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The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Financial industry lobbyists fighting (not very successfully thus far) to block mortgage cram-down authority for bankruptcy judges will not be pleased with this news. 

Two recent studies have concluded that the 2005 bankruptcy reforms the industry sought and won are in part responsible for the mortgage foreclosure crisis that, supporters of the cram-down provision say, makes approval of that borrower-relief option essential today.   

Those who appreciate irony, on the other hand, and consumer advocates who opposed the 2005 Bankruptcy Reform law, will find much to relish in these studies, one by three economists at the Federal Reserve Bank of New York), the other by a Treasury Department research analyst.  Both contend that by making it more difficult for consumers to eliminate their credit card and other unsecured debts through the bankruptcy process, the changes in the bankruptcy code have pushed many borrowers, who might otherwise have been able to hold onto their homes, into foreclosure instead.  

“Is it just coincidence that the surge in subprime foreclosures…came right after the bankruptcy reform [law was passed]?  Is that surge just about falling home prices, bad mortgage decisions, and weak economic conditions?  No and no,” the authors of the New York Fed study – Donald Morgan, Benjamin Iverson, and Matthew Botsch, conclude.    

Under the old, less restrictive, bankruptcy rules, they suggest, debtors were able more easily to erase their unsecured debts through a Chapter 7 filing, freeing up sufficient cash to make their mortgage payments.  The “means test” in the bankruptcy reform law limits the number of borrowers eligible for Chapter 7, requiring them to accept Chapter 13 repayment plans instead.   

“When the means test binds,” the authors say, “cash-constrained mortgagors who might have saved their home by filing Chapter 7, are more likely to face foreclosure.” 

The end result of the bankruptcy reforms, this study concludes, was to “shift [default] risk from credit card lenders to mortgge lenders,” producing, according to their estimates, 32,000 more subprime foreclosures in each quarter than would have occurred otherwise. 

David Bernstein, a Treasury analyst (writing privately, and not as a Treasury official), reaches the same conclusion.  “By restricting financial relief…and by increasing the costs of filing bankruptcy,” he says, the bankruptcy reform   legislation “appears to have increased the number of individuals walking away from their homes, their mortgages and their other financial obligations without seeking the protection of the bankruptcy court.” 

The changes in the bankruptcy code were intended “to help creditors at the expense of debtors,” he notes.  “But the negative impact on real estate markets appears to have damaged the balance sheets of both debtors and creditors,” possibly, he suggests, doing more harm to creditors, because “mortgage debt totals are so much larger than consumer debt totals.”  One of the “greatest lessons and ironies” of the law, Bernstein says, is that “by increasing the dollar value of assets susceptible to default, [it] has weakened many of the financial companies that sought the more stringent bankruptcy code.”   

For policy makers seeking a means of reversing the housing market’s decline, which, most analysts agree, is weighing heavily on the economy, Bernstein suggests, there is a ready solution at hand:  “A policy of forbearance on credit card debt that prevents foreclosures could reduce the total dollar value of defaults, [providing] a low-cost way to reduce foreclosures and mitigate the current housing crisis.”   

In Congress meanwhile, the cram down legislation took another step forward last month, winning a favorable report from the House Judiciary Committee on a 21 to 15 party line vote  presaging similarly favorable (and probably equally partisan) action by the full House.  The Senate Judiciary Committee has not yet marked up its companion bill, but is expected to do so within the next month.

The Democratic leadership has nixed the idea of attaching that measure to the economic stimulus bill that lawmakers are now considering. But enacting the bankruptcy measure, which will give judges broad authority to modify mortgage terms, remains “a very high priority,” House Speaker Nancy Pelosi (D-CA) has stated.  “We will get it done,” she told reporters recently. 


The U.S. Supreme Court has agreed to hear an appeal of lower court decisions holding that the federal preemption principle established in the National Bank Act precludes state regulators from enforcing anti-discrimination laws against national banks operating in the state.  The key question:  Will the court restate federal preemption authority, or rethink it?

This legal battle – the latest in a series of clashes over the preemption authority of the Comptroller of the Currency – began when Elliot Spitzer, then the attorney general of New York, tried to investigate the mortgage lending practices of several large national banks.  The Comptroller interceded, saying national banks were not subject to state scrutiny.  A District Court and the U.S. Court of Appeals for the Second Circuit agreed, rejecting Spitzer’s contention that the expansive interpretation of the OCC’s preemption authority improperly tilted the balance of power between the state and federal governments.   

Andrew Cuomo, Spitzer’s successor as attorney general, sought the Supreme Court review, backed by the attorneys general of the other 49 states.  Allowing the lower court decisions to stand, the attorneys general argue, “undermines core principles of federalism and interferes with the states’ ability to enforce their own laws and to protect their own citizens.” 

Representing the OCC, the U.S. Solicitor General argued that the Supreme Court should not intervene, because there was no evidence to support the   plaintiffs’ claim that the OCC “would not vigorously enforce fair lending laws against national banks.”   

One question, almost as interesting as how the high court will ultimately rule, is whether the Obama Administration will view federal preemption of the banking laws in the same way and defend it as aggressively as the Bush Administration and its Comptroller of the Currency, John Dugan, did during the past eight years.  Another intriguing question:  Why, given the unbroken string of decisions affirming the preemption principle – including the 2007 Supreme Court decision (Watters v. Wachovia) cited in the Appeals Court opinion — the court has agreed to review the issue once more.  (In its 5-3 Watters decision, the court ruled that state regulators lacked the authority to require the mortgage banking subsidiaries of a national bank to obtain a state license and submit to examinations by state regulators.)  

