A smart fix for the subprime mess
Help homeowners by tweaking the bankruptcy code.
Over the past 15 years, homeownership, especially among people of color, has risen to historic levels. In just the past five years, 2.8 million families have bought their first homes. Now, the subprime mortgage crisis is threatening to roll back this progress.
It is clear that subprime loan foreclosures are going to get worse. How can the government help homeowners without putting taxpayer dollars at risk or sending the wrong signals to the housing market?
There is no single answer. Some ideas are intended to bail out Wall Street fund managers who made bad decisions on mortgage-backed securities. Other proposals have the unintended effect of propping up investors who bought property for speculative gain. Some notions, such as programs to educate and counsel homeowners, are a positive but small step. But the reality is that markets do work, and although credit markets are in distress, progress is being made.
I applaud the White House efforts to encourage mortgage servicers to modify existing adjustable-rate loans for a limited number of borrowers who cannot afford interest-rate resets. However, depending solely on the goodwill of an industry that bears no small measure of responsibility in this crisis is unlikely to be the full answer.
What is missing is a rational and urgent push to help the estimated 2.2 million families in imminent danger of losing their homes to foreclosure.
Congress is considering a small fix that would have more impact on these families than any other option under consideration: temporarily allowing bankruptcy courts to give the same relief to homeowners on principal-residence mortgages that business people get on real estate investment loans, that farmers get on farm loans, and that individuals receive on loans for vacation homes, cars, trucks, and boats.
Bankruptcy law is wildly off-kilter in how it treats homeownership. Under current law, courts can lower unreasonably high interest rates on secured loans, reschedule secured loan payments to make them more affordable, and adjust the secured portion of loans down to the fair market value of the underlying property – all secured loans, that is, except those secured by the debtor's home.
This gaping loophole threatens the most vulnerable with the loss of their most valuable assets – their homes – and leaves untouched their largest liabilities – their mortgages.
In the absence of modification, many of today's loans will result in foreclosure.
When servicers are unwilling or unable to voluntarily modify exploding, unsustainable home mortgage loans, Congress has a duty to consider involuntary modification in bankruptcy court, where the same relief is granted on all other secured loans.
The proposed Emergency Home Ownership and Mortgage Equity Protection Act being considered by Congress would do just that. It is targeted only at subprime and nontraditional mortgages and will be available for only seven years after it is enacted in order to mitigate against the next wave of exploding interest-rate resets.
The key is to avoid an overreaction that would have negative long-term effects on the housing market. Allowing certain distressed homeowners limited bankruptcy protection provides the greatest potential benefit with the least market disruption, and it will not cost the Treasury a dime. Moreover, a tweak to the bankruptcy code is a targeted solution. It is estimated that more than 600,000 homeowners could use bankruptcy protection to modify their loans and stay in their homes.
Some argue that expanding bankruptcy relief for homeowners would encourage frivolous bankruptcy filings, but recent reforms have made filing a very onerous process. People who bought homes with the intent of flipping them two years later are not going to go through the aggravation, embarrassment, and cost of bankruptcy.
The House Judiciary Committee passed a bipartisan version of the bill, and the full House is expected to take it up in February. Congress needs to pass it – and soon.