Of Victims and Mortgages

There are bad ideas to address the mortgage meltdown, and then there are ideas so awful that they even have Democrats rebelling against their powerful House chairmen.

Such is the case with the mortgage bankruptcy bill passed yesterday by John Conyers's House Judiciary Committee. We warned in October about this legislation, which would allow bankruptcy judges to treat mortgage debt the same as credit-card debt. It sounds like a great idea to troubled borrowers, because judges could then reduce the amount that a borrower owes on a mortgage -- while letting the owner keep the property.

It's less great for future home buyers, who can imagine how much fun it will be when markets logically respond by setting mortgage interest rates closer to those on credit-card debt. Mortgage debt has always been treated differently -- i.e., the bank will take your house if you don't pay the agreed-upon tab -- precisely to encourage lower rates on a less risky investment.

Justice John Paul Stevens, not exactly a threat to win a Cato Institute fellowship, described the importance of this principle in 1993 in Nobelman v. American Savings Bank: "At first blush it seems somewhat strange that the Bankruptcy Code should provide less protection to an individual's interest in retaining possession of his or her home than of other assets. The anomaly is, however, explained by the legislative history indicating that favorable treatment of residential mortgagees was intended to encourage the flow of capital into the home lending market."

High levels of homeownership have been the result. To repeal this policy and make lenders wonder whether mortgage loans will be secured or unsecured can have only one result -- more expensive mortgage loans.

That's why 16 House Democrats wrote to Mr. Conyers in October urging him not to rewrite the bankruptcy code. The controversy forced him to yank the bill -- until yesterday. His new version would apply only to subprime and nontraditional mortgages originated since the start of 2000, and Mr. Conyers eked out a razor-thin majority, despite a goal-line stand led by Utah Republican Chris Cannon.

What about those 16 Democrats? None serves on Judiciary, but winning them over will be critical if Mr. Conyers hopes to win a floor vote. So far, they seem less than impressed with the Conyers "compromise." When we asked for a comment on the new bill, Kansas Democrat Dennis Moore warned against "undercutting" other potential solutions.

The larger problem with this and many of the other subprime bailout plans is that they conceive of every troubled borrower as a victim. No doubt some borrowers were coaxed to sign loans they didn't understand. But a Treasury report due out next month suggests that the fraud often works the other way around.

One indisputable fact is that mortgage fraud skyrocketed during the Federal Reserve's easy-credit era. When financial institutions see potentially criminal activity in customer transactions, they are required to send a Suspicious Activity Report (SAR) to the Treasury's Financial Crimes Enforcement Network (FinCEN). From 2000 to 2006, SARs related to mortgage fraud increased by almost 700%.

SARs and resulting federal investigations are often aimed at "frauds for profit," in which the goal is typically to take cash out of a closing. Often orchestrated by unscrupulous mortgage professionals, these scams are frequently the subject of media coverage. However, a new report soon to be released by FinCEN shows that borrowers are almost as likely to be implicated in such cases as the crooked brokers so frequently profiled in the press.

Even more shocking to Beltway ears, the upcoming FinCEN data show that "frauds for housing," in which the scam is simply to secure a more expensive property than one's history and finances would justify, account for 60% of all SARs related to mortgage fraud. Based on Treasury's data, it is the borrowers, not the brokers, who are most likely to be the culprits when a lender is victimized.

Frauds for housing "may be a bigger deal than we all thought," says Merle Sharick of the Mortgage Asset Research Institute. He adds that regulators and financial firms are now trying to discern just how common this crime is. Taxpayers, investors and future home buyers asked to sacrifice on behalf of today's subprime "victims" might reasonably ask for a more thorough accounting.

Read the full article at: The Wall Street Journal

Date published: Dec 13, 2007


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