Readers probably know that the changes in the bankruptcy law, which went into effect in October 2005, were a victory for the credit card industry, which had lobbied for tougher rules for years. I had very little sympathy for the banks, since credit cards were an extremely profitable business even under the old law, and if banks thought they were nevertheless taking too many bad debt losses, the solution was to tighten credit standards (of course, that ignores the fact that the most profitable customers are the ones that are overextended, carrying large balances at high interest rates, but haven’t gone under, in other words, the near bankrupt).
One bankruptcy lawyer told me that MBNA (now part of Bank of America) had pushed hardest for the changes, and estimated that the new law would enable it to extract an extra $100 a month from consumers who declared bankruptcy, which would increase their profits by $85 million.
In a bit of schaudenfreude, it looks like the new rules may have increased the profits of their credit card business at the expense of their mortgage business, and in the case of big mortgage lenders, their balance sheet.
Washington Mutual Inc. got what it wanted in 2005: A revised bankruptcy code that no longer lets people walk away from credit card bills.
The largest U.S. savings and loan didn’t count on a housing recession. The new bankruptcy laws are helping drive foreclosures to a record as homeowners default on mortgages and struggle to pay credit card debts that might have been wiped out under the old code, said Jay Westbrook, a professor of business law at the University of Texas Law School in Austin and a former adviser to the International Monetary Fund and the World Bank.
“Be careful what you wish for,” Westbrook said. “They wanted to make sure that people kept paying their credit cards, and what they’re getting is more foreclosures.”
Washington Mutual, Bank of America Corp., JPMorgan Chase & Co. and Citigroup Inc. spent $25 million in 2004 and 2005 lobbying for a legislative agenda that included changes in bankruptcy laws to protect credit card profits, according to the Center for Responsive Politics, a non-partisan Washington group that tracks political donations.
The banks are still paying for that decision. The surge in foreclosures has cut the value of securities backed by mortgages and led to more than $40 billion of writedowns for U.S. financial institutions….
Even as losses have mounted, banks have seen their credit card businesses improve. The amount of money owed on U.S. credit cards with payments more than 30 days late fell to $7.04 billion in the second quarter from $8.37 billion two years earlier, according to data compiled by Federal Deposit Insurance Corp.
In the same period, the dollar volume of repossessed homes owned by insured banks doubled to $4.2 billion, the federal agency said. New foreclosures rose to a record in the second quarter, led by defaults in subprime adjustable-rate mortgages, according to the Mortgage Bankers Association in Washington.
People are putting their credit card payments ahead of their mortgages, said Richard Fairbank, chief executive officer of Capital One Financial Corp., the largest independent U.S. credit card issuer. Of customers who are at least three months late on their mortgage payments, 70 percent are current on their credit cards, he said.
“What we conclude is that people are saying, `Honey, let the house go,”’ but keep the cards, Fairbank said Nov. 5 at a conference in New York sponsored by Lehman Brothers Holdings Inc.
The new bankruptcy code makes it harder for debtors to qualify for Chapter 7, the section that erases non-mortgage debt. It shifted people who get paychecks higher than the median income for their area to Chapter 13, giving them up to five years to pay off non-housing creditors.
The court-ordered payment plans fail to account for subprime loans with adjustable rates that can reset as often as every six months, said Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys. Two-thirds of debtors won’t be able to complete their payback plans, according to the Center for Responsible Lending.
“We have people walking away from homes because they can’t afford them even post bankruptcy,” said Sommer, a Philadelphia- based bankruptcy attorney. “Their mortgage rates are resetting at levels that are completely unaffordable, and there’s nothing the bankruptcy process can do for them as it now stands.”
Four million subprime borrowers with limited or tainted credit histories will see their mortgage bills increase by an average 40 percent in the next 18 months, according to the National Association of Consumer Advocates in Washington. About 1.45 million of those will end up in foreclosure by the end of 2008, said Mark Zandi, chief economist at Moody’s Economy.com, a research firm and unit of Moody’s Corp. in New York.
Lenders began the process of seizing properties on 0.65 percent of U.S. mortgages in the second quarter, a record in a quarterly Mortgage Bankers study that goes back 35 years. The percentage of subprime borrowers making late payments increased to 14.82, a five-year high, from 13.77.
Personal bankruptcies rose 48 percent to 391,105 in the first half of 2007 from a year earlier and Chapter 13 filings accounted for more than one-third of those, according to the American Bankruptcy Institute. In the first half of 2005, they were just 24 percent of the total.
Bad mortgages slashed Washington Mutual’s profit by 72 percent in the third quarter from a year earlier, the Seattle-based thrift said Oct. 17. Income from credit card interest rose 8.8 percent to $689 million in the period, helping to offset a loss the bank warned on Oct. 5 would be 75 percent.
Washington Mutual shares tumbled the most in 20 years yesterday after New York Attorney General Andrew Cuomo said the thrift had pressured real estate appraisers to assign inflated values to properties. Its dividend yield fell to 11 percent and the company traded at 0.74 price-to-book value.
Citigroup’s third-quarter earnings fell 57 percent on mortgage losses. Bank of America stopped so-called warehouse lending to mortgage brokers after its profit declined 32 percent in the same period.
JPMorgan reported profit growth of 2.3 percent in the quarter, the smallest in more than two years, after reducing the value of leveraged loans and collateralized debt obligations, investment packages of mortgages, by $1.64 billion.
Washington Mutual spokeswoman Libby Hutchinson in Seattle, JPMorgan spokesman Thomas Kelly in New York and Bank of America spokesman Terry Francisco in Charlotte, North Carolina, declined to comment on the bankruptcy law.
“The law had an unintended consequence of taking away a relief valve that mortgage borrowers used to have,” said Rod Dubitsky, head of asset-backed research for Credit Suisse Holdings USA Inc. in New York. “It’s bad for the mortgage borrowers and bad for subprime investors because it means more losses.”….
The House Judiciary Committee is working on legislation to let bankruptcy judges restructure home loans by lowering interest rates and reducing mortgage balances to reflect current market value.
Banks including Washington Mutual, Citigroup and Wells Fargo & Co. sent a letter to the committee opposing the change, saying such restructurings should be done privately.
Countrywide Financial Corp., the largest U.S. lender, said last month that it will modify $16 billion worth of adjustable-rate mortgages. Washington Mutual said in April that it will spend $2 billion giving discounted rates to help customers with subprime loans refinance at better terms.
So far, most lenders have been reluctant to change loan agreements. About 1 percent of mortgages that reset in January, April and July were modified, according to a Sept. 21 Moody’s Investors Service report that surveyed 16 subprime lenders that account for 80 percent of the market.
Congress probably will approve at least a limited measure to permit loan modifications, said Westbrook, the University of Texas law professor.
“They are going to have to figure out some way to address the problem,” Westbrook said. “I don’t think our economy or our consciences can handle the number of foreclosures we’ll see if they do nothing.”