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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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The House of Representatives, as expected, approved the controversial bankruptcy “cram down” legislation, but not until after the bill’s sponsors agreed to add provisions making it more difficult for borrowers to qualify for judicial loan modifications. 

The House of Representatives, as expected, approved the controversial bankruptcy “cram down” legislation, but not until after the bill’s sponsors agreed to add provisions making it more difficult for borrowers to qualify for judicial loan modifications. 

The 234-191, largely party-line vote came after a strong push-back from moderate Democrats, echoing the concerns of Republicans and banking industry opponents, who said the legislation authorizing bankruptcy judges to reduce the principal balance of a residential mortgage, would further destabilize the housing market and could encourage borrowers to “game” the system by seeking bankruptcy relief as an easier first choice rather than the last alternative it should be. 

The revised language addresses some of those concerns, by requiring borrowers to seek a modification from their lender before filing for bankruptcy and giving bankruptcy judges the discretion to determine whether a lender has offered a “qualified” modification, defined as one consistent with the standards defined in President Obama’ s recently announced homeowners’ rescue program.

The revised cram down bill also:

  • Encourages (but does not require) judges to consider interest rate reductions before imposing a cram down;Requires the court to verify that a debtor has, in fact, made a good-faith effort to negotiate a workable loan modification with the lender;
  • Requires debtors to wait 30 days  after requesting a loan modification before filing for bankruptcy, and;
  • Allows lenders to recapture, on a sliding scale, any profit realized if the home is sold within five years of a judicial modification. 

Opponents of the measure have warned that the broad judicial cram down authority will unfairly reward borrowers who have made poor financial decisions and discourage mortgage lending activity by creating uncertainty for lenders and investors about the ability to enforce the terms of mortgage loans.

Supporters argue that the legislation will give struggling homeowners leverage they need to persuade lenders to negotiate with them – essential, they say, to curb foreclosures, which continue to weigh on the housing market and the broader economy. Credit Suisse estimates that the cram down provision could cut foreclosures by 20 percent.  The Congressional Budget Office (CBO) estimates that the legislation will boost bankruptcy filings by 350,000 over the next 10 years, but, the CBO report also notes, “The number of additional bankruptcy filings that would occur under the bill is uncertain.”  Even without the cramdown legislation, the CBO predicts that Chapter 13 bankruptcy filings, which increased 14 percent last year, will increase by another 13 percent this year, and 96 percent of Chapter 13 filers, the CBO report notes, are homeowners.

Next stop for the legislation is the Senate, where, despite strong support from the Democratic leadership, the bill’s prospects are uncertain.  Sen. Richard Durbin (D- D-IL), the Majority Whip and primary Senate sponsor of the bill, has reportedly signaled his willingness to make some concessions, although it isn’t clear how far, and in what direction, he will be willing to bend. But legislative vote counters say compromise will be essential given the narrow majority Democrats have in the Senate and the prospect that, as in the House, some moderate Democrats will insist on more restrictive language than Durbin’s bill currently contains.    


The Treasury Department has now published follow-up guidelines filling in the broad outlines of this $75 billion homeowner assistance plan President Obama announced in February.  Among other details, the guidelines specify the eligibility criteria for the loan modification program that is the centerpiece of the President’s plan. 

As explained in the Treasury summary of the guidelines, modifications will be offered to eligible borrowers who have loans originated before January 1, 2009.  There are no income limits for borrowers, but there is a cap on the mortgage amount, set at the current Fannie Mae/Freddie Mac maximum for conforming single-family loans ($729,750) but excluding jumbo mortgages.   

Eligible borrowers must have current loan payments representing more than 31 percent of their income and must document their income and owner-occupancy status.  The rules require a three-month trial period before a modification becomes final; if borrowers miss a payment during the trial period, the modification is revoked and they will not be eligible for another one. 

Unlike most existing modification programs, the president’s plan would include borrowers who are current on their loans but at risk of default.  The guidelines establish a “hardship” test lenders must apply “to ascertain whether the borrower has had a change in circumstances that causes a financial hardship or is facing an imminent increase in the payment that is likely to create a financial hardship.” 

The guidelines require lenders follow a phased “waterfall” process in modifying loans, with the goal of reducing the borrower’s mortgage debt-to-income ratio to 31 percent.  The first step is to lower the mortgage rate to no less than 2 percent, then extend the mortgage term to a maximum of 40 years.  If those steps don’t produce the desired reduction, lenders are to forebear principal payments at no interest.  They may also forgive some principal, but are not required to do so.

Treasury will match, dollar-for-dollar,  the cost of reducing the payment ratio from 38 percent to 31 percent and will provide a ”partial” share of the principal reduction cost “up to the amount the lender would have receive for an interest rate reduction,” as long as the modification produces the target 31 percent payment-to-income ratio.  The modified interest rate will remain in place for five years, after which lenders can increase it gradually, by 1 percent annually, until it reaches the prevailing mortgage rate currently a little over 5 percent) at the time of the modification. 

The guidelines require lenders receiving government financial assistance to offer modifications to borrowers if the cost of the modification, based on a net present value calculation (and including the offset of the government subsidies), is less than the loss the lender would absorb from the foreclosure. If the modification cost exceeds the foreclosure loss, the modification would be voluntary.  

