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Legislation allowing bankruptcy judges to modify the terms of home mortgages, introduced, as expected, in the early days of the new Congressional session, received an unexpected boost when Citicorp broke ranks with the banking industry and withdrew its opposition to the measure.

Three key compromises – narrowing the bill’s scope to include only mortgages originated as of the enactment date, requiring borrowers to certify that they had attempted to discuss a loan modification with their lenders, and specifying that only “major” violations of the Truth-in-Lending Act will completely extinguish a lender’s mortgage claims – paved the way for Citicorp’s support.  The $45 billion in federal aid the banking giant has received might also have had something to do with the change of heart.

“This legislation would represent an important step forward,” Vikram Pandit, Citi’s CEO, said in a letter to lawmakers.  “Given today’s exceptional economic environment,” he added,” we support its swift passage.” 

The Existing bankruptcy law allows bankruptcy judges to modify other consumer loans, including second mortgages, but not the mortgage on a primary residence.  The proposed reform would end that carve-out, giving judges the discretion to reduce the interest rate, adjust the loan term, and “cram down” the loan by reducing its principal balance.  The bill’s supporters say it will give borrowers leverage they don’t currently have to persuade lenders to modify their mortgages.  Senate Democrats plan to incorporate the measure in the massive economic stimulus bill Congress is expected to consider next month. 

Sen. Richard Durbin (D-IL), the Majority Whip, introduced the bankruptcy reforms last year but was unable to overcome the opposition of Senate Republicans and banking industry trade groups.  The opposition of moderate Democrats helped stall a companion bill in the House.  Citigroup’s support “is the breakthrough we’ve been waiting for,” Durbin told the Wall Street Journal.  “To have a major financial institution support this legislation,” he predicted, “will create an incentive to others to come our way.”  Durbin praised Citicorp for being “open-minded about this…and playing a major leadership role.”  

Other financial industry leaders were dismayed by Citi’s decision.  The Financial Services Roundtable, the American Bankers Association, the Mortgage Bankers Association and the American Securitization Forum, which helped block the bankruptcy measure last year, all reaffirmed their opposition.  The legislation remains unacceptable and untenable for banks because it “creates huge risks” for them, Scott Talbott, senior vice president for government affairs at the Roundtable, told reporters.  Stopping short of criticizing Citicorp, Talbott acknowledged that “every company has to do what it has to do.”  But he also noted that “the rest of the industry opposes bill, so they are at this point alone.”

But not entirely alone, it seems.  The National Association of Home Builders, which was part of the coalition of trade groups opposing the measure last year, has indicated that it is now willing to discuss a temporary change in the bankruptcy rules.  “It is a 180-degree turn for us,” Jerry Howard, the NAHB’s chief executive acknowledged to reporters.  “But desperate times call for desperate measures.”

Some banks may be contemplating a similar turnaround, according to Sen. Charles Schumer (D-NY), who told reporters last week that, in the wake of Citi’s announcement, “the heads of most of the major banks in the country [have called my office], saying they want to hop on board.” 

None of those banks has, as yet, announced public support for the bankruptcy changes, but some industry trade groups are toning down their rhetoric as they seek to soften some of the bill’s sharper edges.  “We always believe this economy will recover,” Floyd Stone, executive director of the American Bankers Association (ABA) told the Washington Post, “and banks will be the engine of the recovery. We need to make sure we don’t do things that make it more difficult for them [to play that role.]”

Among other changes, the ABA wants to further restrict the legislation to apply only to “nontraditional mortgages.  Credit unions are seeking a similar change.

“We were able to win support last year for limiting this provision to subprime and non-traditional mortgages that have been the cause of the current crisis,” Brad Thaler, director of legislative affairs for the National Association of Federal Credit Unions (NAFCU), said in a press statement, “and we hope the current legislation will be further amended to reflect his.”  The agreement with Citicorp represents “an improvement” over the original bill, Thaler added, “but we think more needs to be done to protect credit unions and others that have made loans following safe, sound practices.”  

