When President Barack Obama signs credit card reform legislation -- which should happen any day now -- that will be a great day for consumers. The legislation represents the first significant upgrade to American consumer rights in a long time. The bill has some real teeth -- it's much stronger than the original bill that's been floating around the House of Representatives for more than a year. Clearly, the president threw all his political power behind the effort to rein in abusive credit card practices, delivering speech after speech imploring changes and even calling issuers to the White House for a stern reality check.
Too bad the president is backing the wrong horse.
While $39 over-limit fees are hideously unfair and deserving of legislative attention, the number that really needs attention is 649,917 -- the number of U.S. homes that entered foreclosure last quarter.
Credit card debt is not the most serious problem facing America today. Empty houses are. Sneaky late fees and arbitrary interest rate hikes are terrible -- but foreclosures and homeowners who are severely under water carry exponentially higher consequences. For now, however, the Obama administration has decided to take the road more traveled. It has taken up the populist cause of credit card reform while abandoning dramatic mortgage market reform that Obama promised in October and again in February.
I cheer the credit card bill, and frequent readers of this column know I have been urging those changes for many years. I don't lightly surrender credit card issues as a top priority. But last week, Obama quietly watched as efforts to give struggling homeowners help in bankruptcy court died a legislative death. That was a mistake.
How did it happen? Ask Illinois Sen. Dick Durbin, the Democrat who first introduced Obama to the United States at the 2004 Democratic convention.
"And the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place," he told a Chicago radio station recently.
Durbin is the Senate's bankruptcy reform champion. His proposal to allow mortgage rewriting by bankruptcy judges was voted down 51-45 in the Senate, with 12 Democrats joining all Republicans in stopping the effort. While those 12 senators -- including Arlen Specter of Pennsylvania, Max Baucus of Montana and Tim Johnson of South Dakota-- were the direct reason the legislation died, Obama offered no help. In stark contrast to his aggressive public stance on credit card reform, Obama was silent on mortgage/bankruptcy reform.
'A side show compared to the mortgage issue'
Adam Levitan, a Georgetown professor and bankruptcy expert, was disappointed that the administration chose to champion bank credit card reform over bankruptcy reform.
"Obama put his personal prestige on the line for the credit card issue ... and the shame of it is, while I support the credit card legislation, it's just not that important," he said. "It's a side show compared to the mortgage issue. But politically it's an easier sell."
Why is bankruptcy reform so important? Currently, consumers who declare Chapter 13 bankruptcy -- the kind where debtors repay their loans but get extra time and some debt relief -- find themselves before a federal judge who gathers all the debt-holders into a room and forges a compromise payment plan. Credit card firms, personal loan holders -- everybody takes a hit, based on what the debtor can realistically pay.
But currently, primary mortgages are exempt from the process. There's no way to reduce a mortgage loan in bankruptcy. Mind you, mortgages on second homes can be reduced. So can loans for cars, boats investment properties, etc. Primary mortgages stand alone, outside bankruptcy courts.
Naturally, the banking industry likes things this way and has been fighting to keep primary mortgages out of bankruptcy proceedings.
The issue has rankled consumer advocates for decades, but it took front and center as the number of U.S. foreclosures skyrocketed in 2008. Bankruptcy mortgage reductions – known by the pejorative term "cram downs" by the banking industry -- could help 1.7 million consumers avoid foreclosure, according to the Center for Responsible Lending. The mere possibility of a cram down also provides motivation for banks to work with consumers on voluntary modifications, because the bank might lose more in a bankruptcy filing.
In October, when Wall Street banks went looking for a $700 billion bailout from the U.S. Treasury, consumer advocates tried to seize the moment and exact bankruptcy reform in exchange for bailout money. At the time Obama said the bailout bill was so urgent that it shouldn't be bogged down with the potentially contentious bankruptcy provision. He repeatedly said he supported the change, however, and that it would come. He repeated that promise in February, after taking office, when the administration sketched out its housing rescue plans.
