Consumer Watch: Again, Congress fails to act

Inez Love bought her dream home in Germantown four years ago, near the height of the housing bubble. Then she lost her job at a Philadelphia nonprofit group.

Now Love, 59, is in danger of losing her home, too, and ending up with nothing - having liquidated her retirement savings to make payments on a home that appraisers say has dropped 22 percent in value.

There's no easy solution to this kind of problem, which is echoed in the finances of millions of homeowners in the Philadelphia region and across the country - especially in states such as California and cities such as Phoenix, where earlier this decade, exuberance over housing values crossed the border from irrational to insane.

But there is a valuable tool that could help stem the tide of eight million to 10 million foreclosures that may well result. Congress could help Love and other homeowners awash in mortgage debt by allowing bankruptcy judges to do what they do routinely with other kinds of debt, including commercial loans and vacation-home mortgages: bring it back in line with reality.

Last week, though, Congress apparently decided not to help. For the third time since U.S. Sen. Richard Durbin (D., Ill.) first proposed the so-called "cramdown" approach in 2007, his fellow senators - all the Republicans plus nearly a dozen Democrats - squelched the idea in Congress.

The finance industry, led by the Mortgage Bankers Association, had declared all-out war on the concept. But while it celebrates its victory, it's worth considering the irony.

Congress continues to defer to those whose "financial innovations" got us into our current mess.

They ran the gamut: The 80/20 mortgage, where a second lender covered the down payment? The "exploding ARM," an adjustable-rate mortgage with a low teaser rate that "explodes" two or three years later?

Or that special masterwork: the "option ARM" - an adjustable-rate, adjustable-payment mortgage, which gave borrowers the option of not even covering the interest costs for any given month, which meant that principal could grow rather than shrink?

Of course, not every bank or mortgage lender was behind each of those products. But each of them, by enabling borrowers to buy homes at prices otherwise out of reach, pumped up the bubble. And virtually every lender - and every investor who bought the hyperinflated mortgage-backed securities that these loans created - thought they were benefiting from the boom in asset prices, and didn't see the bust coming.

There were some, largely outside the industry, who did see the toxic nature of the burgeoning subprime mortgage market - the loans that eventually gave birth to the "toxic assets" that today are weighing down the nation's banks and have dragged most everyone into the worst crisis since the Great Depression.

One was Alan M. White, a professor at Indiana's Valparaiso University School of Law and, until 2007, a lawyer at Philadelphia's Community Legal Services.

White said that by 2006, the year the bubble finally started leaking, about 60 percent of subprime loans were being made to people with perfectly good credit.

It wasn't that they didn't shop around, White said. They couldn't afford the hugely inflated home prices with standard 30-year fixed-rate mortgages. But give them a low teaser rate, and suddenly they were golden - at least if you were selling them a house, or writing a mortgage you intended to sell quickly to somebody else.

People on both sides of the closing table bear responsibility, but so do those we rely on to oversee the marketplace. It wasn't until the bust that federal regulators finally imposed the ultimate head-slapping, "duh" restriction: Don't qualify people for loans they can only afford for the first two years.

White can answer virtually every argument raised against the cramdown proposal, such as the assertion of David G. Kittle, chairman of the Mortgage Bankers Association, that bankruptcy judges' ability to cram down the principal on vacation-home mortgages has damaged the market for places at the Shore or in the mountains.

As a result, Kittle said, "lenders have required 20 percent down, higher rates, and higher fees." He said the same would happen to loans for primary residences if Durbin and his allies get their way.

"That has nothing to do with the bankruptcy law," counters White. "It's harder to get a loan on a vacation home or an investment property because they're riskier. People are more likely to walk away."

Nor is it clear, White said, that requiring larger down payments would be a bad thing for borrowers or the economy as a whole.

Of course, there's a more basic reason that the cramdown provision should have minimal effect on future rates: to win its passage as a means of helping homeowners survive the financial crisis, supporters offered to limit it only to existing loans, not new ones.

But this isn't really about argument so much as about power: Who has it in our society, and who doesn't.

After the cramdown proposal was defeated Thursday, bloggers pointed to the outsized political contributions that flow from the financial-services industry to key senators, Democrats as well as Republicans, who helped block it.

Others asked why President Obama, who backed the cramdown proposal during the campaign, has only paid lip-service to it more recently.

To Yale economist Robert J. Shiller, co-creator of the Case-Shiller Home Price Index that has tracked the housing boom and bust, the key question is one of fairness.

Shiller was an early supporter of the cramdown proposal, which he backed in October 2007 with his near-legendary prescience. Back then, he said the nation faced "a mortgage crisis that has the potential to wreak havoc on innocent homeowners and on the national economy."

It has, and Shiller hasn't wavered. His larger goal is to reinvent the mortgage market to better protect the innocent. But he said bankruptcy was a crucial tool that should be available to underwater homeowners, not just the wealthy and corporations.

"Economic crises wreak havoc on all kinds of people," he said Friday. In times like these, he said, they all deserve our sympathy and help.