It isn’t clear how many more concessions Democrats will be willing to make, or whether they will have to make any at all.  Opponents of the measure will be fighting significant Democratic majorities in both the House and Senate, a weakening economy and the failure of other efforts thus far to reverse the climb in mortgage foreclosures.  The MBA estimated that, as of year-end, 1/10 borrowers – 4.6 million homeowners – were either delinquent on their mortgage payments or had entered the foreclosure process. 

“With the Democrats having such large margins in the House and the Senate, it was already going to be an uphill battle to stop bankruptcy reform,” Jaret Seiberg, an analyst with the Sanford Group, told American Banker recently.  “Citigroup’s endorsement of the legislation,” he noted, “makes that task infinitely more difficult.” 

Legislating Overdraft Protections

Although pleased generally with the Federal Reserve’s new regulations curbing unfair and deceptive credit card practices, lawmakers have proposed legislation that would impose more sweeping restrictions on credit card issuers.  As we reported in our last update, Rep. Carolyn Maloney (D-NY) has reintroduced the Credit Card Bill of Rights she sponsored last year, seeking more expansive protections than the Fed has endorsed.  And she has indicated plans to refile her Consumer Overdraft Fair Protection Act, calling for more sweeping protections in that area than the Fed has proposed.  The Fed initially included overdraft protections in its credit card rules, but decided to deal with the overdraft issue separately, in a proposal issued recently for public comment.  The Fed’s plan would require lenders to adopt one of two approaches:   

  • Allow consumers to opt-out of overdraft programs, in which case, lenders could not impose an overdraft fee unless the consumer receives an initial notice and the opportunity to decline the service.
  • Require consumer to opt-in.  Under this alternative, lenders could not impose an overdraft fee unless the consumer affirmatively requests the service.

Maloney’s more expansive measure, which she co-sponsored last year with Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, would:

  • Require financial institutions to obtain the written consent of consumers to receive overdraft protection services before imposing a fee for overdraft coverage.
  • Require financial institutions to obtain the written consent of consumers to receive overdraft protection services before imposing a fee for overdraft coverage.
  • Require written disclosure of all terms and charges including the transactions covered and the circumstances under which institutions would not pay for an overdraft.
  • Prohibit a “pattern or practice” of delaying the posting of deposits or deducting charges in order to create overdrafts.
  • Require ATMs operated by the bank holding the consumer’s account to provide the “actual balance” in response to a balance inquiry, not the higher balance based on coverage of an overdraft.
  • Require ATMs at a customer’s home institution to notify the consumer when a transaction might trigger an overdraft and allow cancellation of the transaction to avoid the fee.

A study of overdraft programs published last year by the Federal Deposit Insurance Corporation (FDIC) found evidence of the abuses about which consumer advocates have been complaining for several years. 

Based on a survey of 462 institutions with assets of at least $5 billion, the study found notable differences in the pricing and policies for automatic overdraft programs compared with linked accounts and overdraft lines of credit – two alternatives for handling overdrafts.  One of the key differences:  Most banks offering automatic overdraft protection (75.1 percent) required consumers to opt out if they didn’t want the services; linked accounts and overdraft lines of credit, by contrast, were more commonly treated as opt-in arrangements, requiring consumers to affirmatively request the program.

Among the other findings of the FDIC study: 

  • Most institutions (71 percent) offering automatic overdraft protection notified customers of overdrafts in ATM and POS/debit transactions only after the transaction was complete and the overdraft had been incurred; only 7.9 percent provided prior notification for POS/debit transactions and 23.5 percent for ATMs, allowing customers to cancel the transactions  and avoid the charge.
  • Most institutions (71 percent) offering automatic overdraft protection notified customers of overdrafts in ATM and POS/debit transactions only after the transaction was complete and the overdraft had been incurred; only 7.9 percent provided prior notification for POS/debit transactions and 23.5 percent for ATMs, allowing customers to cancel the transactions  and avoid the charge.
  • Nearly 25 percent of all banks (and more than half of the largest institutions) batched overdrafts by size, from largest to smallest, which had the effect of increasing the size of the overdrafts.
  • Banks charged significantly more for automated overdraft protection (the median fee was $27.00) than for either overdraft lines of credit or linked accounts.  Nearly half the banks offering linked accounts charged no fee; those that did charged a transfer fee averaging about $5.00.  The cost for lines of credit programs was interest on the loan – typically priced at 18 percent.

