Bankruptcy attorney Steve Smith blogs at ‘The Concerned Troll‘ and when he did this post on the surrent state of play in bankruptcy law, I asked if we could crosspost it here. We’ll be discussing these issues more in the coming few weeks.
by Steve Smith
When last we left the thorny subject of the current real estate implosion and its relation to bankruptcy law, the House of Representatives was considering legislation that would relax the current draconian restrictions on homeowners in filing Chapter 13 bankruptcies to stave off the Repo Man. The bill passed through sub-committee last month, and two weeks ago the Chief Economist for Moody’s Corp. testified before the Judiciary Committee that one provision of the bill, which would permit the courts to modify the terms of a home mortgage, would save up to a half-million homes from being lost in foreclosure over the next year and a half.This is such a sensible reform that I can hardly believe it has any chance of passing through Congress, let alone getting signed by the President. It would reamortize the secured amount of a home loan at the appraised value of the home, permitting homeowners to treat oversecured mortgages as unsecured, the same way owners of vacation homes and rental properties, of commercial real property, and family farmers can under the current law. It would also permit repayment plans that exceed the current five-year limit, and end the worthless requirement that debtors seek credit counseling as a precondition to filing a bankruptcy.
To those reforms I would add three others: raising the debt limit on Chapter 13 filings; eliminating the barrier that prevents homeowners from receiving discharges in Chapter 13 when they have filed a Chapter 7 within the last four years; and ending the presumption of abuse element. The current limits (just over a million dollars in secured debt, and just under $337,000 for unsecured debt) are particularly arbitrary for middle class homeowners, many of whom made the mistake of borrowing against the artificial rise in the value of their homes just before they needed hospitalization, or had a high judgment imposed against them or their business. The elimination of the 4-year barrier on Chapter 13 filings should be self-evident in this economy; many of the people who filed bankruptcies on the eve of YBK in October, 2005 also own homes, and not allowing them to save their homes would be unfair. And the presumption of abuse element, always the most controversial aspect of the 2005 law, forces many homeowners who simply wish to walk away from their property, into Chapter 13 (or its very expensive cousin, Chapter 11), benefiting no one, least of all the banks that are prevented from foreclosing by the automatic stay.*
But as I said, its chances for passage are dim, at least until after the 2008 election. Few Republicans in either house of Congress back the measure, and even if it gets out of the House, the likelihood that the Democrats could invoke cloture in the Senate, or even get a majority to support such reforms, is bleak. And by the time another session of Congress decides to act, the devastation to the economy that will no doubt be caused by the upcoming landslide of foreclosure sales will have already occurred.
*Its stated purpose, to discourage filings by middle and upper class debtors, has failed miserably; in the Central District of California, less than one percent of all affected cases get dismissed, in spite of all the time and paperwork the statute imposes.
It seems to me that the bankruptcy laws that were passed a few years ago were not thought through. It is important that the consequences of bankruptcy be particularly onerous to the lender as well as the borrower. The lender goes into a loan transaction taking a risk to make a profit. I think too much focus now and at the time of the passage of the most recent bankruptcy laws was put on the dastardly debtors. As we see in this latest situation, lenders are as culpable if a loan goes bad as the borrower is. At the very least, lenders should pay a price for faulty due diligence
The claause is question makes no sense from neither a moral nor a economic standpoint.
There are many ways around this law, if you have enough money. One of the simplest is funnel money out of one corporation and into the others, and consolidate debt in that one, and then have the corporation declare bankruptcy instead of you personally. But that doesn’t work unless you have enough resources to hide the corporate shuffling.
So anyway, why would republicans not like the bill as it stands? The GOP passed this bill when they were in control, and this was its intended result. What’s not to like about it?
Why should the US government bail out middle-class deadbeats who can’t pay their bills?
The underlying economic flaws of ‘bailing out’ either debtors or lenders thoroughly trump legalistic debates over this (or that) variation of bankruptcy law.
Every debt is eventually repaid, by the borrower, by the lender, or (unfortunately these days) by productive taxpayers. Easy money and relief from economic mistakes each serve to ‘subsidise’ stupid economic decisions and poor allocation of capital.
