Few Americans would question the need to enact speedy reforms to prevent the national foreclosure crisis from cascading into catastrophe, but in their haste to pass the Helping Families Save Their Homes In Bankruptcy Act, congressional leaders have overlooked a detail that will make the credit markets much, much worse unless it is quickly corrected.
The main purpose of the Helping Families bill, whose principal sponsor is Rep. John Conyers, D-Mich., is to empower federal bankruptcy judges to restructure the terms of home mortgages just as they already do with most other forms of insolvent borrowers’ consumer credit. Buried in the bill, however, is another provision that, unlike the so-called “cramdown” provision, has gotten virtually no media attention. This stealth provision states that lenders will not be able to enforce claims in bankruptcy for home mortgage loans that are “subject to a remedy for rescission under the Truth in Lending Act.”
What’s so bad about that? For starters, when Congress enacted Tila in the late 1960s, it had in mind a carefully balanced remedy for violations that are often quite technical.
When lenders failed to make the disclosures specified in the statute, the borrower could rescind the loan by tendering back the full principal amount of the loan, less any interest and fee amounts. The potential loss of interest and fees was thought to be an appropriate incentive for lenders to comply with the law’s disclosure requirements.
As currently proposed, the new “Helping Families” bill would throw Tila’s balanced remedy out the window and let a borrower who can prove a technical Tila violation walk away not only from his interest and fee payments but also from the principal.
That’s right: Under Section 506(d) of the Bankruptcy Code, any loan that previously would merely have been subject to rescission under Tila — meaning that the borrower would have been entitled to avoid interest and fees but still obliged to repay principal — would now be void. The borrower could keep his house and walk away debt-free.
Lest the voting public think this remedy imposes some measure of cosmic justice on an industry that has had its share of criticism lately, consider the picayune circumstances in which loans have been ordered rescinded under Tila. For example, if a lender commits the crime of giving the borrower only one copy of a Notice of Right to Rescind, instead of the required two copies, the borrower is entitled to rescind the loan at any time within three years of the loan’s origination. So, too (at least in the view of most courts), if the lender tells a borrower that he may rescind within three days but fails to specify what date that is. Or (in some courts) provides the required disclosure information on a form other than the exact form dictated by the Federal Reserve Board.
No one should minimize these violations; Tila was enacted to protect the rights of the “least sophisticated consumer,” as many courts have put the point. But it is one thing to put lenders at risk of losing their interest and fees for a violation and quite another to wipe out their principal.
At a time when most people agree that more credit, not less, is needed to stimulate the economy, a provision that threatens the ability of creditors to recoup even their principal investments is a giant leap in the wrong direction. Creating incentives for enterprising plaintiffs’ attorneys to bring every Tila claim in federal bankruptcy court in order to capitalize on the new “wipeout” remedy is not a good idea either.
The details of the cramdown bill matter, and this detail must be fixed right away.