With residential mortgage foreclosure rates setting new records (again) in the third quarter and the pain from the ailing housing market continuing to spread, Congress and the Bush administration are under increasing pressure to help struggling borrowers hang on to their homes and to prevent the fallout from the housing/subprime crisis from tipping a weakening economy over the recession edge.

Treasury Secretary Henry Paulson is intensifying his efforts to promote the voluntary loan modification plan he has negotiated with secondary market players, but the plan’s limited reach will likely push it into the background, keeping the focus on more comprehensive Congressional initiatives. The House has already passed a mortgage reform bill sponsored by House Financial Services Chairman Barney Frank (D-MA). Frank was able to win considerable support from Republicans and a measure of support from mortgage industry executives by soliciting their input and softening some of the legislation’s sharper edges – particularly the provision dealing with yield spread premiums (YSPs) – banned in the initial draft but permitted, with restrictions, in the measure the House approved.

Tougher than the House

When the Congressional session resumes following the holiday recess, the Senate will be considering its version of a mortgage reform bill, drafted by Christopher Dodd (D-CT), chairman of the Senate Banking Committee. After insisting that any legislative action should be limited and repeatedly expressing the hope that regulatory initiatives would make legislative action unnecessary, Dodd, a candidate for the Democratic presidential nomination, unexpectedly altered his position. Pronouncing the Fed’s proposed HOEPA revisions as “a step backward” (see related story, page x) and the Administration’s loan modification plan as inadequate, Dodd has proposed a measure that is considerably more stringent than the House bill. Key provisions would:

• Establish a fiduciary obligation for mortgage brokers to act in the best interests of borrowers and a standard of “good faith and fair dealing” for originators and loan servicers.
• Bar the use of yield spread premiums in subprime and non-traditional (“exotic) mortgages.
• Cap debt-to-income ratios for subprime mortgages at 45 percent (defining loans with higher ratios as “unaffordable”.
• Prohibit borrowers from bringing class action suits against secondary market entities that establish appropriate due diligence measures to avoid purchasing “unsound loans,” but allow class actions against loan originators who violate the underwriting and other requirements established by the law.
• Make lenders liable for faulty appraisals by requiring them to adjust the mortgage amount if the appraisal exceeds a property’s market value by 10 percent.
• Prohibit prepayment penalties and the financing of points and fees for “high-cost” loans.

In a notable departure from Frank’s Bill, Dodd’s legislation would not make syndicators liable for the loans they package and sell, but would allow borrowers to rescind mortgages that violate the law, in effect, shifting liability to investors. The idea, a Dodd staffer told Congress Daily, is to “encourage investors to press for better standards down the line.”

Dodd’s presidential aspirations have kept him on the campaign trail and away from Washington for the past several months, but following the first batch of primaries (in which he is not likely to be among the leaders), Dodd his expected to resume his focus on Congressional issues, and he has indicated that mortgage reform will be a priority.

In announcing his bill in December, Dodd emphasized the need for aggressive action. “By putting an end to abusive practices such as prepayment penalties and steering homeowners to more costly loans, and by providing strong enforcement to ensure that these new protections are followed,” he said, “we will protect present and future homeowners from the plague of predatory lending.”

Ready to fight

Mortgage lenders generally, and mortgage brokers in particular, are gearing up to fight the legislation. “We’re just going straight to our membership base and start activating them,” Roy DeLoach, senior vice president of the National Association of Mortgage Brokers (NAMB), said of Dodd’s bill, which, he told reporters “would potentially wipe out all mortgage brokers.”

The bill is likely to win strong support from consumer advocates (who criticized Frank for weakening the YSP and liability provisions of the House measure, to gain Republican and industry support), but it will face strong opposition from Senate Republicans, as indicated by what Rep. Tom Price (R-GA), told American Banker last week.

“[The bill] is awful,” he said, adding, “I don’t think you could get anything out of the Senate that would remarkably restrict the marketplace in the next six to eight months that would be signed by the President.”

Bankruptcy fears

While reasonably confident that they will be able to defeat, stall, or substantially modify Dodd’s Senate bill, industry lobbyists are becoming increasingly concerned about pending legislative proposals that would amend the bankruptcy law to provide relief for subprime borrowers at risk of losing their homes. In the House, efforts to increase Republican support for a measure sponsored by Rep. Brad Miller (NC) paid off in a 17-15 vote to report the bill favorably out of the Judiciary Committee.

