Bankruptcy tweak can ease subprime woes, lawmakers told

By Patrick Rucker

WASHINGTON (Reuters) - A former U.S. housing secretary on Tuesday urged allowing bankruptcy judges to erase some mortgage debt, saying it would save several hundred thousand borrowers from foreclosure as a nationwide housing crisis tightens its grip.

Under current law, bankruptcy judges may restructure most loans, from credit cards to car payments, but they may not tinker with a troubled consumer's mortgage debt.

Jack Kemp, a Republican who once headed the federal Department of Housing and Urban Development, said reform could save as many as 600,000 borrowers from foreclosure and prevent $72.5 billion of homeowner wealth from being lost.

"This bill will have more impact on these home-owning families than any other option currently on the table," he told a panel of the House Judiciary Committee.

In the past, Kemp said the plan amounts to a tweaking of current bankruptcy law.

Lenders say the home loan exemption keeps those borrowing costs low. But in addition to Kemp, an economist and several consumer groups argued that today's crisis requires a change of policy, and they endorsed a bill that would give bankruptcy judges more leeway.

Congress and policy-makers have taken several initiatives to arrest an unfolding crisis of failing mortgages and sinking home values in many once-hot housing markets.

The White House has expanded some federal housing programs and the U.S. Treasury Department has midwifed an industry-led program called HOPE NOW that aims to adjust the loan terms for many troubled borrowers. Lawmakers have weighed in by offering changes to tax law that could ease the cost of failing loans.

On Tuesday, the House of Representatives overwhelmingly passed an economic stimulus bill that lawmakers negotiated with the White House that would expand the reach of the Federal Housing Administration and mortgage finance companies Fannie Mae and Freddie Mac.

The Judiciary Committee's top Republican said lawmakers should hold off on tinkering with the federal bankruptcy code until they see whether existing measures are enough to ease the crisis.

It would be best to "allow time for these measures to work before considering the dramatic step of rewriting key, long-standing terms of the bankruptcy code," said Rep. Lamar Smith of Texas.

Lenders have warned that giving bankruptcy judges the power to alter mortgage terms would create such uncertainty that it would inevitably increase borrowing costs.

In a brief to the committee, the American Bankers Association argued that the measure would also create a perverse incentive for borrowers to file for bankruptcy.

While the Judiciary Committee has already passed its version of bankruptcy reform, it has not yet been debated in the full House of Representatives. The Senate has not taken up the measure in earnest.

In his statement, Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania, endorsed the reform as a fitting step to help stem the 2 million foreclosures he predicts for this year and next.

But David Kittle, chairman-elect of the Mortgage Bankers Association, said prospective homebuyers would end up paying for such a move because lenders would charge higher interest rates to protect against the risk of a bankruptcy judge invalidating a mortgage.