Bankruptcy Bill May Unsettle Mortgage Markets

Implications: Legislation moving in the House and Senate may have significant adverse impact on the mortgage markets, hurting both mortgage lenders such as Washington Mutual, Countrywide, Wells, HSBC.  Companies holding MBS portfolios will also be hurt, including Goldman Sachs, Bear Stearns and Merrill Lynch.  The bill would apply retroactively to upset settled understandings of the rights of mortgage holders in bankruptcy proceedings.  As a result, mortgage rates will have to reflect the additional risks and outstanding mortgage-backed securities will lose value.

Analysis: Bills in both the House and Senate would amend the Bankruptcy Code to permit a debtor in Chapter 13 to submit a plan to restructure mortgage debt.  The new provisions would authorize the court to declare the amount of the debt in excess of the market value of the home as unsecured, would allow the debt to be paid off over an additional 30 years, and would permit the court to set the interest rate over this period.  The debt would not have to be amortized over the life of the loan, thus permitting the plan to provide for 30 years of small payments followed by a balloon.  The performance of MBS will be adversely affected as the debt backing these securities will be re-structured with new payment streams and new interest rates.  Mortgage originators will have to price mortgages to reflect the added risk.  While it is not certain which version of these bills will ultimately pass, some legislation in this area is likely, especially as foreclosures begin to increase next year.