Some analysts think the court simply wants to reaffirm its interpretation of the OCC’s preemption authority; others say the justices want to address a question Watters did not raise – the extent to which preemption applies specifically to the enforcement of state anti-discrimination laws.   

Although most legal analysts think it is unlikely the court will reverse the long line of precedents upholding the OCC’s preemption power, some speculate that one or more justices may want to rethink the limits of that authority.  That prospect makes some banking industry executives nervous, especially since Justice Clarence Thomas – who recused himself from the Watters decision (because his son was employed by Wachovia) but will be able to participate in this one – is said to have favored the dissenting opinion, arguing for a more robust interpretation of state regulatory authority.   

“This case seems to be the strongest possible state sovereignty case I can imagine,” Art Wilmarth, a law professor at George Washington University, told American Banker.   “That would attract Thomas,” he agreed, but the state sovereignty argument might also appeal to Justices Anthony Kennedy and Samuel Alito, who, Wilmarth noted, represent “at least potential swing votes.”   


Adding more fuel to the regulatory fires building under the credit card industry, the Center for Responsible Lending (CRL) has published two studies chronicling and decrying practices that newly enacted federal regulations and pending legislation target.  The studies assess the use of penalty rates and   the allocation of monthly payments to higher-cost balances, describing both practices as “deceptive and abusive” and dismissing industry arguments supporting them as “making no economic sense.

Credit card issuers intentionally use “complex” pricing policies that “exploit borrowers’ lack of information,” the CRL contends, noting as particularly confusing, the differences between introductory teaser rates, rates on purchases and rates charged for cash advances.  “Only 3 percent of Americans understand these differences well enough to be able to make the least costly decision” about their payments, the consumer advocacy group asserts in its summary of the study results. 

The study of penalty pricing – higher rates triggered by missed or late payments – found that 11 percent of consumers have been placed in the “penalty box,” but more than half are not aware of it and “issuers do not go out of their way” to inform consumers of the pricing shift. The higher rates have a significant impact on credit costs, however, adding $1,800 annually to the interest charges paid by a family with an average credit card  debt of $10,678, according to the CRL study.  

Lenders have been deriving an increasing amount of revenue from penalty fees, which, the study notes, increased by 67 percent between 2003 and 2007, as issuers included the penalty rates in 94 percent of all new credit card solicitations in 2008, up from 82 percent in 2003.

The study of payment allocation practices was equally critical of the industry, describing the   allocation of payments to lower-rate balances first as “harmful to borrowers, highly deceptive and inconsistent with risk-based pricing,” which is the industry’s argument for using this approach.  In fact the study contends, the practice “distorts” risk-based pricing, because it is the lower-risk consumers, not those posing greater risks, who end up paying higher rates.  Issuers use this approach anyway, the study suggests, because it allows them to raise effective card rates without altering the stated rate; takes advantage of consumers’ “known tendencies to overvalue the present and over-discount the future,” and capitalizes on the “excessive optimism” of consumers, which leads them to ignore the higher credit costs or understate their impact.   


Beginning May 1, lenders and appraisers will be operating under new rules designed to prevent the undue influence of appraisals that, some say, contributed significantly to the housing bubble and its devastating aftermath.  The new rules, adopted by Fannie Mae and Freddie Mac under an agreement with New York Attorney General Andrew Cuomo, prohibit mortgage brokers and real estate brokers from selecting the appraisers used in residential real estate transactions.  Lenders must make those choices, but under stringent guidelines forbidding them from trying to influence appraisers by withholding payments, promising or threatening to deny future work.  The rules also require lenders that own or control an appraisal firm to erect strict “firewalls” between the appraisers and loan officers, and specifically prohibit lenders from suggesting a “target” value for a property.

The agreement grew out of an investigation Cuomo launched last year to determine the extent to which improper appraisal practices contributed to the collapse of mortgage lending giant Washington Mutual.  As a result of that investigation, Cuomo had threatened to sue Fannie and Freddie for failing to adopt policies insulating appraisers from undue lender influence.  The new appraisals rules apply only to loans purchased or originated by Fannie and Freddie, but as a practical matter, the secondary market umbrella covers most residential mortgage, especially in today’s credit-constrained environment. 

Although appraisers have complained bitterly in the past about pressure from lenders to inflate values, the industry has not embraced the new “Home Valuation Code of Conduct.”  More than 60 percent of the appraisers responding to a recent poll conducted by the Appraisal Institute said they   doubted the new rules will improve the quality of appraisals.  Many said eliminating the mortgage broker referrals on which many depend will more likely drive experienced appraisers out of the business.

The National Association of Mortgage Brokers (NAMB) agrees and has threatened to file suit to block the new rules.  In a press statement, NAMB President Marc Savitt said the agreement between Cuomo and the GSEs “amounts to a de facto regulatory action which avoids the appropriate process” and fails to address the underlying problem – “appraiser fraud.”  The agreement will also “increase costs to consumers …remove thousands of small business competitors from the marketplace…create a severe disadvantage for mortgage brokers, and prevent them from engaging competitively in the mortgage marketplace,”  according to the NAMB, which has also filed suit to block implementation of HUD’s newly revised RESPA regulations. 

While emphasizing NAMB’s willingness to work with the GSEs, “to achieve the objective of eliminating appraiser fraud without disrupting the marketplace or hurting consumers,” Savitt said the organization intends to “consult with our legal advisors and to take appropriate legal action if necessary.”  


It’s hard to find much humor in the news, but the bleaker the headlines, the greater the need for comic relief.  In that spirit, we offer a little unsolicited advice for marketing professionals, culled from Collateral Damage, a blog that collects examples of marketing and advertising missteps.

Tip:  Make sure your products work.

Tip:  Don’t say stupid things 

Tip:  Try to anticipate what others will see