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President-elect Obama is meeting with economic advisors today, and you have to believe that the housing crisis will be pretty high on the agenda.

What a lot of folks in the mortgage industry, however, are not high on is the proposal to allow bankruptcy judges to modify loans. This proposal was actually ripped out of the Housing and Economic Recovery Act passed over the summer, because it was a deal-breaker for President Bush. But it is is listed as one of the four main tenets of Obama's housing plan.

So what's wrong with it? Well, here's the take from the Mortgage Bankers Association:

Granting judges this power would throw into question the value of the collateral that backs every mortgage made in this country—the home. In response, investors—to offset the risk of a judge unilaterally modifying the loan—would require an additional risk premium and thus lenders will be forced to charge higher rates, require higher down payments and charge higher costs at closing. All these costs would be borne by the borrower.

The mortgage bankers claim that mortgage rates would increase by at least one and a half points.

But proponents argue that bankruptcy judges already have the ability to modify the terms of other debt, including car loans, to help individuals who file for bankruptcy protection from creditors get back on their feet. So why not homeowners? Also, the proposal would make the new law only apply to loans made before its enactment.

In a January 2008 report from the Congressional Budget Office entitled Options for Responding to Short-Term Economic Weakness (obviously it wasn't clear that long-term economic weakness was ahead), researchers write:

Allowing bankruptcy judges to modify the terms of mortgage loans would give distressed homeowners another avenue for shedding burdensome debt. It might also give mortgage lenders a greater incentive to restructure debts outside of the bankruptcy court system. From one perspective, furthermore, it would eliminate a current preference for mortgage debt relative to other types of debt among lenders and thereby possibly help avoid future excesses in the mortgage markets. It could, however, add to the caseload of the bankruptcy court system, causing delays in resolving cases.

President-elect Obama is clearly for the proposal, and with a majority in both houses of Congress, it is more than likely that this could happen once he takes office. Until then, the foreclosures continue to mount, as the current administration still mulls how exactly they're going to use some of that $700 billion to help troubled homeowners and right the housing market. 

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