Bankruptcy Reform Not a Solution to Foreclosures, Baclays Says

by Simon Lindsay on Bankruptcy

A U.S. House bill that would authorize bankruptcy judges to modify mortgage terms is not a good solution to the foreclosure problem, according to Glenn Boyd, top securities strategist of New York City-based Barclays Capital.

Boyd said the modification would tempt borrowers who had been trying their best to maintain their mortgages to default. He also said that most of the homeowners whose mortgages were modified in 2008 had already defaulted and had lost their homes to foreclosure.

Under current Chapter 13 bankruptcy law, judges do not have the power to reduce the first mortgage debt owed on a primary residence. Under the House proposal endorsed by Democrats, judges would have authority to reduce the homeowner’s debt by ordering principal reduction and interest reduction.

The remaining balance from the original principal would be classified as unsecured. Unsecured debts could be discharged in bankruptcy proceedings.

News of bankruptcy reforms heightened last week when Citigroup Inc. endorsed the proposal, adding its own willingness to help mitigate foreclosures by helping its non-defaulting borrowers stay away from situations that would put them at risk of foreclosure. The Center for Responsible Lending also applauded the proposal, asserting that the bill would prevent the foreclosure of about 600,000 mortgage loans from 2009 to 2010.

However, the bill has not been endorsed by other banks. Worse, it has been opposed by industry groups such as the American Bankruptcy Institute and the Financial Services Roundtable. They argue that loan modifications would increase mortgage costs, as bankers would find ways to cover their increased risks.

Furthermore, according to Boyd, judge-ordered mortgage modification would encourage consumers to file for bankruptcy at the slightest indication of hardship and would increase losses by mortgage firms and credit-card lenders.

Nevertheless, Boyd is hopeful about the Federal Reserve’s decision to lower mortgage rates and acquire $500 billion worth of mortgage bonds. The action is expected to revitalize the housing market which has long been languishing in foreclosure.