WASHINGTON — Congress faces a host of daunting challenges next year, from restructuring the financial regulatory system to creating new mortgage underwriting standards.
But its first priority is likely to be unfinished business from 2008: preventing home foreclosures.
Though lawmakers enacted a major bill designed to do just that, and federal regulators have talked about doing more, little has stemmed the tide of foreclosures, which could reach 10 million over the next five years.
Democratic leaders — with wider majorities on both sides of Capitol Hill and control of the White House — are expected to press for systematic loan modifications and a bill that would allow judges to rework mortgages in the bankruptcy process. Though there have been similar efforts before, lawmakers said they expect quick action next year.
"President-elect Obama has said that he is very much supportive and interested in getting loan modifications done and indicated that the bailout should have done that," Rep. Maxine Waters said in an interview. "That is high on my agenda and I think high on the agenda of a lot of legislators who are just caught without being able to help their constituents who are in these home foreclosure problems."
Rep. Waters was one of many lawmakers who had expected the current administration to deal with the issue using the $700 billion Troubled Asset Relief Program. Despite requirements in the Oct. 3 legislation that the program offer its own foreclosure mitigation plan, however, it has not yet done so. The incoming administration is expected to quickly offer its own plan.
"The single biggest issue is going to be loan modifications," said Laurence Platt, a partner at the law firm K&L Gates. "They are going to throw the kitchen sink at it."
(This article is the first of three on the 2009 legislative outlook for the financial services sector. Future articles will examine efforts to restructure the regulatory system, dictate new mortgage underwriting standards, and rein in the credit card industry.)
The incoming administration has already said foreclosure prevention is a top priority.
According to the Obama-Biden transition team Web site, the administration will "instruct the secretaries of Treasury and Housing and Urban Development to use their existing authority to more aggressively modify the terms of existing mortgages."
It is also developing "a plan to work with state housing agencies to coordinate broad mortgage restructurings," the site says.
What impact the shift to an Obama administration will have on policy is hard to gauge, since the president-elect is not sworn in until Jan. 20, but congressional leaders have clearly remained engaged in the issue.
In recent weeks House Financial Services Committee Chairman Barney Frank has sharpened his criticism of the Bush administration for failing to implement a loan modification plan. Earlier this month Rep. Frank said "the whole issue of foreclosure relief is the single greatest failure … in public policy recently."
He is preparing legislation that conditions the release of the remaining $350 billion in Tarp funds on their specific use in loan modifications.
Though current Treasury Secretary Henry Paulson is running out of time to request the second half of the funds, Rep. Frank has said his own intention is to ensure that "a lot of it would go for sufficient foreclosure reduction, including principal reduction, which is I think part of what we need — not all of what we need — to prevent redefaults."
Lawmakers and industry participants have praised one of the few comprehensive plans to emerge, a systematic loan modification plan endorsed by Federal Deposit Insurance Corp. Chairman Sheila Bair. It lays out a framework for conducting modifications and would combine cash incentives to servicers of $1,000 per loan, with guarantees on a portion of any losses after six months.
Rep. Waters said she plans to reintroduce a bill early in the next Congress that would implement the Bair plan.
"Servicers have to look at all of their loans and not just do it loan by loan when somebody complains," the California Democrat said.
Industry groups, keen on financial incentives to ease foreclosures, have been providing feedback on the Bair plan to Rep. Frank's staff.
"We're working with the Hill and with the FDIC to work with some of the plans out there to make them work on a broad basis, including the Sheila Bair plan," said Michael Paese, the executive vice president for global advocacy for the Securities Industry and Financial Markets Association and a former member of Rep. Frank's staff. "We understand the urgency of this matter."
Given Rep. Frank's expressed interest in principal reduction as a safeguard against redefault, an emphasis on it is likely to be considered in any foreclosure prevention policy, sources said. Principal reduction is likely to be even more important given new information from the Office of the Comptroller of the Currency that many modified loans are redefaulting at a fast pace, some said.
