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October 08, 2007

Debt Slave Act of 2005 Revisited
by Mike Shedlock

It's time to review the inappropriately named Bankruptcy Reform Act of 2005. It really should be called the Debt Slave Act of 2005. The bill stops short of imprisonment for failure to repay debts, but provisions of the bill seem eerily reminiscent of the Tennessee Ernie Ford song "Sixteen Tons".

With that backdrop, I see that a consumer advocacy group thinks a Bankruptcy 'tweak' could save 600,000 homes.

One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code. The Center for Responsible Lending (CRL) calls it a tweak, but it could be a significant change for homeowners and the market for mortgage-backed securities. CRL's proposal - reflected in a House bill recently introduced - would make changes to the regulations for Chapter 13 bankruptcies, which don't wipe out debts, but rather establish a repayment plan.

Under current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person's primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner's property is worth less than what he owes. The judge could reduce the principal to match the home's current market value as well as reduce the loan's interest rate.

Steve Bartlett, president and CEO of the Financial Services Roundtable, contends the ultimate price would be paid by consumers. "If enacted, [the House bill] could have a de-stabilizing effect on the mortgage markets, which are now begging to stabilize," Bartlett told a House Judiciary subcommittee.

Funding for the mortgage-debt market would dry up, and consumers would pay the ultimate price, he said. "This will force mortgage lenders to charge much higher interest rates for all types of mortgage loans. This will dry up credit for any American who cannot afford these higher interest rates."

The Center for Responsible Lending (CRL) is pulling out all the stops to prevent foreclosure. So is Congress and Countrywide financial. See Mortgage Forgiveness Act - The Seen and Unseen and Countrywide: Mortgage Restructure Free-For-All?

The latest drumming the benefits of foreclosure prevention is the FDIC.

Plea To Freeze ARMS Rates

The FDIC is stepping up the foreclosure prevention silliness with an October 5th plea to Freeze ARM Rates.

The heat on U.S. mortgage lenders and servicers was turned up a few degrees this week when the country's chief bank regulator publicly proposed that they permanently freeze interest rates on subprime adjustable-rate mortgages (ARMs) for many homeowners.

"Keep it at the starter rate. Convert it into a fixed rate. Make it permanent. And get on with it," Federal Deposit Insurance Corp. Chairman Sheila Bair said in prepared remarks at an investor's conference.

Roughly 1.3 million subprime ARMs are due for a rate reset between now and the end of 2008, according to data from First American Loan Performance.

"We can't just sit here doing this kind of case-by-case, laborious restructuring process with all these millions of subprime hybrid ARMs," Bair said, citing a recent Moody's survey, which found that less than 1 percent of problem subprime ARMs were being restructured.

"[Bair's recommendation] is exactly what's needed," said Michael Shea, executive director of ACORN Housing, which has offices around the country where counselors have been working with troubled homeowners to renegotiate their subprime mortgages with servicers.

Mortgage servicers - those that administer and collect payments on the loans - may be restricted by the terms of their pool servicing agreements (PSAs), which are their contracts with the investors who own the loans being serviced. Those contracts may specify when and how many loans may be modified.

But the servicer typically does have discretion when a loan has become or is likely to become delinquent. And investors are unlikely to object if the servicer can make the case why a modification will lose less money than a foreclosure, said William Rinehart, vice president and chief risk officer of Ocwen, a loan servicer that administers 470,000 loans.

And in many instances, foreclosures can create bigger losses for investors. "[E]ffective restructuring can preserve credit support [and] reduce credit losses," Bair told the investor conference.

If servicers acted on Bair's suggestion verbatim, "you'd likely have a backlash, particularly from your senior investors," said Larry Litton, president of Litton Loan Servicing, which has been proactive about contacting borrowers before their rates reset and modifying their loans in instances where a rate reset would make the home unaffordable for them.

The message Litton thinks the industry will take away from Bair's proposal is "you have to do a better job of fixing loans that are fixable. And if you don't do it, someone else will do it for you," he said, noting, for instance, that a proposal on the Hill to let bankruptcy judges reduce the mortgages of borrowers filing for Chapter 13 would not go over big with the industry.

Price Fixing & Government Central Planning

The proposal to cap the Rate of ARMs is no different than long failed Russian central planners attempts to fix prices, President Nixon's foolish wage and price control mandates, the Fed's irrational insistence that it can "control" prices, or China's recent attempt to rein in price hikes by decree.

See Can the Fed control prices? for more on the Fed's attempt to control prices.
See Price Stability & Top Secret Missions for more on doomed to fail measures in China.

It should not take a genius to figure out that if ARMs rates are "frozen" at a point where the market does not think rates should be, there simply will be no more ARMs offered. Furthermore, to cover the cost of existing ARMS, prices would rise on new fixed rate mortgages. Oddly enough, price fixing ARMs would not even help the person most at risk because that person cannot afford the teaser rate, let alone the cost of a current ARMS rate. Thus price fixing ARMs is a sure fired guaranteed way to cause a continued weakness in home prices, if not an actual out and out crash.

It's really hard to believe the FDIC is that incompetent. However, the alternative is to believe the FDIC is involved in a conspiracy to cause home prices to crash. So which is it?

Those On The Bubble

Is anyone really looking out for the best interest of the consumer? From where I sit, a person $50,000 in the hole on their mortgage and holding month to month credit card obligations may be far better off financially throwing in the towel than working out a payment plan.

How long would it take to pay back that $50,000 just to get even? For some it might be 5 years, for others 10 years and for others never. It all depends on what home prices do in the meantime. Even giving the benefit of the doubt to home price stabilization, it is a tough row to hoe. If bankruptcy is looming anyway, additional payments are a huge waste of capital.

Who Benefits?

There is a huge misguided theory that suggests everyone benefits if home prices head back up. I disagree. Everyone does not benefit. In addition, those who do benefit do not benefit equally.

Rising home prices from this level will bail out some fraudulent lenders, fraudulent appraisers, irresponsible borrowers, and irresponsible lenders at the expense of responsible borrowers and people on fixed income who see property taxes rise and with no means to pay the increases.

To date, Bernanke has been willing to bail out his banking buddies at the expense of the dollar. But it has not affected mortgage rates so far. (See September Jobs - Crisis Averted?)

Sooner or later it is going to dawn on many who bought homes recently, as well as many who are unexpectedly thrown into unemployment form the economic disaster that is shaping up, to simply walk away.

Three Ways the Debt Slave Act of 2005 Will Fail

• Unemployment has bottomed. It has nowhere to go but up. Anyone losing a job will flunk the means test. Therefore lenders willing to make loans to poor risks will regret it sooner or later.
• Anyone with a job, looking at the fundamentals of debt enslavement, just might manage to lose that job on purpose.
• Many who do survive the system will strive to never run up a credit card balance again.

When the Fed, Congress, the FDIC, Countrywide Financial (CFC), consumer advocacy groups, and banks like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are all acting to prevent "something" from happening, the logical conclusion is because it is in the best interest of the lenders for that "something" not to happen. The "something" in this case is foreclosure.

Sooner or later, those on the edge are going to realize that what everyone the above collective group wants (debt slavery), just might not be in their best interest. As more and more legislation is enacted (and silly ideas proposed) to prevent foreclosures, the greater the likelihood that people find a way around the measures.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Michael "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.

Copyright © 2005-2008 Mike Shedlock

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