[NYTr] Bankruptcy reform backfires on creditors

[All the News That Doesn't Fit]

sent by Steven L. Robinson

Bloomberg - Nov 8, 2007
http://www.bloomberg.com/apps/news?pid=20601109&sid=ar909uO1CqHw

Bankruptcy Law Backfires as Foreclosures Offset Gains

By Kathleen M. Howley

Washington Mutual Inc. got what it wanted in 2005: A revised bankruptcy
code that no longer lets people walk away from credit card bills.

The largest U.S. savings and loan didn't count on a housing recession.
The new bankruptcy laws are helping drive foreclosures to a record as
homeowners default on mortgages and struggle to pay credit card debts
that might have been wiped out under the old code, said Jay Westbrook,
a professor of business law at the University of Texas Law School in
Austin and a former adviser to the International Monetary Fund and the
World Bank.

``Be careful what you wish for,'' Westbrook said. ``They wanted to make
sure that people kept paying their credit cards, and what they're
getting is more foreclosures.''

Washington Mutual, Bank of America Corp., JPMorgan Chase & Co. and
Citigroup Inc. spent $25 million in 2004 and 2005 lobbying for a
legislative agenda that included changes in bankruptcy laws to protect
credit card profits, according to the Center for Responsive Politics, a
non-partisan Washington group that tracks political donations.

The banks are still paying for that decision. The surge in foreclosures
has cut the value of securities backed by mortgages and led to more
than $40 billion of writedowns for U.S. financial institutions. It also
reached to the top echelons of the financial services industry.

Prince Exits

Citigroup Chief Executive Officer Charles O. ``Chuck'' Prince III
stepped down this week after the country's biggest bank by assets said
it may have $11 billion of writedowns on top of more than $6 billion in
the third quarter. Stan O'Neal was ousted as CEO of Merrill Lynch &
Co., the world's largest brokerage, after an $8.4 billion writedown.
Both firms are based in New York.

Morgan Stanley, the second-biggest securities firm, said in a statement
today that subprime losses will cut fourth-quarter earnings by $2.5
billion. The New York-based bank said it lost $3.7 billion in the two
months through Oct. 31 as prices for securities linked with home loans
to risky borrowers sank further than traders expected.

Even as losses have mounted, banks have seen their credit card
businesses improve. The amount of money owed on U.S. credit cards with
payments more than 30 days late fell to $7.04 billion in the second
quarter from $8.37 billion two years earlier, according to data
compiled by Federal Deposit Insurance Corp.

In the same period, the dollar volume of repossessed homes owned by
insured banks doubled to $4.2 billion, the federal agency said. New
foreclosures rose to a record in the second quarter, led by defaults in
subprime adjustable-rate mortgages, according to the Mortgage Bankers
Association in Washington.

`Let the House Go'

People are putting their credit card payments ahead of their mortgages,
said Richard Fairbank, chief executive officer of Capital One Financial
Corp., the largest independent U.S. credit card issuer. Of customers
who are at least three months late on their mortgage payments, 70
percent are current on their credit cards, he said.

``What we conclude is that people are saying, `Honey, let the house
go,''' but keep the cards, Fairbank said Nov. 5 at a conference in New
York sponsored by Lehman Brothers Holdings Inc.

The new bankruptcy code makes it harder for debtors to qualify for
Chapter 7, the section that erases non-mortgage debt. It shifted people
who get paychecks higher than the median income for their area to
Chapter 13, giving them up to five years to pay off non-housing
creditors.

No Help Left

The court-ordered payment plans fail to account for subprime loans with
adjustable rates that can reset as often as every six months, said Henry
Sommer, president of the National Association of Consumer Bankruptcy
Attorneys. Two-thirds of debtors won't be able to complete their payback
plans, according to the Center for Responsible Lending.

``We have people walking away from homes because they can't afford them
even post bankruptcy,'' said Sommer, a Philadelphia- based bankruptcy
attorney. ``Their mortgage rates are resetting at levels that are
completely unaffordable, and there's nothing the bankruptcy process can
do for them as it now stands.''

Four million subprime borrowers with limited or tainted credit histories
will see their mortgage bills increase by an average 40 percent in the
next 18 months, according to the National Association of Consumer
Advocates in Washington. About 1.45 million of those will end up in
foreclosure by the end of 2008, said Mark Zandi, chief economist at
Moody's Economy.com, a research firm and unit of Moody's Corp. in New
York.

