H.R. 1106

H.R. 1106 is expected to be considered on the floor on Thursday, February 26, likely under a structured rule. This legislation was introduced by Representative John Conyers (D-MI) on February 23, 2009.

Residential Mortgage Modification

Expanded Chapter 13 Bankruptcy Eligibility: Expands eligibility for Chapter 13 bankruptcy by excluding home mortgage debt from the current maximum debt limitations. Under current law, debtors may only enter into a Chapter 13 bankruptcy if they have less than a predetermined maximum amount of debt. This provision excludes home debt from a Chapter 13 eligibility evaluation if the value of the debtor's home is less than the mortgage owed. Under this provision, certain individuals with multi-million dollar homes would be eligible to file under Chapter 13, so long as their mortgage debts exceed their home's current value.

Cram Down: Allows judges to modify the rights of a mortgage holder-whether that mortgage holder is a primary lender or an investor in a mortgage backed security-with regard to delinquent mortgages on primary residences if the borrower has entered Chapter 13 bankruptcy proceedings. Among other modifications, the bill would allow bankruptcy judges to reduce the principal amount contractually owed by the borrower under the original mortgage.

This provision, known as "cram down," has been criticized because it allows borrowers to abdicate their contractual obligation to repay the full amount of their loan. Many have argued that cram down would make it more costly for other individuals to purchase a home because lenders would have to increase interest rates and down payments to supplement the loss from the loan modification. Though the cram down provision in H.R. 1106 only applies to mortgages initiated before enactment of the bill, lenders may increase interest rates and down payments out of fear that the total principal of the home may not be paid back because of future cram down legislation. Some Members may be concerned that this provision would provide benefits to delinquent mortgage borrowers at the expense of investors and responsible home buyers in the future. Members may be concerned the increased costs imposed on mortgage providers by cram downs would add more uncertainty and upheaval into an already volatile housing market that is characterized by tight lending and uncertainty.

H.R. 1106 requires any borrower that receives a cram down on the principal of their loan to pay the mortgage holder a percentage of the sale of the home if it is sold within four years of the cram down and the borrower has not paid the entirety of the loan. The debtor would be required to pay a percentage of the difference between the amount the house is sold for and the amount of the mortgage owed. The debtor would be required to pay 80% if the home was sold within one-year of a cram down. That percentage would decline by 20% each of the following three years.

Additional Modification Authority: Allows bankruptcy judges to alter mortgage loans owed by individuals participating in Chapter 13 proceedings in a number of additional ways. Specifically, the bill would allow a judge to require a mortgage holder to lower the interest rates on a loan or extend a repayment period of the loan (often 30 years) to up to 40 years in an effort to reduce the borrower's monthly payment.

Any Chapter 13 loan modification authorized by H.R. 1106 (including cram down) would only be available for loans that originated prior to the passage of the bill and would not be available to debtor's that have been "convicted of obtaining by actual fraud the extension, renewal, or refinancing of credit that gives rise to a modified claim."

Waiver of Fees: Waives any fees, costs, or charges incurred by the borrower while a Chapter 13 case is pending unless the mortgage holder notifies the borrower of the fees before the earlier of one year after the fee is incurred or 60 days before the closing of the bankruptcy case.

Standing Trustee Fees: Reduces fees paid by the debtor to a standing trustee (who reviews the borrower's plan and disburses the borrower's payments) from 10% to 4% for Chapter 13 bankruptcies that are modified under the legislation. The bill would eliminate the fees for a borrower with an annual income less than 150% of the poverty line.

Additional Modification Provisions

VA Insured Loan Payments: Authorizes the Secretary of Veterans Affairs (VA) to pay a mortgage holder any or all unpaid balances on a VA-insured affordable loan that is modified by the legislation.

