The Wall Street Journal-20080129-A Mortgage -Tweak- We Don-t Need

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A Mortgage 'Tweak' We Don't Need

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Politicians are always willing -- if not quite qualified -- to play the role of economic savior. And with fresh bad news about the economy coming out regularly, there are plenty of would-be saviors auditioning for the role.

Some of their proposals are serious reforms. Others are Keynesian- inspired, more silly than harmful. But too many are dangerous ideas that would undermine recovery and do long-term harm to both homeowners and our general prosperity.

One of the most dangerous proposals is now moving through the House of Representatives. The Emergency Home Ownership and Mortgage Equity Protection Act was voted out of the Judiciary Committee recently. It takes aim at Chapter 13 bankruptcy proceedings to make it easier for buyers to rewrite the terms of their mortgage contracts in court. It would do this by changing how a debtor's principal residence is treated in bankruptcy, allowing mortgage contracts to be modified by the courts.

In short, if this bill becomes law a mortgage would no longer be a matter between a borrower and a lender, but instead, between a borrower, a lender and a judge. Rather than interpreting private contracts, judges would suddenly be able to rewrite them.

Current bankruptcy law has existed for more than 100 years, and was designed to promote homeownership by making mortgages secure from outside meddling. Strong contracts make for a vibrant mortgage industry. Weakening mortgage contracts would endanger the future of American homeownership by making it harder for homebuyers to obtain a loan.

The bill's backers, of course, claim otherwise. Former Housing and Urban Development Secretary Jack Kemp, for instance, argues that this is merely a "tweak" to the law that would benefit subprime mortgage holders at risk of foreclosure. According to Mr. Kemp, "when servicers are unwilling or unable to voluntarily modify exploding, unsustainable home mortgage loans, Congress has a duty to consider involuntary modification in bankruptcy court." This type of modification is more commonly known in the industry as a "cram down."

By introducing uncertainty into mortgage contracts, this rule change would make it harder and more expensive for buyers to get a mortgage. The Mortgage Bankers Association recently estimated that, if this reform becomes law, borrowers will have to start putting down 20% on a home to get a loan, which is much higher than today's standard. So in their efforts to cushion the fall of a few, advocates of this reform would raise costs on an untold number of future mortgage seekers.

Cram downs might not even provide security to those in risk of default. Changing the terms of a loan provides no assurance that the homeowner will not default at a later date. Moreover, recent research by the Federal Reserve Bank of Boston suggests that subprime borrowers are particularly susceptible to fluctuations in home prices. The end result of assistance may be to prolong the problems in the subprime market by extending the opportunity for borrowers to borrow to the point of default.

Only in Washington, where a billion dollars is treated as pocket change, could a change affecting millions of current and future homeowners, as well as the stability and success of the entire mortgage market, be referred to as "a tweak."

In recent congressional testimony on the economic stimulus package, Congressional Budget Office Director Peter Orszag noted that mortgages are treated differently than other property in bankruptcy, specifically to provide benefits to consumers: "The rationale for the current differential treatment of residential mortgages is that exempting mortgage debt from reduction [in bankruptcy] would lower mortgage interest rates and encourage homeownership." Mr. Orszag predicts that such a change in the bankruptcy laws will yield higher mortgage rates.

Not only does this upend more than 100 years of public policy promoting homeownership, it also raises important questions about the sanctity of contract. "The definition of injustice is no other than the not performance of covenant," wrote Thomas Hobbes in "Leviathan." Yet now, it seems that some in Congress want to enshrine breach of contract into the law itself, ostensibly in service of assisting the nation's homeowners. Such a move would not serve homeowners in the least, but it would surely be an injustice.

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Mr. Armey, Republican majority leader of the U.S. House of Representatives from 1995 to 2001, is chairman of FreedomWorks.