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Bankruptcy Law Changes Part of Obama’s $275 Billion Housing Plan

By , Contributing Writer, Money Morning •

By Don Miller
Associate Editor
Money Morning

U.S. President Barack Obama yesterday (Wednesday) released a proposed housing program designed to prevent up to 9 million "at risk" Americans from losing their homes. However, some critics say they were surprised that the proposal is more ambitious - and more expensive - than initially expected, and includes controversial changes to bankruptcy laws that could cause the mortgage market to freeze up.

In fact, an Obama administration official told Reuters the total plan commits up to $275 billion for housing, including $50 billion from funds already committed in the country's financial sector bailout.

Headlining the plan is a $75 billion Homeowner Stability Initiative, aimed at helping 4 million to 5 million struggling homeowners refinance their mortgages which are owned or guaranteed by mortgage giants Fannie Mae (FNM) or Freddie Mac (FRE).  

A second piece of the program would help 3 million to 4 million additional homeowners cut monthly mortgage payments to sustainable levels by providing incentives to any participating lender to lower monthly interest rates.

Obama billed his two-pronged effort as critical to stanching the relentless run of foreclosures, which is key to turning around the recession-bound economy.
"In the end, all of us are paying a price for this home mortgage crisis. And all of us will pay an even steeper price if we allow this crisis to deepen," President Obama said while announcing his plan in Arizona, a state hard hit by the housing crunch.

But critics feel the proposals will have a minimal impact on homeowners who are behind on their mortgage. And most say Obama's plan won't make banks more willing to lend to consumers with less-than-perfect credit scores or meager downpayments.

"It's like a new captain of the Titanic after it has hit the iceberg," Guy Cecala, publisher of Inside Mortgage Finance, told MSNBC. "What can he do? Rearrange seating on the lifeboats?"

Housing Crisis Key to Recovery

Obama's plan was created comes in response to a housing crisis that has acted like an anchor on U.S. growth, spawning a recession that started last December and shows no signs of letting up.

The housing crisis has played a central role in the financial and credit turmoil now spread across the globe, with many U.S. homeowners hamstrung by mortgages they cannot pay.

That has led to record foreclosures in the past year, swelling the glut of properties on the U.S. market, forcing down home values and crimping the wallets of homeowners unable to refinance or sell their homes. For instance:

  • The housing market lost an estimated $3.3 trillion in value last year and almost one in six owners owed more than their homes were worth, according to online data provider Zillow.com.
  • At the end of last year, slightly more than 9% of all home loans in the United States were in arrears, or already in foreclosure, according to the Mortgage Bankers Association, Reuters reported.
  • A total of 8.1 million U.S. homes, or 16% of all households with mortgages, could fall into foreclosure by 2012, according to a report by Credit Suisse Group AG (ADR:CS).

The President says his program will finally stop the bleeding and help turn around an economy staggered by a withering recession.

"It will give millions of families resigned to financial ruin a chance to rebuild," Obama said. "By bringing down the foreclosure rate, it will help to shore up housing prices for everyone."

The plan exists in several key parts.

Boost Funding for Fannie & Freddie

The first part of the President's plan calls for the Treasury Department to double its financial support for Fannie and Freddie to allow them to refinance homeowners with mortgages valued at more than 80% of the homes' values.

The Treasury plans to provide as much as $200 billion in capital to ensure that Fannie and Freddie, the government-sponsored enterprises (GSEs) that guarantee home loans for millions, can stabilize markets and hold loan rates down.

In order to assure adequate funding, the Treasury said it was increasing its preferred stock purchase agreements with the two government-controlled companies from $100 billion to $200 billion, Bloomberg News reported. 

It also said it was taking the limit on the size of the mortgage portfolios the two companies can hold and boosting the cap on each to $900 billion, an increase of $50 billion. It's also increasing their debt ceilings.

This part of Obama's plan is designed to give relief to homeowners struggling with deflated property values and/or interest-rate "re-sets," by allowing the big mortgage companies financing leeway. 

"The plan I'm announcing focuses on rescuing millions of families in traditional mortgages who are under water or close to it ... and to keep mortgage rates low so that families can secure loans with affordable monthly payments," Obama said.

$75 Billion Incentive for Lenders

A key second part of the plan involves providing $75 billion in incentives to lenders, making them responsible for lowering interest rates so a borrower's monthly mortgage payment is no more than 38% of his or her pre-tax income.  After that the government program would match the amount reduced by the lender to bring a homeowner's payments down to 31% of their pre-tax income, MarketWatch reported.

If a lender is unable to get a homeowner's payment down to 31%, it can also lower the principal owed on the mortgage and take advantage of government assistance.

As part of the initiative, servicers will receive $1,000 for each loan modification, as well as additional government funding for each month the borrower stays current on the loan. Homeowners can also receive $1,000 annually for five years as part of the program, as long as they stay current on their loan payments.

Funding of $50 billion for this part of the program will come from the Troubled Asset Relief Program (TARP) and $25 billion will come from Fannie Mae and Freddie Mac, said a Treasury official.

Overall, the Obama administration's summary of the plan said the plan could offer a buffer of as much as $6,000 against declining value on the average home.

Fight in Congress Looms Over Bankruptcy Law Changes

One controversial part of the plan is a proposed law that allows judges to rewrite the terms of a mortgage for homeowners who land in bankruptcy court - changes in law that can be made only by Congress.

Without such a law, people are being forced into foreclosure, even though they would be "potentially ... better off, and the bank would be better off, and the community would be better off, if they're at least making some payments, but they're not able to make all the payments necessary," President Obama said.

But some in the mortgage industry - and many on Wall Street - say that such a law, known as "cram down" in bankruptcy lingo, would cause the mortgage market to seize up, because investors would stop buying mortgage-backed securities out of fear a judge could unilaterally change the terms of the deal the securities were created around, MSNBC reported.

"It could significantly destabilize the marketplace," Steve O'Connor, the Mortgage Bankers' senior vice president of government affairs, told reporters.

Builders Confirm Need for Action

Meanwhile, as if to underscore the timing of Obama's plan for an ailing housing market, U.S. builders broke ground in January on the fewest number of houses on record, as housing starts plunged 17% last month to an annual rate of 466,000, Bloomberg reported.

If nothing else, the new housing program signals the Obama administration plans to take a more aggressive stance on foreclosure relief than the Bush administration, which supported voluntary efforts by the mortgage industry to ease the housing crisis.

"The problem with the build-up in inventory is coming from the increasing number of foreclosures," Nicolas Retsinas, director of Harvard University's Joint Center for Housing Studies in Cambridge, Massachusetts, said in a Bloomberg interview. "It's about time the government intervened so directly in the problem."

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