FHA Insured Loan Payments: Authorizes the Secretary of the Department of Housing and Urban Development (HUD) to pay out all or some of the balance owed on any Federal Housing Administration (FHA)-insured loans that are modified under the legislation. The Secretary would also be authorized to make interest payments on FHA-insured loans that are modified pursuant to the bill. If the FHA were to pay the entire balance of an insure loan, the FHA would receive all rights, interest, and claims to the mortgage.

The bill would also grant the FHA the authority to carry out a program to encourage loan modifications by making payments on delinquent FHA-insured mortgages.

Rural Development Loan Payments: Authorizes the Secretary of the Department of Agriculture (USDA) to pay a mortgage holder any or all unpaid balances on a USDA Rural Housing Loan Program loan that is modified under a the legislation.

Foreclosure Mitigation and Credit Availability

Safe Harbor for Loan Modification: Provides a legal safe harbor from liability for lenders that enter into loan modifications or workouts with borrowers. Under current law, lenders that have packaged and sold one or more mortgages to investors as securities may be held liable for losses suffered by the investor as a result of the loan modification. The bill would deny affected investors that have contracts with lenders from suing for losses that occur because of mortgage modifications if:

• Default on the mortgage has occurred or is "reasonably foreseeable."

• The borrower occupies the home.

• The lender "reasonably and in good faith" believes that more money would be recovered through a loan modification or workout plan than foreclosure.

Changes to Hope for Homeowners Program: Makes a number of changes to the $300 billion HOPE for Homeowners (H4H) modified mortgage insurance program in an attempt to expand participation in the program. Though Democrats initially touted that the legislation would help 400,000 homeowners modify their loans, only 43 mortgages have actually been processed and modified under the program. H.R. 1106 attempts to increase participation in the program by transferring significant authority from the HOPE Board to the Secretary of HUD, providing incentive payments to servicers of mortgages that are modified through the program, and reducing certain program entry costs that were initially included to protect taxpayers.

Specifically, the legislation would transfer authority to establish requirements for participation in the program and prescribe regulation of the program from the Board of Directors of the H4H program directly to the Secretary of HUD. This provision would give the Secretary of HUD unilateral authority to determine how the program is carried out. Under current law, the Board consists of the Secretary of the Treasury, the Chairperson of the Board of Governors of the Federal Reserve System, and the Chairperson of the Board of Directors of the FDIC.

H.R. 1106 would authorize the payment of up to $1,000 to mortgage loan servicers for every mortgage that is modified and insured under the H4H program. To offset the cost of this provision, the bill would reduce funds for the Troubled Asset Relief Program (TARP) by $2.3 billion.

The bill also reduces the 3% upfront insurance premium that lenders are currently required to pay before refinancing into a FHA-insured H4H mortgage to 2%. Similarly, the bill reduces the 1.5% annual premium requirement for mortgages refinanced under the H4H program to 1%. These changes will make it cheaper for lenders to refinance into FHA-insured H4H mortgage, while increasing the debt liability insured by the federal government.

The legislation would restrict any individual with an annual income of more than $1 million or any individual convicted of one of a number of real estate, mortgage, or businesses related felonies from receiving a H4H insurance benefit.

Permanent FDIC Insurance Increases: Permanently increase Federal Deposit Insurance Corporation (FDIC) deposit insurance coverage for banks and credit unions from $100,000 to $250,000. The Emergency Economic Stabilization Act temporarily increased FDIC coverage to $250,000, however, that provision is set to expire on December 31, 2009.

In order for the FDIC to absorb increased deposit insurance and future bank failures, the bill would also increase the FDIC's authority to borrow from the Department of Treasury from $30 billion to $100 billion. Likewise, the National Credit Union Association's borrowing limit would be raised from $100 million to $6 billion. The FDIC's insurance program is generally self-sustained through fees paid by participating institutions. However, in the event that a number of insurance pay-outs occur simultaneously, the FDIC is authorized to borrow funds from Treasury. The funds would eventually be repaid through reworked fees on insured institutions. While any increased Treasury would be replenished over time, reports indicate that the increase included in H.R. 1106 would result in a violation of PAYGO budget rules over the next five years.

