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It’s official: the first domino has fallen.
The L.A. Times has reported that Citigroup Inc. has agreed that bankruptcy courts should be allowed to change the terms of mortgages, including ordering reductions in the principal amount of loans, as part of court-ordered debt restructuring for troubled borrowers. In doing so, Citigroup becomes the first major mortgage lender to buck the industry’s fierce opposition to this change in the nation’s bankruptcy laws, currently being proposed in the U.S. Congress.
Though legislators and consumer lobbying groups have been calling for this change for years, and this chorus of calls grew markedly louder during 2008, the unified opposition of the industry and Republican lawmakers (as well as a few Democrats) have thus far combined to defeat this change–even as part of the $700 billion TARP bailout bill in the fall. Their argument? That giving bankruptcy judges this power would increase the cost to future homeowners and reduce available credit. In the climate of the previous ten years, a reduction in credit to potential homeowners was considered a very bad thing.
But now the U.S. economy has experienced a reduction in credit across the board and with foreclosures skyrocketing, the focus has clearly shifted away from preserving cheap credit to providing aid to existing homeowners struggling to make their monthly payments.
Lawmakers believe that Citigroup’s acquiescence will encourage other major banks and mortgage lenders to follow suit, bringing about a logical expansion to the powers of bankruptcy judges. Indeed, Chapter 13 already allows judges to to reduce the principal balances of auto, credit card and other loans, but have been completely restricted from doing so in the mortgage context.
So why the turnabout? No, Citigroup did not suddenly find a soft spot for troubled borrowers. Instead, the current economic climate and the new administration appear to be the primarily drivers of this change in course. The Obama administration has made this reform a central part of its economic package, and legislators are eager to provide aid to its constituents clamoring for relief in the face of a housing crisis and a deepening economic downturn. Citigroup sees the writing on the wall, and likely believes its best approach is to achieve what concessions it can now, before the tide turns completely against it and its holdout becomes irrelevant. It probably doesn’t hurt that Citigroup also fears that the nice stream of income coming in from the government’s $700 billion bailout fund could dry up quickly if it continues to hold out.
The concessions Citigroup has demanded actually form the most intriguing aspect of this shift. As reported in the L.A. Times article:
Citigroup said it would support [Senator Richard] Durbin’s legislation provided that it applied only to mortgages in effect before passage of the act. To be eligible, borrowers would have to contact their lenders and try to work things out before filing for bankruptcy.The company also said it would support the proposal only if a provision was eased that would void the mortgage if the lender was found to have violated consumer protection laws.The exception would be if the lender violated specific sections of the Truth in Lending Act that already carried such rescissions of mortgages as penalties
What does this all mean? Most obviously, Citigroup wants this change in the law to be a temporary measure, available now to provide relief, but not available to any new homeowners going forward. But what about the second part–easing provisions that would void the mortgage if Citigroup was found to violate consumer protection laws? Something tells me Citigroup is aware of widespread violations of these laws on its part and is afraid that homeowners will band together to obtain rescissions of their mortgages en masse. As discussed in a prior posting here, the Seventh Circuit has recently ruled that Truth-in-Lending-Act (TILA) violations could not form the basis for class action complaints. But, that’s just one court’s take on an issue that is still open for the debate. And in this current economic and political climate, as Citigroup’s capitulation demonstrates, the tides can turn in the blink of an eye.