Miller’s bill still allows bankruptcy judges to adjust the terms of mortgages on a primary residence and “cram down” the mortgage amount if the property’s value has declined. But the compromise, targeting objections from Rep. Steve Chabot (R-OH), narrows the pool of borrowers eligible for this relief to holders of subprime or “non-traditional” loans (as defined by the regulatory guidance on subprime mortgages) obtained between Jan. 1, 2000 and the enactment date of the legislation. Eligible borrowers would also have to meet the means test the bankruptcy reform law establishes for debtors seeking to eliminate their debts through a Chapter 7 bankruptcy filing. The revised measure also now contains a seven-year sunset provision – another concession sought by Chabot.

Despite the changes, Miller said the bill “will still accomplish what we wanted to accomplish,” which is to provide necessary relief to subprime borrowers in danger of losing their homes by making bankruptcy a viable option for them. “Homeowners facing foreclosure should not have to beg predatory lenders to let them keep their homes,” he told reporters recently. “If a homeowner can’t pay a predatory mortgage but can pay a fair mortgage, the homeowner should have the same rights in bankruptcy that a business has.” Miller and other supporters of his bill note that residential mortgages are currently the only loans bankruptcy judges lack the authority to restructure.

Credit union compromise

The National Association of Federal Credit Unions (NAFCU), which claimed credit for helping to broker the compromise with Chabot, hailed the progress on the bankruptcy legislation and the balance it strikes between the needs of lenders and borrowers. “We are delighted to have come to this compromise, which affords consumers welcome relief from possible foreclosure, but still protects the majority of credit union loans,” NAFCU President Fred Becker said in a press statement. “At a time like this,” he added, “the last thing we want to do is make credit harder to come by when people need it most.”

Somewhat less enthusiastic about the compromise, another credit union trade group -- the Credit Union National Association (CUNA)-- is calling for further modifications, needed, that group says, to clarify that the bankruptcy protections do not apply to borrowers with interest-only prime loans. Absent that clarification, the restrictions “would impact almost 500 credit unions that have made interest-only loans in good faith in response to member requests” in California, where high housing costs required innovative lending tools, CUNA chairman and CEO Dan Mica warned in a letter to members of the House Judiciary Committee. “These are not subprime loans,” he insisted, “but rather loans which were rigorously underwritten with full and clear disclosures.”

While CUNA is concerned about one provision of the proposed bankruptcy legislation, bank and mortgage industry trade groups oppose its underlying premise: That bankruptcy judges should be allowed to restructure some residential mortgages. “That will impose added risk and uncertainty on an already volatile market,” according to the American Bankers Association (ABA). Even with the compromises approved by the House Judiciary Committee, the legislation “still gives bankruptcy judges, with no expertise in mortgage lending, the ability to re-determine the size, value, and length of the loan,” the ABA complained in a press statement. “This will introduce more risk for the lender by creating uncertainty about when and if a loan will be repaid,” the association warned.

The Mortgage Bankers Association (MBA) expressed similar concerns. The legislation “brings into question the value of the collateral [securing loans], which is the cornerstone of our mortgage finance system,” David Kittle, chairman-elect of the MBA said in a press statement. “The end result will be a major repricing of risk by lenders,” Kittle added. MBA economists predict that the legislation would increase the rates on most residential mortgages by from 1.5 percent to 2 percent.

Gap in the Senate

Two bills are competing for attention and position in the Senate, one backed by Democrats, the other by Republicans, and neither likely to get very far without support from the other party. Sen. Richard Durbin (D-IL) and Arlen Spector (R-PA), sponsors of the Democrat and Republican bills, respectively, have been trying to forge a bipartisan compromise closing the gaps between those measures, but thus far, without success. Sen. Durbin’s bill is similar to the House measure sponsored by Rep. Miller, but without the modifications approved by the House Judiciary Committee. Sen. Spector’s considerably narrower bill would permit bankruptcy court judges to alter only the interest rate on a mortgage, but not its principal balance, and would permit changes in the mortgage terms only if both the borrower and lender agree. “The concern I’ve had and continue to express to Sen. Durbin,” Spector told American Banker recently, “is if we [permit more extensive loan modifications in bankruptcy], lenders will be reluctant to advance loans out of fear that there will be another action by Congress to move the goalposts.”

If nothing else, industry concerns about the bankruptcy reform proposals are building support for the Bush Administration’s voluntary loan modification plan. “We have a window of opportunity to show that industry efforts can bear fruit before people begin to make the judgment as to whether something else needs to be done,” Scott DeFife, a lobbyist for the Securities Industry and Financial Markets Association (SIFMA), representing secondary market syndicators, told American Banker. SIFMA will continue to argue that bankruptcy is not a viable solution for borrowers seeking to avoid foreclosure, DeFife added, “but to the extent that the advocacy groups have not other plan, we’re going to continue to hear about it unless progress can be made” in reducing the foreclosure wave.