 

BACKGROUND

H.R. 1106 combines a number of bills marked-up in the Financial Services and Judiciary committees and since amended. The legislation makes a number of changes to current law regarding bankruptcy, federally insured mortgages, federal deposit insurance, and federal mortgage modification programs. While the stated goal of the legislation is to "prevent mortgage foreclosures and enhance mortgage credit availability," the legislation contains a controversial provision which allows bankruptcy judges to reduce the principal of a debtor's mortgage. This provision, known as "cram down," has been widely opposed by the financial services industry and many Members for a number of reasons. Opponents argue that cram down encourages debtors to file for bankruptcy, increases lender's risks, increases mortgage costs, and makes it much more difficult for home owners that have paid their mortgage and new home buyers to purchase a home.

Limited Credit Availability:  Rather than enhancing mortgage credit availability, many opponents contend that cram downs would increase the cost of home loans, thus decreasing the availability of mortgage credit for potential home buyers. Although H.R. 1106 is meant to address the current mortgage crisis, many contend that the cram down provision will only worsen the crisis by increasing the cost of residential mortgages. Mortgage holders would be responsible to pay down the principal on loans modified under the bill. The cost of the pay downs would be passed on to other home mortgage consumers in the form of higher interest rates and higher down payments. If the increased cost of home mortgages results in a reduction of housing demand, this legislation, which is intended to stabilize the housing market, could perpetuate the current crisis.

Increased Bankruptcy Claims:  Many critics of cram down legislation have also noted that the provision would encourage homeowners to hastily file for Chapter 13 bankruptcy, even if other options were available that would be more beneficial to the debtor and the lender. By allowing bankruptcy judges to reduce home mortgage principle, the bill would add incentives for home owners to enter Chapter 13 bankruptcy proceedings rather than seeking voluntary loan modifications through their mortgage holder. The result may be a huge increase in the number of Chapter 13 filings that overwhelm courts and permanently harm the credit of homeowners that could have settled their mortgage debt through a great number of less damaging means. According to HUD, "Having the option of cram down would increase the attractiveness of Chapter 13 filings versus working directly with lenders to find an appropriate loss mitigation workout plan." The increased number of bankruptcies could also lead to a reduction in the value of real estate as collateral for mortgage loans-a cost which would be passed on to consumers trying to buy a home.

Economic Impact:  Critics point out that cram downs could result in financial institutions hoarding their capital reserves further in anticipation of the impact that a large number of cram downs could have on mortgage backed securities, which would lose more value if numerous mortgages in the securities were subject to principal reductions. If this to indeed occur, it would result in a tightening of mortgage credit which has accounted for a large portion of our current economic crisis. According to Pepperdine University School of Law Professor Mark Scarberry, who testified before the Judiciary Committee about the foreclosure crisis, changing the characteristics of home mortgages would result in a "shadow cast on the trustworthiness of American mortgage-backed securities. The implications are disturbing given that such securities are held worldwide by investors who count on the protection of property and contract rights under American law.''

Industry and Congressional Concerns:  As a result of these concerns, many leading organizations of independent lenders, banks, and businesses have expressed their opposition to cram down provisions in the legislation. Some of the organizations that oppose cram downs including, the American Bankers Association, the American Financial Services Association, the American Insurance Association American, the Independent Community Bankers of America, the Mortgage Bankers Association Securities, the Financial Services Roundtable, and the U.S. Chamber of Commerce. In addition, every Republican Member of the Judiciary Committee signed a statement of minority views in opposition to cram down legislation which stated, in part, "Allowing for modification of principal residence mortgages in bankruptcy comes with too many attendant costs and the failure rate of Chapter 13 bankruptcies is much too high for it to be considered a practical approach to stopping foreclosures."

COST

A CBO cost estimate was not available at press time, however, reports have indicated that the FDIC loan limit increase included in H.R. 1106, would result in a PAYGO violation.