For a candidate who is as undeniably committed to the cause of economic justice as Barack Obama is, his selection of Joe Biden to be his running mate is a severe disappointment. In 2005, when Obama was working with Sens. Durbin and Dodd to blunt the excesses of the harsh and punitive new bankruptcy bill, Joe Biden and the Republicans fought them every step of the way. Obama’s supporters need to make him understand that this is one area where he can’t afford to let Biden set policy.

“The first wave of Americans to default on their home mortgages appears to be cresting,” writes Vikas Bajaj in this morning’s New York Times, “but a second, far larger one is quickly building.”

Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults.

The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time.

What’s especially interesting is how closely the scenario outlined in the Times article matches up with this chart, published last year by the International Monetary fund using data from Credit Suisse, showing the value of mortgage rate resets due to happen each month between 2007 and 2015. (A reset is when the repayment terms of a loan change—invariably by increasing—according to a schedule determined by the loan contract.)

Earlier this decade, as the ballooning housing market pushed the affordability index past the point where the average first-time homebuyer could afford a typical home in many areas, the real-estate industry kept the boom going by offering “teaser-rate” mortgages. These loans had artificially low annual percentage rates that were only good for the first few years of the contract, after which they would reset to a much higher APRs that the buyers in many cases would not be able to afford. As long as housing prices kept going up, the story went, buyers would be able to use the increased equity in their homes to refinance into more affordable loans. Then housing prices stopped going up.

As the IMF graph shows, the problem began a couple of years ago with a huge wave of resets in the subprime market, giving rise to talk about the so-called “subprime crisis.” It has been the failure of these loans that has been responsible for much of the turmoil in the housing market over the past couple of years. By early 2009, however, most of the subprime resets will be over and done with. Then, beginning in early 2010 and continuing for a couple of years, there will be another big wave of resets, this time in alt-A and option ARMs.

As this scarily prophetic Business Week article from nearly two years ago puts it, option adjustable rate mortgages — the so-called “pick-a-payment” mortgages — “might be the riskiest and most complicated home loan product ever created.” Option ARMs offer several payment choices each month, typically differing by thousands of dollars. The least expensive option doesn’t even cover the full amount of the interest due on the loan, so the leftover interest gets added to the principle (a situation called negative amortization). Option ARMs sold like hotcakes during the boom, accounting for 9 percent of the volume of all mortgages sold in the US in 2006, and significantly more in boom states like California and Florida.
According to Standard & Poor’s, more than 75 percent of option ARM holders were making only the minimum monthly payment in 2007.

Those attractive payment options come to an end when the mortgage resets. Faced with a monthly payment that’s nearly double what they’ve been making, a debt that’s tens of thousands of dollars bigger than it was when they took it out, and a home that may be worth less than their outstanding debt by a wide margin, many homeowners will be forced to default or to seek protection in bankruptcy court.

Option ARMs, it can’t be pointed out often enough, are prime loans, not subprime. As today’s Times article notes, prime and alt-A loans make up a much bigger percentage of most banks’ mortgage portfolios than subprime loans do, raising the specter of a new wave of defaults that may dwarf the troubles we’ve already seen:

“Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.”

Bankruptcy law professor Elizabeth Warren on that Barack Obama speech I wrote about earlier:

I can think of many reasons that bankruptcy is a terrible subject for someone running for president. It is very technical (hard to wedge into a sound bite). It is depressing (no one wants to think about going bankrupt). It will annoy big-money interests (financial services gave big money to pass the current bankruptcy laws).

Savvy handlers would advise against it. So why would Obama make bankruptcy relief a visible part of his platform?

…Obama has history. He voted against the bankruptcy bill. He voted in favor of the amendments that would have eased the effects of the amendments. But his real history is deeper. He was a community organizer who saw first-hand the effects of aggressive lending. He was a state legislator who felt the impact of federal pre-emption on his ability to protect the citizens he represented.

That makes sense. When Obama was in the Illinois state senate, he represented a district on the South Side of Chicago, a diverse region with a long working-class history. Individual bankruptcy is an alien concept to the economic elite who populate K Street and the corridors of Congress, but it’s a very real issue for the kinds of people Obama has represented throughout his political career. It’s been a while since we’ve had a figure on the national scene who was as well equipped to address debt and bankruptcy issues as Obama is.

Something I’ve wanted to do for a while has been to put together a series of posts examining where the 2008 presidential candidates stand on bankruptcy, debt, and personal finance issues. The candidates have starkly differing views on a number of fundamental economic issues, and weighing these differences is going to be a top priority for voters this fall. Without further ado, therefore, here’s where the candidates stand on the very important issue of individual bankruptcy:

Barack Obama on Bankruptcy (Issues Page)

Sen. Obama has made bankruptcy issues a talking point in his campaign. Here he is speaking in Powder Springs, Georgia last week about his proposals to make bankruptcy law fairer and to fast-track the bankruptcy process for military families, among other reforms:

This speech echoes a number of familiar themes for Obama, who has been prominent on bankruptcy and lending issues since he arrived in the Senate in 2005. He voted against the Orwellian “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” a horrible piece of legislation that has made it harder for millions of Americans to seek bankruptcy protection, and he accuses Washington—and John McCain in particular—of standing up for the interests of big banks and credit card companies instead of for the American people. He is harshly critical of the loophole in the current bankruptcy law that allow bankruptcy courts to modify the loan for a borrower’s second home, but not their primary home.

