Foreclosure bill faces Senate test

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NEW YORK (CNNMoney.com) -- Foreclosure gets Congress' attention Tuesday when the Senate decides whether to end debate on a bill aimed at helping homeowners avoid losing their homes.

The Foreclosure Prevention Act of 2008's most important - and most controversial - provision would allow judges to reduce mortgage balances for at-risk borrowers to current market prices.

House prices have fallen sharply during the past year, taking many mortgage borrowers "underwater," meaning they owe more than their homes are worth.

Under the bill, a mortgage balance of, for example $200,000, could be reduced to what the home would sell for, say $160,000, on the open market. That would save the borrower hundreds of dollars a month in mortgage payments.

Senate Democrats will seek to force an immediate vote on the bill, according to Jaret Seiberg, senior vice president at the Stanford Group, a Washington policy research firm.

"They need 60 votes to prevail and, right now, they're short of that goal," Seiberg wrote in an e-mail. "That means they will need to compromise to pick up GOP support."

In the Senate, the opposition coalesces around three groups, according to Jack Williams, resident scholar at the American Bankruptcy Institute: Those opposed to giving bankruptcy judges any more discretion; those who favor individual rights and responsibilities; and those aligned with lenders.

"I don't see the roadblock in the Senate breaking up," he said.

Bankruptcy courts once had more control over the process, but the lending industry worked to make it more difficult for borrowers to discharge debts. Lenders don't want new laws that will make it easier for judges to act unilaterally.

Many opposition lawmakers cite responsibility issues; for them, anyone who signs a loan contract should abide by its terms.

But most opposition stems from the possibility that mortgage bankruptcy reform will make mortgage borrowing more expensive for everyone.

The Mortgage Bankers Association claims that if judges are allowed to reduce loan balances, cutting into lenders' profits, it would introduce extra risk for lenders, which they would pass on to borrowers.

The MBA said such a situation could increase interest rates by the equivalent of 1-1/2 percentage points, which would add a couple of hundred dollars a month to a $200,000, 30-year, fixed-rate mortgage.

Community and consumer advocates counter those numbers by pointing out that no substantial premium attaches to second-home mortgages, which judges are allowed to adjust.

Despite the opposition, the bill has some momentum because it could help several hundred thousand borrowers stay in their homes at no cost to the government, according to one of its sponsors, Sen. Richard Durbin, D- Ill., .

"That's very appealing politically as the election season heats up," said Seiberg. "It is the only comprehensive solution to keep people in their homes that does not require taxpayers to foot at least a large chunk of the bill."

He pegged the odds of passage at 60%, but said Republicans may try to remove the bankruptcy reform provision.

In turn, "Democrats may still decide that it is politically more attractive to watch Republicans kill the bill than to pass a watered-down version," said Seiberg. Plus "There's a real question about whether the president (Bush) will accept a housing stimulus bill that includes mortgage bankruptcy reform."

One reason the mortgage industry opposes the bill is that, even without actually going into bankruptcy, borrowers could use it to threaten lenders reluctant to restructure mortgages.

"And, savvy borrowers may decide it is worth carrying the stigma of bankruptcy in order to cut their monthly mortgage payments," said Seiberg. "We would expect an advertising wave from consumer bankruptcy lawyers to educate and entice borrowers to look at whether they could use bankruptcy to reduce their monthly mortgage costs."

If Senate Democrats fail to achieve cloture Tuesday, it means the bill is still open to debate, and may be filibustered by Republicans. Nobody relishes that, and it may push Senate Majority Leader Harry Reid, D-Nev., to table the whole thing.

In fact, he may even cancel the cloture vote because of that, according to Williams.

The other provisions in the bill have drawn far less fire. These include:

• Allocating $200 million in addition spending for foreclosure prevention counseling;
• Allowing Housing Finance Agencies, state chartered organizations created to help home buyers find financing, to issue refinancing bonds for home owners with subprime loans;
• Authorizing communities with high foreclosure rates to use community development funds to buy vacant, foreclosed properties, rehabilitate them and resell or rent them;
• Simplifying disclosure forms so that mortgage borrowers can more easily understand their payment obligations; and
• Allowing companies that have suffered losses to use those losses to offset profits from as many as five prior years instead of the current two.

A bill with a similar mortgage-bankruptcy-reform provision is working its way through the House of Representatives. It's still pending a vote in the full House but has picked up an additional 66 co-sponsors, according to the office of Rep. Bradley Miller, D-N.C., the bill's sponsor.