Lenders began the process of seizing properties on 0.65 percent of U.S.
mortgages in the second quarter, a record in a quarterly Mortgage
Bankers study that goes back 35 years. The percentage of subprime
borrowers making late payments increased to 14.82, a five-year high,
from 13.77.

Bankruptcies Increase

Personal bankruptcies rose 48 percent to 391,105 in the first half of
2007 from a year earlier and Chapter 13 filings accounted for more than
one-third of those, according to the American Bankruptcy Institute. In
the first half of 2005, they were just 24 percent of the total.

Bad mortgages slashed Washington Mutual's profit by 72 percent in the
third quarter from a year earlier, the Seattle-based thrift said Oct.
17. Income from credit card interest rose 8.8 percent to $689 million
in the period, helping to offset a loss the bank warned on Oct. 5 would
be 75 percent.

Washington Mutual shares tumbled the most in 20 years yesterday after
New York Attorney General Andrew Cuomo said the thrift had pressured
real estate appraisers to assign inflated values to properties. Its
dividend yield fell to 11 percent and the company traded at 0.74
price-to-book value.

Citigroup's third-quarter earnings fell 57 percent on mortgage losses.
Bank of America stopped so-called warehouse lending to mortgage brokers
after its profit declined 32 percent in the same period.

`Unintended Consequence'

JPMorgan reported profit growth of 2.3 percent in the quarter, the
smallest in more than two years, after reducing the value of leveraged
loans and collateralized debt obligations, investment packages of
mortgages, by $1.64 billion.

Washington Mutual spokeswoman Libby Hutchinson in Seattle, JPMorgan
spokesman Thomas Kelly in New York and Bank of America spokesman Terry
Francisco in Charlotte, North Carolina, declined to comment on the
bankruptcy law.

``The law had an unintended consequence of taking away a relief valve
that mortgage borrowers used to have,'' said Rod Dubitsky, head of
asset-backed research for Credit Suisse Holdings USA Inc. in New York.
``It's bad for the mortgage borrowers and bad for subprime investors
because it means more losses.''

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was
the biggest overhaul to the code in more than a quarter of a century.
The old law, the Bankruptcy Reform Act of 1978 that was signed by
President Jimmy Carter, had loosened requirements for debt forgiveness.

Lobbying Effort

Financial companies began a coordinated lobbying campaign for bankruptcy
reform in 1998 when the American Financial Services Association, a trade
group representing credit card companies, joined the American Bankers
Association to form the National Consumer Bankruptcy Coalition.

Campaign contributions from the coalition and its members totaled more
than $8.2 million during the 2004 election that gave Bush his second
term in office. Two-thirds of the donations were given to Republicans
who supported the bankruptcy changes, according to the Center for
Responsive Politics.

The group, later renamed the Coalition for Responsible Bankruptcy Laws,
has since disbanded. Its members included Washington Mutual, JPMorgan,
Bank of America, Citigroup, MasterCard Inc., and Morgan Stanley.

Ford Motor Co., General Motors and DaimlerChrysler also were members.
They won provisions in the new code that changed the way car loans are
treated in bankruptcy.

Reform the Reform

Congress may soon take action to ``reform the bankruptcy reform,'' Zandi
said. The House Judiciary Committee is working on legislation to let
bankruptcy judges restructure home loans by lowering interest rates and
reducing mortgage balances to reflect current market value.

Banks including Washington Mutual, Citigroup and Wells Fargo & Co. sent
a letter to the committee opposing the change, saying such
restructurings should be done privately.

Countrywide Financial Corp., the largest U.S. lender, said last month
that it will modify $16 billion worth of adjustable-rate mortgages.
Washington Mutual said in April that it will spend $2 billion giving
discounted rates to help customers with subprime loans refinance at
better terms.

So far, most lenders have been reluctant to change loan agreements.
About 1 percent of mortgages that reset in January, April and July were
modified, according to a Sept. 21 Moody's Investors Service report that
surveyed 16 subprime lenders that account for 80 percent of the market.

Congress probably will approve at least a limited measure to permit loan
modifications, said Westbrook, the University of Texas law professor.

``They are going to have to figure out some way to address the
problem,'' Westbrook said. ``I don't think our economy or our
consciences can handle the number of foreclosures we'll see if they do
nothing.''