November 09, 2007

Reason will not lead to Solution: 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.

UPDATE: Thanx to the good folks at Winds of Change for cross-posting this.

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