It took nearly nine years for Republicans and the banking industry to
successfully revise federal bankruptcy laws, but the subprime mortgage
crisis, a crisis on the verge of torpedoing the entire US economy, could prompt substantial changes in a matter of months.

History is littered with examples of rampant greed destroying national economies. In the past few years, overly aggressive loans and mortages have gotten out of control, and, coupled with the 2005 bankruptcy bill that tilted the delicate social balance in ways that have been driving more and more people through foreclosure and into all-cash underground economies, is also triggering massive problems in the housing industry.

Efforts to let borrowers restructure their primary mortgage during
bankruptcy proceedings gained steam last week as a House Judiciary
subcommittee approved legislation and two Senate bills were introduced.

Lawmakers
say the bills are critical to resolving problems in the subprime
market, but lenders say they would potentially devalue portfolios
across the board.

Rep. Linda Sanchez, D-Calif.,
the chairman of the House Judiciary subcommittee on commercial and
administrative law, said the House bill approved by her panel simply
recognizes that the mortgage market has changed since the Bankruptcy
Code was amended in 1978 to prevent primary loan modifications.

“It’s
addressing an artificial distinction that was made 30 years ago when
the market conditions for mortgages were much, much different,” said
Rep. Sanchez, who cosponsored the bill.

But industry analysts and
representatives see the effort as wider-reaching, arguing the bills
would allow judges excessive leeway to change the terms of a mortgage.

The legislation “could wreak havoc on the credit markets,” said Jaret Seiberg, an analyst with Stanford Washington Research Group.
“It takes an asset that had been protected in bankruptcy and priced as
if it was protected and now opens it up for wholesale changes. The
mortgages that banks are holding in portfolio or the mortgage-backed
securities that an investor has could suddenly be worth substantially
less.”

Of the three bills that have been winding through Congress, the one by Senate Majority Whip Richard Durbin, D-Ill.,
is considered the most expansive. Its provisions include one to let
borrowers rescind a mortgage if the lender violated Truth in Lending
Act or any other state or federal consumer protection law.

The
Durbin bill also would give bankruptcy court judges the power to reduce
the interest rate on home mortgages and extend the maturity of it up to
30 years. Additionally, it would mandate more up-front disclosure of
all charges that debtors would be responsible for and would allow the
U.S. trustee overseeing the Chapter 13 bankruptcy case to pursue claims
that were not initially sought by the debtor. And it would allow more
debtors to skip the credit counseling mandated by the 2005 bankruptcy
reform law.

Sen. Durbin’s position on the issue is key. As
Majority Whip, he is a top member of the Democratic leadership and
helps determine what bills get floor time.

The scope of Sen. Durbin’s bill is said to have caused a last-minute split with Sen. Arlen Specter, R-Pa.,
who planned to work with the Illinois Democrat on a bipartisan
proposal. Sen. Specter, the lead Republican on the Senate Judiciary
Committee, introduced his own bill on Wednesday that would allow
mortgages to be modified only if they were underwritten before Sept. 26.

Sen.
Specter also split with Sen. Durbin on a provision that would allow
bankruptcy judges to “cram down” a mortgage’s principal value. Sen.
Specter would allow judges to decrease the value of the loan only with
the consent of both the lender and borrower.

Aides to Sen.
Specter said Sen. Durbin is seeking permanent changes to the Bankruptcy
Code instead of helping homeowners struggling with the subprime crisis.
A memo outlining the differences between the two bills says, “The
Durbin bill effects permanent, far-reaching changes to the way
mortgages are treated in bankruptcy by eliminating provisions that have
kept interest rates on home mortgages low for the past 30 years.”

A bill from Rep. Brad Miller, D-N.C.,
is designed to be more targeted. It would require timely notification
of fees and would not expand the power of the U.S. trustee to go after
claims the debtor did not request. The House bill would also give fewer
debtors the option to waive their credit counseling.

But the bill
would allow bankruptcy court judges to reduce the interest rate on home
mortgages and extend its maturity. The bill passed the House
administrative law subcommittee along party lines 5 to 4 on Thursday,
and is expected to be voted on by the Judiciary Committee this week.

Though
the three bills vary in scope, industry representatives said privately
that they would probably oppose all of them, because each contains a
provision to allow terms of a mortgage to be altered, which they say is
unfair and would inject even more uncertainty into the mortgage market.

“In
the short run, when the game book changes there are a whole bunch of
players who got in and thought they were playing by another playbook,”
said Sandeep Bahiya, an associate professor at Georgetown University’s business school. “To change the book on them in the middle is wrong.”

Several industry representatives agree. Scott Talbott,
the senior vice president of government affairs at the Financial
Services Roundtable, said that risk would be passed on to consumers in
the form of costlier mortgages and less access to credit.

“It
would increase the cost of owning a home to middle-income Americans and
would prevent lower-income borrowers from owning a home,” he said. “The
lenders and the markets would respond by adjusting, which translates
into higher down payments or increased interest rates or both.”

Lawmakers
say the industry is overreacting. In an interview Thursday, Rep. Miller
said the markets would adjust for added risk without hurting homeowners.

“Apparently
I have more faith in the market than they do,” he said. “I think that
the market can assess risk and price for risk, and a home mortgage is
the only kind of secured debt that cannot be modified now. I don’t
think that the effect on the pricing of home mortgages will be
measurable.”

And though bankers contend that any change to the
Bankruptcy Code could eventually lead to a broader overhaul of the
Bankruptcy Abuse Prevention and Consumer Act of 2005, one of the
industry’s key legislative victories in recent years, lawmakers said
they are keeping their bills targeted for now.

“This bill has nothing to do with that,” said Rep. Melvin Watt, D-N.C.
, speaking of the Miller bill, which he cosponsored. “This is an
emergency bill that’s in response to what’s going on in the market now
and what we anticipate is going to continue to go on in the market.”

Rep.
Sanchez also said the bill is “not an attempt to undo the bankruptcy
reform that was passed. It’s trying to react to a specific crisis that
we see in a way that’s very strategic.”

Prospects for the
bankruptcy reform bills remain uncertain, but analysts said the
subprime crisis continues to put pressure on Congress to act.

“We
believe the odds are 1 in 3 for enactment, because we expect there to
be enormous political pressure to provide relief to troubled
borrowers,” Mr. Seiberg said. The legislation under consideration is
the only option “on the table that provides relief without bailing out
lenders or costing taxpayers a dime.”

Via American Banker