As congressional negotiators labored over the giant financial bailout plan last week, business leaders saw little to applaud in more than a few of the ideas under discussion, including one that proposed changing the nation’s bankruptcy laws to make it easier for homeowners to downsize troubled home mortgages.

On Sunday, when the head-butting ended and the dust cleared, a well-funded coalition of banking and mortgage industry lobbyists had reason to celebrate. The final bill included no changes in federal bankruptcy laws.

Americans who take out loans to purchase cars, boats and even investment properties can file for bankruptcy protection and have a judge restructure their payments. But that’s not the case with their home mortgages. Since 1978, bankruptcy laws have prohibited judges from adjusting loans on a “principal residence.”

Some Democrats had called for the bailout bill to change bankruptcy laws to permit such restructuring as a way to offer something for Main Street America.


But those proponents -- major labor unions, consumer groups and other pillars of the Democratic Party establishment -- proved no match for a coalition that included the American Bankers Assn., the Mortgage Bankers Assn. and the National Assn. of Home Builders.

Starting with a core of Republicans who adamantly opposed any such change, the coalition persuaded key Democratic leaders in Congress that pushing the idea could doom the rescue effort and endanger the whole economy.

So successful was the effort to portray the bankruptcy idea as a deal breaker that Democratic presidential candidate Barack Obama, while campaigning in Florida last week, said he thought the proposal was meritorious but did not belong in the emergency bailout bill.

Some analysts saw Obama’s statement as a practical recognition of political reality: Republicans would never accept the bankruptcy provision, and the bailout plan was too important to the economy to jeopardize. The Illinois senator’s position drew cheers from business and banking lobbyists and from Republicans.


Consumer and labor advocates consider Obama a friend, but his statement rankled. They say that current law has made it more difficult for homeowners to work their way out of difficult financial straits and that a change in the rules would have eased the crisis for all concerned.

The skirmish was part of a larger war waged on Capitol Hill over the last decade. For years, banking and credit interests fought to make it more difficult for consumers to apply for bankruptcy protection and finally won in 2005, when Congress passed a bankruptcy revision bill.

But the seven-year battle was so expensive and memorable that advocates were reluctant to reopen any aspect of the issue, especially in the midst of an emotion-charged debate over the financial crisis.

To the backers of the change, Obama’s statement was an enormous disappointment. In their view, Obama and the congressional leadership missed an opportunity to amend the bankruptcy code in a way that could have resolved a big part of the current crisis.


“The heart of the current problem is the foreclosure crisis,” said Maureen Thompson, legislative director for the National Coalition of Consumer Bankruptcy Attorneys, which worked with labor and consumer groups pushing the proposal. “It is the foreclosures that caused this economy to go into a tailspin.”

A modification of the bankruptcy law passed in the late 1970s “would allow people to stay in their homes, make their loan payments, stabilize families, neighborhoods and the real estate market,” Thompson said.

The business lobbyists countered that modifying bankruptcy law in this fashion would create “a rush to bankruptcy courts across the country,” as Joe Belew, president of the Consumer Bankers Assn., put it in a letter sent to members of the Senate last week. The Senate version of the bill had included the proposed change.

Republicans on Capitol Hill argued that altering bankruptcy law would raise costs for consumers and businesses and create a boon for trial lawyers, who generally back Democrats. One e-mail from the business coalition to lawmakers warned that inclusion of the bankruptcy provision would exacerbate the current situation.


“Authorizing write-downs of mortgages by bankruptcy judges will increase the risks of mortgage lending at a time when the market is already struggling and this will harm consumers by increasing the cost of credit and reducing its availability,” said the e-mail written jointly by the bankers lobby, the home builders lobby, the U.S. Chamber of Commerce and others.

Although modification of bankruptcy laws was rejected, the compromise bill approved Sunday contained language encouraging help for homeowners. Thompson said that provisions to help homeowners were little different from voluntary homeowner protections already in place.

“My view is that the plan included in the bill is not likely to be effective or fair,” she said. “They missed a real opportunity to help homeowners” and the nation.

Some in the coalition backing the change have indicated they will nonetheless support the bill.


“I will reluctantly hold my nose and support this package,” said Terence O’Sullivan, president of the Laborers’ International Union of North America, who says his members are livid at the idea of using tax dollars to bail out Wall Street.

The failure to include a bankruptcy law modification “doesn’t sit well with me,” he said. “The bankruptcy provision was a big one for us.”

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tom.hamburger@latimes.com


Times staff writer David G. Savage contributed to this report.