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Congress Plays Principal Modification Roundabout

by Chicago Agent

Congress is taking another stab at rewriting the bankruptcy code, after failing in 2009.

The principal modification just earned a new player in the form of Earl Blumenauer, a Democratic congressman from Oregon who is backing a bill that would allow bankruptcy judges to force write downs on loans during bankruptcy proceedings.

The Bankruptcy Equity Act, as the bill is called, would amend bankruptcy laws and allow judges to modify mortgages to avoid foreclosures.

In a statement about the bill, Blumenauer said his legislation would simply extend to regular homeowners the same privileges that luxury clients already receive.

“People with vacation homes or investment properties can have their mortgage terms reduced by a bankruptcy judge, but regular folks who live in their own homes are forced to play by different rules — bankruptcy judges aren’t allowed to change mortgage terms of primary residences,” Blumenauer stated, according to a HousingWire story on the bill.

Blumenauer also said in an appearance on Capitol Hill that regular homeowners are unable to declare bankruptcy and receive mortgage relief, a privilege that owners of multiple homes are allowed; instead, homeowners are often left with foreclosure as their only option.

As with all legislation, though, there are also some concerning elements to Blumenauer’s bill, as Peter Moulton, a managing broker in the North Shore for @properties, explained.

Moulton said such a policy would have both short and long-term indications for the mortgage markets. Though the bill could be beneficial to consumers in the short term, Moulton said it could also create “considerable cost” to consumers in the long term, as more and more underwater homeowners entered bankruptcy proceedings to have principal reductions applied to their mortgages.

Without a specific framework that establishes how judges could order and manage reductions, Moulton said the legislation would “open the floodgates” on reductions, and banks, in response to the lost revenue on the reduced loans, would pass those costs on to consumers in the form of higher interest rates and other costly measures.

The bill is still in its infant stages, but it represents yet another attempt by the government to work around the Federal Housing Finance Agency’s efforts to prevent a government-led principal reduction program. For months, now, the FHFA has refused to even consider write downs as an effective response to the foreclosure crisis, a resistance that has led some legislators to attempt a coup, of sorts, and replace the agency’s acting director.

The progress of the bill will be interesting to chart, especially considering that it is not the first time Congress has attempted to amend the nation’s bankruptcy laws. Nearly three years ago, Illinois Senator Dick Durbin attempted to insert a similar measure in a Senate bankruptcy bill, and, when faced with severe opposition from both banking lobbies and Republican lawmakers, made one of the more oft-quoted proclamations of 2009.

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