Obama proposes to reform the bankruptcy laws to make it easier for individuals to seek debt relief when they file for bankruptcy protection due to medical expenses. He also wants to raise the homestead exemption and enact other reforms that would make it easier for seniors to keep their homes.

John McCain on Bankruptcy

Sen. McCain’s record on bankruptcy issues is not good. He voted for the 2005 bankruptcy bill, calling it “an important step toward a fair and balanced approach to restoring personal responsibility to our federal banking system.” As the bill was being debated, Senate Democrats introduced a number of amendments in an effort to reduce the punitive impact it would have on working families. McCain voted no on almost all the amendments, even ones that would have extended some protections to individuals whose financial problems were due to medical problems or identity theft.

McCain’s economic issues page say nothing about bankruptcy. He does mention the subject on a page devoted to veterans’ issues, touting his support of an amendment by Sen. Jeff Sessions (R-Ala.) that would have protected veterans from being denied bankruptcy claims if they incurred their debts while on active duty—an amendment Obama voted against. However, what McCain doesn’t mention is that this amendment was a watered-down response to an earlier amendment offered by Sen. Richard Durbin (D-Ill.), which Sessions criticized as “overly broad.”. McCain voted against the Durbin amendment; Obama voted for it.

Coming next week: The Candidates on Mortgage and Foreclosure Issues

Just a quick note this holiday weekend to alert everyone to Liz Pulliam Weston’s great article “Lenders create a bankruptcy monster” on MSN Money. Gee, you mean the “Bankruptcy Abuse Prevention and Consumer Protection Act” hasn’t actually prevented abuse or protected consumers? I’m shocked! Happy Fourth, everyone.

Following up on yesterday’s post about lenders being unable to produce the mortgage note in a shockingly high percentage of foreclosure cases, here’s a short video from the Consumer Warning Network about how you can make your lender prove in court that it has the right to foreclose on you in the first place.

It’s imporant to understand that challenging your lender on the note isn’t a “get out of debt free” card. What it can do is give you more leverage to bargain with an institution that may be treating you unfairly, and establish the true ownership of the loan so another party doesn’t try to collect the same debt from you in the future. Your creditors are trying to take your home to compel you to uphold your end of the mortgage contract. You have the right to insist that they uphold theirs.

This CNN story from earlier today highlights something I’ve been seeing recently in my practice: in many foreclosure cases, the lender can’t even produce the mortgage note—in other words, they can’t prove they’re the holder of the debt.

During the credit bubble, these mortgages were traded and repackaged so many times in so many different ways that the banks and servicers got lazy and sloppy with recordkeeping. They simply never thought they’d be called on it, it seems. Now they’re being called on it, and they’re in a bit of trouble.

When I represent a client in a foreclosure proceeding, the very least  I expect from the “lender” is that it be able to show that it is the lawful owner of my client’s debt. Increasingly, the lenders are finding out that bankruptcy judges get a bit irked if they can’t. Stay tuned.

At Seattle Debt Law we consider bankruptcy a last resort option for homeowners who are behind on payments and/or facing imminent foreclosure. However, clients struggling with payment resets that can often increase their monthly mortgage payment by a third or more have few options. Luckily Congress is pledging to finally bring relief to homeowners through a government housing fund backed by Fannie Mae and Freddie Mac. Although the final bill has yet to come up for a vote, a deal has between reached by Senate Democratic and Republican leaders to bring a bill to the Senate floor and it should help homeowners with expensive adjustable-rate loans apply to refinance to stable 30-year fixed rate FHA mortgages.

It is too early to assess the impact of this bill on homeowners facing imminent foreclosure, but if there is a way to save your house, we will work with housing counselors to make it happen and keep your legal options for bankruptcy or predatory lending litigation open if the refinance or loan modification does not come through.

The New York Times’ Gretchen Morgenson wrote a great article last month rounding up a number of recent cases of bankruptcy court judges doing what the government seems unable to do: reviewing how and why homeowners are losing their homes, and holding lenders and servers responsible for their bad acts. The article covers the Louisiana case I wrote about yesterday, plus two others in Delaware and New York. The New York case is especially interesting to me because I have a current client dealing with exactly the same issue: the lender refused to accept a payment made by a borrower in bankruptcy, then tried to take action against the borrower for not making the payment!

Lenders have gotten away with these abuses for a long time, but I think these recent decisions show that the pendulum is beginning to swing back in favor of the consumer.

Among the many unsavory, unethical, and downright illegal practices employed by mortgage services in recent years is the way they drench borrowers with excessive and punitive fees for just about anything they can think of, often without even notifying the borrower. Fortunately, judges are beginning to take notice. An important decision last month (PDF) from the U.S. Bankruptcy Court for the Eastern District of Louisiana found Wells Fargo negligent in the case of Dorothy Chase Stewart, a New Orleans-area widow whose mortgage the bank serviced. The court found that Wells Fargo levied numerous fees and charges against Mrs. Stewart’s account without ever notifying her, for such things as late payments and “inspections” that never took place. In one particularly egregious instance, Wells Fargo charged Mrs. Stewart $250 for two inspections that supposedly took place on September 12, 2005—a day when her parish was under an evacuation order due to Hurricane Katrina! Judge Elizabeth W. Magner assessed more than $27,000 in damages against Wells Fargo, and ordered additional sanctions to force the bank to clean up its act.

If you have encountered any bogus fees on your statement, take a few minutes to read the attached decision—it’s kind of long, but well worth it.