As a result we are gradually moving towards the economic equivalent of the California fires — if (year after year) you don’t allow the underbrush to be burned out in a series of small fires, eventually the mass of dead wood becomes large enough that some spark sets off a true conflagration.
Lenders don’t want to be in the real estate business, so they’re actually quite reluctant to foreclose. As it is they can renegotiate a deal. If they have to foreclose, let ’em take the hit.
On the other end of the equation, home ‘owners’ — if that’s what you can call someone who took out a 100% interest only ARM against a house that was dreadfully overpriced in the first place — should NOT be relieved of the consequences of their decisions. Many, finding themselves seriously upside-down in the house have simply elected to toss the keys on the lender’s desk by not making payments.
Should they, too, not face the consequences, even to the point of losing everything and finding themselves in Section 8 housing somewhere? If they have a job and finally develop a bit of financial maturity, they should make out just fine with a Chapter 13, even if they can no longer live in the (borrowed) lifestyle to which they had become accustomed.
And then, through it all, what the hell is anybody doing lending to recent bankruptees of any sort in the first place? It’s crazy, and all the legal tinkering around the edges will only make things worse.
If we don’t stop covering for people’s financial mistakes they’ll continue to make ever more of them. When that coverage comes through the government we’re gradually transferring resources from stronger hand into weaker ones, which is the exact opposite of what we should be doing.
My preferred bankruptcy reform would be a repeal of the last reform. Steve Smith’s three reforms seem sensible.
I don’t understand the appeal of the mortgage bill. It would appear to reduce mortgage payments so that more money can go to paying unsecured (credit card) debt. I think the secured lender took certain risk in loaning money on a house, namely that the value of property can rise and fall and circumstances may require its value to be realized at an inopportune moment. The bill would appear to require that inopportune moment to be now. (Secondary issue, would “officially” devaluing these home have its own negative implications?)
I would much prefer legislation that made sure that homeowners get an opportunity to negotiate prior to foreclosure. I agree with Bart Hall that the mortgage lender has every interest in doing so anyway.
It is a political year. I cannot believe that the Republicans will pull a Herbert Hoover and not agree to some plan that at least appears to keep “people in their homes.” There is absolutely no political future doing otherwise, but this clique of ideologues we have in power now might be dumb enough to stand on “principle”.
I also think it is going to be very difficult to do otherwise when the Feds have to bail out the financial industry from what could become a total catastrophe in the global debt markets.
We have had two interest rate cuts and the market is still tanking. The debt market is awash in uncertainty. Since nobody has yet to come clean on how deep they are in the sub prime crisis. The housing boom that propped up the economy for years is now dead in its tracks. The dollar is falling precipitously.
All we need now is a 2% to 3 rise in unemployment, which in these conditions is not out of the question and we have a perfect storm. Getting tough with “homeowners” could keep the Republicans out for office for decades.
The best thing that could happen for the Republicans is for there to be a waive of investigations and indictments against lenders. Politically, they are the ones that have to take the fall. Home owners and employed people equal votes for the Republicans. Foreclosure and unemployment equal votes for the Democrats. The ill conceived 2005 bankruptcy law changes, will paint the Republicans as Simon Legree’s if things start to go any further south.
The problem with analyses of the incentive of the mortgage lender to negotiate is that it ignores a fundamental fact of the industry, that in the bulk of the cases, the mortgage lender does not have an incentive to negotiate because of the existance of mortgage insurance. Mortgage insurance, often called “PMI” because of the initials of one of the larger insurers, insures the lender for the revenue of the loan.
It is not until the mortgage insurer is involved, usually far too late for the borrower to have any realistic chance of becoming current, that there is in the deal the actual entity that will take the direct financial consequences of foreclosure.
#7 from Robin Roberts at 8:39 pm on Nov 11, 2007
Is mortgage insurance that universal? I know it is mandatory in California, but I am not sure it is everywhere. With the absolutely fly by night aspect of the sub-prime market in general, I could see a lot f these loans not having insurance. After all, the whole point of the process was to get a house spending the least money possible.