Extent of Bankruptcy Reform Hinges on Details

By Renae Merle
Washington Post Staff Writer
Saturday, February 21, 2009

When President Obama touted reform of the bankruptcy code while unveiling his foreclosure prevention program earlier this week, it wasn't much of a surprise. He had advocated allowing judges to modify troubled loans several times before, including during the presidential campaign.

But in the fine print of Obama's proposal were restrictions that some of his fellow supporters of bankruptcy reform said could blunt its impact. Opponents, meanwhile, have said they viewed the president's version of the proposal as a move in the right direction.

For one, the Obama initiative would cap the value of mortgages that could be revised in bankruptcy court. It would also pertain only to loans originated in the "past few years," according to a summary of his proposal.

How the administration chooses to define several parts of its plan will impact whether tens of thousands of homeowners are excluded, said Henry Sommer, a past president of the National Association of Consumer Bankruptcy Attorneys. "It could affect a lot of people or very few people, we don't know," he said.

The details will ultimately be hammered out on Capitol Hill, where lawmakers have been wrangling with the financial services industry for years about allowing bankruptcy judges to lower the principal owed on home loans. Now, bankruptcy judges are precluded from modifying mortgages on primary residences, a practice known as cramdown. The House, where bankruptcy reform has already been approved in committee, could take up the measure as soon as next week, a Democratic aide said.

Republicans and the financial services industry fiercely oppose the measure, complaining it could drive up mortgage rates and increase losses to lenders. But some financial industry sources have said they expect some version of the legislation to pass and are working to limit its scope.

"What the administration put out was encouraging, because it looked at bankruptcy as a last option rather than a first option," said Francis Creighton, chief lobbyist for the Mortgage Bankers Association.

Scott DeFife, senior managing director of government affairs at the Securities Industry and Financial Markets Association, said that his industry "saw the president's proposal as improvements to the bankruptcy cramdown debate."

The provision will also be a key part of a housing package being put together by Congress to codify changes to housing policy called for by Obama, a congressional aide said. The administration has designed a program to lavish incentives on lenders that modify mortgages. The incentives are the carrots to encourage more modifications, and bankruptcy reform is seen by the administration as the stick lenders would face for failing to comply.

Democratic congressional leaders aim to have the legislation passed within the next month, the aide said.

Nearly three-quarters of homeowners in Chapter 13 bankruptcy -- which allows borrowers to restructure their debt -- have unaffordable home payments, said Katie Porter, a University of Iowa law professor who has studied the bankruptcy process. About 20 percent of homeowners spend at least half of their income on their mortgage. Having an unaffordable mortgage can be a major stumbling block to completing the bankruptcy process successfully, she said.

Obama's plan would limit bankruptcy cramdown to mortgages written in "the past few years" -- a restriction advocated by industry officials.

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