantly increased monthly payments for six to twelve months to liquidate arrears. According to the MBA?s own study, repayment plans are failing at a high rate. A short sale consists of allowing the homeowner to sell the house for less than the loan balance, with the mortgage investor receiving less than full payment. A short sale is not a foreclosure, but it results in the same two losses as a foreclosure: the homeowner loses their home, and the investor loses unpaid interest and often some principal.

In contrast, a loan modification will result in the homeowner retaining the home and the investor receiving full payment of principal, as well as interest (albeit at a reduced rate, say 7% or 8% instead of the 11% or 12% the investors had hoped for.) Of course some homeowners will fail to make the modified payments, and that can result in a greater or smaller loss for the investor down the road, depending on what happens to home prices.

2) MBA claims that half of the risky subprime loans in danger of foreclosure were refinanced in 2007, so that CRL is overstating the problem by half. While refinancing continued at a brisk clip until about August of 2007, it is clear that the refinancing option has disappeared for many subprime borrowers at this point, because of the decline in property values and the secondary market?s tightening of underwriting standards. Going forward, refinancing is less likely to be a solution for homeowners in trouble. As for the 2005 and 2006 subprime mortgages, it is true that some of them were replaced with 2007 mortgages. However, the riskiest and worst-performing mortgages are those originated in the first half of 2007. So while many 2005 and 2006 subprime ARMs were refinanced away in 2007, they were replaced with loans at even greater risk of foreclosure.

3) If bankruptcy judges are allowed to modify loan terms, will the mortgage market raise interest rates in response? MBA asserts, without citation, that interest rates would rise by 1.5%. A nice round number. Our colleagues at Credit Slips have rather convincingly discredited this claim. During past periods when bankruptcy judges did have the ability to modify mortgage terms, there was no detectable effect on interest rates. The bill being considered in Congress does not give bankruptcy judges blanket authority to modify all mortgages. It applies only to existing mortgages, not to new mortgages, and limits the bankruptcy judge's modification powers in numerous ways. The bankruptcy "cramdown" bill is thus even less likely to affect interest rates.

At this point, CRL has the better of the argument, at least where the facts are concerned.

Full post as published by CL&P Blog on January 29, 2008 (boomark / email).