But when bankruptcy reform died in the Senate, Obama was silent.
Levitan, the Georgetown professor, said Obama's failure to go to bat for bankruptcy cause could doom the administration's other efforts to help troubled homeowners. So far, the administration has decided to rely on voluntarily mortgage modifications from banks, augmented by incentives from the government in the form of direct payments to banks that complete modifications. (See my colleague John Schoen's overview of the plan.)
"It's quite bad for consumers," Levitan said."The Obama plan was designed as a combination of carrot and stick. We are now left with only carrot and no stick. In some ways, it's the worst of all worlds."
Most consumer agencies, excited to have someone from "their team" in the White House, aren't making much noise about the bankruptcy issue. After years of feeling ignored, they are thrilled to get movement on the credit card issue. In fact, one consumer advocate I spoke to said she believed that Obama's abandonment of the bankruptcy reform was part of a strategy -- banks couldn't swallow both credit card and mortgage changes at the same time, she speculated, so he went with the easiest step first and plans to take on the harder issue later. I hope she's right.
Levitan thinks changes in bankruptcy law might still be in the cards, but he interprets the events of the past few weeks differently. The current administration, he says, is hoping to "muddle through" the housing crisis without making substantial changes to the mortgage market.
"If an acute crisis can be avoided, they'll settle for that," he said. "The Obama plan was never super aggressive. It was always a mitigation plan not a solution."
Good, but tepid, market reforms
Additional housing market reforms that are being discussed in three separate congressional bills involve important, but minor technical changes to the market. A House bill would prevent mortgage originators from selling off all their loans to investors, which would force them to keep "skin in the game," and provide an incentive to more carefully screen applicants. Lenders would have to keep at least 5 percent of their loans on the books, according to the bill's provisions. Part of the mortgage meltdown was blamed on originators dumping all their loans on under-informed investors, giving originators no incentive to avoid making bad loans.
This "skin in the game" provision won't work, however, if lenders are allowed to insure themselves against losses in these loans.
The same bill, the Mortgage Reform and Anti-Predatory Lending Act, would ban many kinds of early-payment penalties and prohibit lenders from steering consumers into higher-cost loans when they could qualify for cheaper loans. The penalty provisions are weak though: Lenders would have 90 days to act after receiving consumer complaints, allowing banks to have what is sometimes called a "first bite at the apple." The most profitable strategy for a bank would be to mistreat all customers, then modify loans for the few consumers who noticed and complained.
Kathleen Day, spokeswoman for the Center for Responsible Lending, says the legislation isn't perfect, but it's a good start.
"We wish it were stronger, but it's much better than the (legislation proposed last fall)," she said. "At its core, this legislation provides that mortgage lenders may only make mortgages that a consumer can afford to repay."
The legislation, which is still working its way through Congress along with two other similar bills, will help many future homebuyers. So will a new HUD-1 form, the key document consumers sign at mortgage closings, which take effect in place Jan. 1 The new form more clearly explains fees and other costs to purchasers.
its their core, these mortgage reform efforts aren't designed to help struggling borrowers much. They are left with the carrot-but-no-stick plan mortgage rescue plan. So far little has been done to slow the national foreclosure rate, which doubled in the first quarter of this year, compared to last year. And it does nothing to help the one in five homeowners who live in a building that's not worth their mortgage.
Perhaps Obama and his economic advisers have changed their mind on bankruptcy modification since his promises in October and February. There is a legitimate debate to be had about the bankruptcy option. Banks argue that allowing mortgage loans into bankruptcy would raise the cost of all mortgages and dramatically change the nature of contracts between consumers and banks. Perhaps the administration now sees this issue the banks' way. If so, Obama's supporters, and consumers sitting in under-water homes, deserve an explanation. Perhaps during all the predictable celebration and back-slapping about credit card reform, Obama could take a moment to address the empty home problem.
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