"A large foreclosure mitigation plan that would include principal writedown as part of it would be helpful early next year. I think what we are learning is that modifications with just rate reductions or term extensions aren't working well," said Mark Zandi, the chief economist at Moody's Economy.com. "It obviously sort of reflects the bad economy... but a plan is necessary, and one that includes principal writedowns is the only one that will work."
Further details on Rep. Frank's plans are likely to come out of a Jan. 7 hearing on the next administration's priorities under Tarp.
The Massachusetts Democrat has also discussed the need to improve the Hope for Homeowners program, which allows borrowers to refinance into a cheaper mortgage guaranteed by the Federal Housing Administration, but only after lenders accept significant principal writedowns.
The program was one of lawmakers' prime hopes for reducing foreclosures; and developing it took up much of the first half of 2008.
The Hope for Homeowners program went into effect Oct. 1. Since then HUD, which administers the FHA, has loosened the program's criteria by letting lenders take smaller haircuts, but to little avail. The program is still floundering as very few lenders have applied to put loans through it.
"I'm hopeful that they will simplify Hope for Homeowners," Mr. Platt said. "It just doesn't work. It's just too complicated. There are too many legal issues. It just isn't what it is purported to be. It's clunky."
Brian Gardner a policy analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc., said, "Hope for Homeowners … seems to be an abject failure to date."
Rep. Frank has said the program "misfired," and he has urged the FHA to make changes.
"The problem with our bill is … the fees are too high and the loan-to-value ratio and we hope to adjust both of those," he said.
But Democrats also favor another solution — allowing mortgages to be reworked in bankruptcy — that industry representatives adamantly oppose.
Sen. Richard Durbin, a political mentor to President-elect Obama and a leader in the Senate, is pushing to include mortgage bankruptcy reform in an economic stimulus package.
"I think this should be part of" such a package, "because if we don't deal with the mortgage foreclosure issue, we are not getting to the root cause or the catalyst of the recession we are in," Sen. Durbin said during a Dec. 9 press conference.
An aide to Sen. Durbin said "it's going to be the first bill that he introduces on the first day of the next Congress."
"That will be one of our top legislative priorities," the aide said.
Banking industry representatives argue the bill would drive up the cost of credit by creating legal uncertainties that would have to be priced into mortgage rates.
"We're concerned. Quite concerned," said Francis Creighton, the chief lobbyist for the Mortgage Bankers Association. "There's a good chance it will happen, and we strongly oppose that."
But the industry may have itself to blame. Slow progress in voluntary modification efforts has emboldened advocates to call for stronger action.
"In this economy … it's irrational not to do it," said Jim Carr, the chief operating officer of the National Community Reinvestment Coalition.
Reform leaders, like Sen. Charles Schumer, have argued that the threat of a judicial modification is needed to spur servicers to rework mortgages.
"No voluntary program is going to work. None," the New York Democrat said during a Senate Judiciary Committee hearing on the issue.
Lawmakers have weighed various incarnations of the legislation over the past two years, at times narrowing its scope to target aberrant loans.
The House Judiciary Committee approved a bill in December 2007 that would let bankruptcy judges modify subprime and nontraditional mortgages made from 2000 through the bill's enactment date with a sunset in seven years.
Sen. Durbin's most recent iteration gives judges broad running room to alter the terms of any mortgage including reducing the principal or interest rate and extending the loan for up to 40 years.
While there is no guarantee that bankruptcy reform will be enacted through a stimulus package, many observers say it is inevitable given stronger Democratic majorities and a supportive president.
"We've reached the tipping point, because there are now the votes to enact mortgage bankruptcy reform and both sides realize that," said Jaret Seiberg, an analyst with Stanford Group Co. "Mortgage bankruptcy is the biggest threat out there for the first quarter. Every investor I've talked to believes this is going to significantly raise the cost of getting a mortgage and may permanently kill the whole mortgage-backed securities markets … because you are going to add tremendous uncertainty."