Banking lobby tries new argument to derail bankruptcy bill language

Banking lobbyists are telling wavering lawmakers that the economy will probably dodge a full-blown foreclosure crisis, a controversial argument intended to help defeat a measure aimed at helping troubled homeowners to shrink their mortgage debts.

The banking lobby argues that plunging short-term interest rates will prevent sub-prime borrowers from seeing their mortgage payments soar.

{mosads}Because of these falling rates, the need for drastic intervention by Congress — namely, legislation to allow bankruptcy judges to rewrite the terms of mortgages for some borrowers — has faded, they argue.

“This is no silver bullet,” said Francis Creighton, a lobbyist for the Mortgage Bankers Association. “[But] that specific problem that this bankruptcy bill was meant to address basically is being fixed.”

The legislation at issue, which Republicans are attempting to block in the Senate, would apply only to sub-prime or non-traditional mortgages that exist before the law is enacted. The banking lobby’s main argument against the measure is that allowing judges to rewrite the terms of home loans for borrowers facing foreclosure would raise the cost of mortgages for everyone.

But the industry is also trying to ease fears about a foreclosure meltdown, a strategy that carries risks. A Senate GOP aide who is working alongside banking lobbyists to defeat the legislation cringed at the tactic, citing a number of stronger arguments the industry has in its arsenal.

“I hesitate to go that far, and I wish they hesitated too,” the aide said. “I never like to go ahead and set expectations that we’re out of a hole just yet.”

Most hybrid adjustable-rate mortgages (ARMs), which were commonly sold to borrowers with shaky credit during the housing boom, are tied to the London Interbank Offered Rate, or LIBOR. After borrowers pay a fixed rate for a set period, often as long as four years, the mortgage switches to LIBOR plus a preset margin.

As the Federal Reserve has slashed its key short-term rate, LIBOR also has fallen. It is hovering around 3 percent now, down from about 5.4 percent for most of last year.

Banking lobbyists aren’t the only ones who see this as a promising sign. Federal Reserve Gov. Randall Kroszner earlier this month told an audience that falling LIBOR rates were “fortunately reducing the payment shock” that many borrowers would have to face in the coming months.

However, critics dispute whether the lower LIBOR rate will avert a staggering number of foreclosures this year. They say that factors other than interest rates, such as plunging home values, portend a deepening crisis.

“There’s some truth in it,” allowed Eric Stein, the top lobbyist for the Center for Responsible Lending (CRL), a backer of the bankruptcy legislation. But the argument is  “a little ironic,” he added, since low rates caused the housing bubble that precipitated today’s record foreclosures. {mospagebreak}

Independent analysts are still issuing grim predictions, despite the falling LIBOR rates. All told, 2 million homes will be foreclosed upon from the beginning of 2007 to the middle of 2009, Moody’s Economy.com predicted recently.

“Yes, payment-reset shock is going to be smaller. But there is a bunch of people who are not going to afford it,” said Gus Faucher, the director of macroeconomic forecasting at Moody’s Economy.com. He added that the foreclosure estimate already factors in the falling rates.

{mosads}According to CRL, between $15 billion and $20 billion in sub-prime mortgages will reset at higher rates every month in 2008. But there is a host of other factors conspiring against borrowers, Stein argued.  

As the housing bubble has burst, many homeowners have found themselves underwater, with their home worth less than their mortgage. In cases where homeowners have little or no equity, they will be forced to put up large sums of cash to sell their homes, increasing the risk of foreclosures.

Also, borrowers with so-called option-ARMs, which require interest-only payments for a set period, will face more than just higher rates: They will have to start paying down the principal on their mortgages.

Meanwhile, people with so-called Alt-A loans — aimed at a category of borrowers in between sub-prime and prime — may not be helped much by falling rates because the loans granted wide leeway in interest payments for a set period.

Those loans will start to reset at floating rates in 2009, on the heels of this year’s sub-prime resets. “It’s a five-year phenomenon. It’s not short-lived,” Stein warned.

Finally, there is no guarantee that LIBOR rates will stay low or fall further. In testimony Wednesday before the House Financial Services panel, Federal Reserve Chairman Ben Bernanke signaled that he would ease the Fed’s key interest rate more despite quickening inflation.

But if inflation continues to pick up, the Fed may need to reverse course, which would ripple through to LIBOR. Said Faucher, “We’ve probably seen most of the big declines in LIBOR rates.”