FDIC analysts estimated that a consumer who incurred a $20 overdraft and repaid it within two weeks would be charged an APR of 3,520 percent.  “Even payday lenders don’t charge that much,” a Bankrate.com article on the issue noted.  

Yes They Will

Concern about the deteriorating economy overcoming dismay about the failure of efforts to date to shore up the nation’s shaky banking sector, the Senate voted to release the second half of the funding approved for the Troubled Asset Relief Program (TARP).  But incoming newly-inaugurated President Barack Obama has made it clear that his administration will manage the next $350 billion differently than the Bush Administration managed the first $350 billion. 

"Restoring the economy requires that we maintain the flow of credit to families and businesses," Obama said in a statement. "So I'm gratified that a majority of the U.S. Senate, both Democrats and Republicans, voted today to give me the authority to implement the rest of the financial rescue plan in a new and responsible way." 

Pressure for a change in direction for TARP is mounting, as some of the financial institutions that have received funding are lining up for additional aid to close their still yawning capital gaps, and the billions of dollars pumped into the banking industry thus far has yet to trigger the lending resurgence policy makers had hoped to achieve. 

The Congressional panel overseeing the administration of TARP, which issued a critical report on the program a month ago, published an even more scathing analysis last week, citing, among a litany of shortcomings, the Treasury Department’s failure to use any of the funding for foreclosure mitigation.   

“For Treasury to take no steps to use any of this money to alleviate the foreclosure crisis raises questions about whether [the department] has complied with Congress’s intent that Treasury develop a ‘plan that seeks to maximize assistance to homeowners,’” the report states.   

The oversight panel, chaired by Harvard Law Professor Elizabeth Warren, also repeated key complaints in its first report, that Treasury has not responded fully “or at all” to requests for information about its distribution of TARP funds and has not demanded sufficient accountability from institutions receiving the assistance.  “Although Treasury notes that it is also monitoring the effects of capital infusions on lending, it does not state what metric it plans to use,” the report says.  And while the depressed lending activity is attributable to the economic slowdown as well as to restrictive lending standards, “these events do not justify the failure to measure whether the TARP capital investments are having a positive effect on lending….So long as investors and Customers are uncertain about how taxpayer funds are being used,” the report continues, “they question both the health and the sound management of all financial institutions.”  

As for the repeated assertions of Treasury officials that the TARP efforts to date are bearing fruit, the panel responded, “It is not enough to say that the goal is the stabilization of the financial markets and the broader economy.  The question is how the infusion of billions of dollars to an insurance conglomerate or a credit card company advances both the goal of financial stability and the well-being of taxpayers, including homeowners threatened by foreclosure, people losing their jobs, and families unable to pay their credit card [bills].”

Separately, the Federal Deposit Insurance Corporation (FDIC) has issued guidance requiring the 5,000 banks it regulates to document how they are using any federal funding they have received – under TARP’s Capital Purchase Program, the Fed’s multiple liquidity programs, or the FDIC’s guarantee of unsecured debt – to help homeowners avoid foreclosure. 

“The FDIC expects that state nonmember institutions (or their parent companies) will deploy funding received from these federal programs to prudently support credit needs in their market and strengthen bank capital,” the agency guidance, issued January 12, states.  The four banking giants that have received the bulk of TARP funding – Bank of America, Citigroup, Wells Fargo and JPMorgan Chas – are not covered by the FDIC’s directive.

The agency’s letter was intended “to reinforce” the message in a November interagency statement directing financial institutions to use their funds prudently, Steve Fritts, associate director of risk management policy for the FDIC, told American Banker.  “Banks never had public money investment before,” he observed, adding, “This is a big, new deal.  It’s important to communicate with them and make sure they understand that…the expectation is that they use this to support their primary business activities.”  

