Consumers need a new type of bankruptcy that would better aid homeowners and be fairer for mortgage bond investors than the Obama administration's loan-modification program, BlackRock Inc. Vice Chairman Barbara Novick said.
BlackRock, the world's largest asset manager, proposes creating a bankruptcy option under which terms of a consumer's mortgage can be eased, though only after other debts are eliminated, Novick said in an interview. Judges would need to follow a formulaic approach, she said.
"There's Chapter 7, Chapter 11, Chapter 13 — we need a special chapter for the Great Recession," Novick said.
Under existing bankruptcy rules, judges cannot alter terms on mortgages on primary residences, though they can change those on vacation homes or investment properties. Since 2007, lawmakers have several times considered so-called cramdown legislation that would give the court power to lengthen mortgage terms, cut interest rates and reduce balances.
BlackRock's idea would differ from lawmakers' proposals in part because it would address concern that judges have "a huge amount of leeway" deciding how to rework debt, she said.
The New York company's plan would also allow reduction of mortgage size if it would make homeowner payments affordable, rather than address so-called negative equity that leads borrowers to walk away from the debt, Novick said.
"There is tremendous moral hazard in just writing off the loan and telling consumers not to worry" about bad decisions, she said.
The proposal follows complaints about the Obama administration's $75 billion Home Affordable Modification Program by mortgage bond investors, Pacific Investment Management Co. and Fortress Investment Group.
Bondholders have objected to plan provisions leaving borrowers' home equity loans unchanged or outstanding while easing mortgage terms, boosting the odds homeowners will default later and benefiting banks at the expense of securities investors.
"Clearly, something that addresses the first mortgages without addressing the home equity is beneficial to those with lower-ranking debt," Novick said. "I'm not sure whether it's deliberate or inadvertent, but that's the impact" of an approach that's unfair to mortgage bond investors and "not really helping consumers: You're just extending what are not viable situations."
The Treasury Department has been "moving forward" on a program announced eight months ago in which home equity debt would be reworked or retired as first mortgages are changed, Meg Reilly, a spokeswoman, said by e-mail. "We expect to begin finalizing participation contracts in the very near future," she wrote. "The administration does not have a position on the idea you describe, nor" does it support or oppose the bankruptcy change lawmakers have proposed.
The House rejected a proposal last month to add a cramdown amendment to a broader financial-overhaul bill that passed. The provision was identical to legislation that passed the House in March but then failed in the Senate amid banking industry opposition.
The current treatment of junior-ranking home equity debt may do more to undermine the confidence of investors in the mortgage bond market, making financing more costly for borrowers in the future when private sources of capital are needed to replace government-backed loans now accounting for almost all new debt, Novick said.
