The U.S. House Judiciary signed off on Wednesday on a bill designed to help certain bankrupt homeowners stay in those homes. The highly controversial bill, which faces significant bi-partisan opposition on the floor, is yet another piece in a crazy-quilt of government and mortgage industry attempts to curtail rising foreclosures and stem the collapse of lending and lenders.

The bill, a substitute version of the Miller-Sanchez "Emergency Homeownership and Mortgage Equity Protection Act of 2007" allows bankruptcy courts to change the terms of some existing mortgages to the benefit of the homeowners.

The bill changes the creditor-friendly overhaul of the nation's bankruptcy code passed in 2005. This legislation, heavily promoted by the credit card industry, virtually eliminated the ability of borrowers to wipe out their existing debt through a Chapter 7 bankruptcy filing. Most debtors now are forced to file under Chapter 13 which restructures the debt so that payments are made more manageable while allowing creditors a chance of eventual recovery. Courts can manipulate the terms of credit card and other unsecured debts to fit restructuring plans but cannot force changes in the contractual terms of mortgages so banks can foreclose on the collateral.



The proposed legislation applies only to homeowners with sub-prime and non-traditional loans such as interest only or optional payment loans taken out since January 1, 2000 who file for Chapter 13 bankruptcy relief. They must lack sufficient income after payment of specified expenses under IRS guidelines to remain current or cure arrears on their mortgages under the restructuring plan. Supporters of the bill estimated that about one-half million homeowners might be helped by the legislation.

This would probably be a different subset of borrowers than would qualify under the rate freeze proposed by an alliance of Bush administration and mortgage industry leaders last week. The window for that relief is much narrower - loans had to have been originated between January 1, 2005 and July 2007 - and borrowers need to be current with their mortgage payments. Bankruptcy is typically the court of last resort for debtors who are delinquent on virtually everything.

Judiciary Chairman John Conyers, Jr. (D-MI), in a press release on Tuesday said that the legislation would allow the courts to "reduce exorbitant mortgage interest rates and avoid onerous prepayment penalties; set aside excessive and often secret fees charged by unscrupulous mortgage lenders; modify the principal amount of the mortgage to reflect the home's actual value.

The House panel voted 17-15 in favor of the legislation but it faces tough going in the House. Republicans in the main oppose it and in October 16 Democrats, none of them on the Judiciary Committee, wrote to Conyers urging him to drop his proposal. He did, but with a few modifications such restricting relief to subprime mortgagors and limiting the timeline, recently resurrected it.

There may be a lot to oppose in the Conyers bill. First, as in the rate freeze, there is the issue of fairness. Why January 1, 2005 and not December 31, 2004, etc., etc? There is also what we described last week as a sort of "dog in the manger" attitude among the citizenry; why should anyone else get that kind of help when no one is throwing me a bone? This may be a particularly widespread complaint in this instance as, fairly or not, persons who file for bankruptcy aren't generally regarded by the public as responsible citizens.

The Wall Street Journal Online in an opinion piece this morning complained that many of the bailout plans view every troubled borrower as a victim. Never let it be said that the Journal will overlook an opportunity to blame a victim and it continued on to do saying that "fraud for housing" in which a borrower falsely presents himself as capable of buying a more expensive property than his finances would justify account for 60% of all mortgage related "suspicious activity reports" filed by banks with federal investigators. "Taxpayers, investors and future home buyers asked to sacrifice on behalf of today's subprime 'victims' might reasonably ask for a more thorough accounting" (of this fraud activity.

The Journal, however, presents a reasoned argument against the bill on a more pragmatic basis; the Law of Unintended Consequences.

Mortgage debt, the editorial stated, has always been treated differently than other types of debt. The threat that the bank can and will take the house if the payments are not made is designed to encourage lenders to offer lower rates on a less risky type of investment.

The Journal quoted Supreme Court Justice John Paul Stevens' 1993 opinion in Nobelman v. American Savings Bank. "At first blush it seems somewhat strange that the Bankruptcy Code should provide less protection to an individual's interest in retaining possession of his or her home than of other assets. The anomaly is, however, explained by the legislative history indicating that favorable treatment of residential mortgagees was intended to encourage the flow of capital into the home lending market."

Giving credit for the current high levels of homeownership to the success of this policy, the Journal raised the specter that mortgage interest rates may soon reflect the greater risk to lenders by equaling credit card or signature loan rates.