A New Bankruptcy Status For Stressed Homeowners?

Concerns about lien-holder rights are prompting bond manager BlackRock to advance a proposal that would create a new bankruptcy chapter to help those struggling homeowners in the market today who are falling behind on their mortgage payments.

This new chapter would give bankruptcy judges the authority to reduce the underwater homeowner's debt load, including credit card and home equity debt before the first mortgage is modified, according to BlackRock vice chairman Barbara Novick.

"Why not write a new chapter of the bankruptcy code specifically for the 'Great Recession' to deal with the large number of distressed homeowners?" Ms. Novick said in an interview.

The BlackRock executive is well aware of the mortgage industry's opposition to modifying mortgages in bankruptcy and its success in defeating "cramdown" legislation in 2009.

However, the BlackRock proposal would not give bankruptcy judges wide-ranging authority to reduce or cram down the principal amount of a mortgage to current fair market value. Instead, Congress could establish clear guidelines or formulas for bankruptcy judges to reduce the homeowner's total debt-to-income ratio to a reasonable level so they can afford to make their mortgage and service other debt.

Ms. Novick, who chairs BlackRock's government relations steering committee, is trying to start a dialogue with Obama administration officials and lawmakers to consider better ways for restructuring homeowner debt than the government's Home Affordable Modification Program.

"The problem with HAMP modifications," she said, is it generally reduces the borrower's lowest-cost debt (the first mortgage), but not their highest-cost debt: credit card, auto and home equity loans.

It also turns creditor rights upside down and forces first-lien holders to indirectly subsidize banks and other investors that own seconds and credit card receivables.

The HAMP approach is "basically creating enormous losses for both Fannie Mae and Freddie Mac, even though they are in a first-lien position," Ms. Novick told Mortgage Servicing News.

With a HAMP modification, homeowners wind up with a less costly mortgage payment, but still labor under more debt than they can afford, which increases their chances of redefault. In many cases, HAMP modifications only delays foreclosure, she said.

Data collected by federal banking regulators show that first-lien modifications (where monthly mortgage payments are reduced by 20% or more) still have a 38% redefault rate after 12 months.

"There are a fair number of people questioning whether or not HAMP works," said Ms. Novick said, noting that it has opened a window for a "constructive dialogue about a potential solution."

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