The National Credit Union Administration has joined the federal bank regulators in encouraging financial institutions to participate in the modification plan.  In a joint statement, the agencies note that the program, with its incentives for borrowers, lenders, and servicers, “should help responsible homeowners remain in their homes and avoid foreclosure, thereby easing downward pressures on house prices in many parts of the country and averting the costs to families, communities, and the economy from avoidable foreclosure.”

Industry analysts have also found much to like in the plan, especially its breadth and effort to standardize the modification process.  But while the plan has many strengths, it also has some potentially serious flaws, a recent analysis by in Financial Times observed.  Among the concerns noted in a Financial Times analysis:   Lenders may skew the net present value calculations to make the modifications appear more costly than they are.  The FT analysis also noted the “logistical challenges” involved in dealing with loans in private-label pools, and the difficulty of securing the cooperation of junior lien-holders, “who may have little incentive to acquiesce” and who have the ability to block modifications.   The bottom line, according to Financial Times:  While the Obama plan has much going for it and reasonable prospects of success, “there are more heads to knock together yet.”   


With all the damage caused or exacerbated by the subprime melt-down, there has been the consolation that the relaxed underwriting standards that have produced record foreclosure rates also boosted homeownership levels in this country. But maybe not.

A new study suggests that the homeownership gains were ephemeral, at best, buried in the dust of the subprime collapse. Yuliya Demyanyk, a senior research economist at the Federal Reserve Bank of Cleveland, studied subprime loans originated between 2001 and 2006 and found that 80 percent of them were “terminated” by refinancing or default, within three years.  Of the 5 million loans in this pool, an estimated 1 million went to first-time buyers; a review of a “limited sample” of these loans found a 50 percent default rate within the first two years, “almost equal to the estimated number of first-time homebuyers who took subprime mortgages,” the study, published by the Federal Reserve Bank of St. Louis, calculates. “For subprime mortgages, the data seem to suggest that the number of foreclosed homes…already exceeds the estimated number of first-time homebuyers with subprime mortgages,” Demyanyk concludes. “At most,” she says, “the subprime boom accelerated the growth of homeownership,” financing purchases that would have occurred eventually without the high-risk financing.  “Given the impossibility of knowing when any first-time homebuyer who used a subprime mortgge would have become a homeowner with a prime loan, if ever,” Demyanyk argues, “the data do not support the argument that subprime mortgages increased homeownership.” 


Like a flower bed perennial, legislation requiring credit unions to comply with the Community Reinvestment Act (CRA) – the legislation requiring banks to demonstrate that they are meeting the credit needs of their communities – is blooming again.  Rep. Eddie Bernice Johnson (D-TX), who has introduced similar legislation in the past, is trying again to bring credit unions and “non-banks” currently exempt from the CRA, under its umbrella.

“CRA has been an extremely successful law,” Johnson said in a press statement.  “[It] encourages prime lending…, offers incentives for safe and sound loans and foreclosure prevention efforts… [and] penalizes banks and thrifts if they engage in predatory or discriminatory lending or [other actions] that have a negative impact on the community.”

Banks and some community groups have insisted in the past that larger community credit unions should be subject to the same community lending standards as banks.  In response to those arguments, which have become more insistent as credit unions have expanded their membership base, the National Credit Union Administration has begun collecting more detailed demographic data from credit unions to demonstrate that they are serving the members of “modest” means, that credit unions were originally created to serve. 

Both the National Association of Federal Credit Unions (NAFCU) and the Credit Union National Association (CUNA) have issued statements opposing the latest CRA expansion bid.  NAFCU President Fred Becker noted that CRA initially targeted evidence that banks were “redlining” – declining to serve low- and moderate-income consumers and neighborhoods.  Credit unions, by contract, Becker noted, “have a solid history of serving those of lesser income and minority applicants.”  Credit unions also were not involved in originating the subprime loans that contributed to “the current economic crisis.”  Imposing CRA obligations on credit unions, he said, would have “the unintended effect of draining resources that would otherwise go to help credit unions members [and] help stimulate the nation’s economic recovery.” 

John Magill, senior vice president of legislative affairs for CUNA, echoed those concerns, terming the CRA expansion bill “a solution in search of a problem.  “All available data suggests that credit unions…are out there lending to their members, even and especially in these tough times.  Credit unions are and should be focused on meeting the needs of their members,” Magill added in his press statement. “This legislation,” he warned, “would be a distraction from the good work credit unions do day in and day out.”


For a while, it promised to be a financial industry version of a “smack-down.”  Two giant trade associations – the National Association of Realtors (NAR) and the American bankers Association (ABA) were threatening a fight to the finish, or its political equivalent, over the bankers’ demand for authority to offer real estate brokerage services – a prospect the Realtors rejected out-of-hand.  Both trade groups wield considerable influence in Congress, and both said they had no intention of backing down.  But the financial melt-down of recent months has created new priorities and new concerns, to say the least.  So the ABA did not object, or even comment, when legislators included a provision in a pending appropriations bill permanently prohibiting the Treasury Department and Federal Reserve from approving a proposed rule opening real estate brokerage to banks. 

“It just wasn’t important to bankers, and we had many other fish to fry,” ABA President Ed Yingling told American Banker. 

The NAR, which has made the issue a top priority in the past and loudly protested the anti-competitive impact of allowing banks to offer realty services as well as loans to consumers, also had little to say about their apparent victory in the long-running dispute.   “NAR believes it is a victory for consumers in protecting the separation of banking and commerce and maintaining a competitive real estate environment,” an NAR spokesman told the Banker.