Needs Work

Echoing what is emerging as a consensus view among academics and many lawmakers, a government report has concluded that the existing financial regulatory system needs a substantial overhaul.  The current regulatory system “is ill-suited to meet the nation’s needs in the 21stcentury,” the report, by the Government Accountability Office (GAO), contends.  A major problem, the report says, is the “fragmented” regulatory structure makes it impossible to identify risks in all sectors of the financial system.  Other weaknesses include:  The 107-page report cites several essential criteria for a new regulatory structure, primary among them:

  • Clearly defined regulatory goals.
  • A “comprehensive” and “system-wide” focus.
  • Flexibility and the capacity to adapt quickly to market changes and product innovations.
  • Efficiency
  • The ability to ensure consistent protection for consumers and investors
  • Independence and accountability for regulators
  • Consistent financial oversight
  • Minimal taxpayer exposure.

Although financial industry executives will almost certainly balk at efforts to tighten regulation of their activities – and, in fact, have already begun to note the dangers of “over-reacting” to current problems -- a recent poll indicates that the push for more federal regulation will likely enjoy strong public support.  The poll, conducted by Public Strategies Inc. and Politico, an on-line news organization, found that more than seven in 10 Americans think U.S. business is on the wrong track, and 67 percent think federal regulation of businesses should be increased.

The first of what is intended as a quarterly survey of public trust in public and private institutions, demonstrates that “American voters enter the new year with little confidence in either government or business to solve the nation’s problems, but they are very receptive to more government regulation of the nation’s business community,” a press release describing the poll results, said. Among the key findings:

  • Identical percentages of registered voters (62 percent) said their confidence in government and in the business community has fallen over the past year.
  • A plurality —45 percent — chose "an economic stimulus package that will employ out-of-work Americans” over other issues as the government’s most important task in the next 12 months.
  • Nearly half (46 percent) chose "direct spending on infrastructure programs" over "investments in corporations to protect existing jobs" or allowing the business cycle to run its course, as the best means of responding to the current economic crisis.
  • Nearly half of the respondents (49 percent) said they were worried that the federal government will “go too far” in providing assistance to corporations.

“This survey makes clear that in the eyes of voters, both government and business face challenges related to their reputations heading into 2009, and as a result, both have great opportunities to regain the public trust going forward,” Mark McKinnon, vice chairman of Public Strategies, Inc. , said in a press statement.  “The public wants action from the government in the regulatory sphere, “ he added, “but, given the low levels of confidence expressed both in government and business, those who take leadership roles in helping craft solutions to the nation’s difficulties are likely to see their reputations improve.” 

Holding Back the RESPA Tide

Facing two law suits – thus far – the Department of Housing and Urban Development (HUD) has agreed to delay for 90 days implementation of one provision of the revised Real Estate Settlement Procedures Act (RESPA) regulations. The delay responds to a suit filed by the National Association of Home Builders (NAHB) challenging the provision, which would prohibit builders from offering incentives to prospective buyers to steer them toward mortgage lenders affiliated with the builders. 

The NAHB contends that the restriction arbitrarily and illegally targets only affiliated businesses operated by builders, ignoring affiliates owned by title insurance companies and other settlement services providers, which would still be free to offer discounts and other incentives to borrowers.

“The HUD rule prevents home builders from offering consumers the best possible deal on the purchase of a new home and limits the options available to new homebuyers as they seek out the services necessary at closing,” NAHB President Jerry Howard said in a press release announcing the suit. 

HUD officials said they decided to delay the provision’s effective date so the agency can mount “a vigorous defense” of its merits.  The rule, they argued, does not prevent builders from offering incentives to buyers; it bars them only from making those incentives contingent on their use of a designated lender.  “The only thing this rule does is de-link these incentives, or disincentives, from the required use of affiliated settlement service providers,” Brian Sullivan, a spokesman or HUD, told reporters. 

A U.S. District Court will hear arguments in the NAHB suit in April.  A separate suit, to be filed by the National Association of Mortgage Brokers (NAMB) targets another provision of the revised RESPA rules, requiring mortgage brokers to disclose the yield spread premiums lenders pay brokers for originating loans above the “par” rate. Unlike the NAHB suit, which challenges only one provision of the revised RESPA rules, the NAMB suit seeks to throw out the entire reform package. As of last reports, NAMB had not yet filed its suit, which will ask initially for a temporary injunction barring implementation of the RESPA reforms, some of which became effective this month.