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Tuesday, March 3, 2009

The Democrat's Mortgage Compromise: A Distinction Without a Difference

The Democrats have apparently reached a compromise on a bill that would give judges more power to modify loans for borrowers in foreclosure.

House Democrats, under pressure from a group of moderates in their ranks and the banking lobby, agreed Tuesday to narrow legislation that gives bankruptcy judges the power to force lenders to rewrite mortgages for debt-strapped homeowners.

The compromise legislation was expected to come to a vote in the House as early as Thursday.Under the terms of the agreement, judges would have to consider whether a homeowner had been offered a reasonable deal by the bank to rework his or her home loan before deciding whether to take judicial action to lower the interest rate or principal.

Borrowers also would have a responsibility to prove that they tried to modify their mortgages with their lenders before seeking help in bankruptcy court.

"If there is modification available, you would prefer that than a bankruptcy," said Rep. Zoe Lofgren, D-Calif., one of the centrist negotiators on the bill.

So, what this bill would allow is for a bankruptcy judge to modify the loan unilaterally of those that are in bankruptcy. This compromise does two things. First, borrowers would need to have shown a good faith effort to have attempted to get a loan modification on their own with the bank prior to going into bankruptcy. Second, the rate on the modification offered by the bank would need to be "reasonable".

Now, this compromise would keep those that were deadbeats and avoided even talking to the bank from then extending their hand out in bankruptcy court from having it be modified then. That would keep the most egregious cases from receiving a modification.

It wouldn't, however, fix the philosophical problem with this bill. First, banks would feel forced into a modification with this bill. Any borrower would be more than willing to accept any modification whether it is done by the bank or by a judge. As such, it is very unlikely that a borrower would apply for a modification with a bank and reject whatever modification program the bank created. This problem is from the perspective of the bank. Banks are reluctant to give a loan modification. Now, with this bill, if they reject someone that applies, they can very likely be overruled by a bankruptcy judge. Furthermore, the investors that bundle these loans are a lot less likely to buy these loans if they know that judges can renegotiate them by fiat. Neither of these problems are fixed by this compromise.

This bill is very consumer friendly. It is, however, very unfriendly to the banks. By extension, this bill is very unfriendly to anyone that pays their mortgages on time. That's because the losses the banks will have from this bill will have to be passed onto everyone else in the form of higher rates and fees.

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