An oldie but a goodie: If my blog will be remembered for anything, it will be for accurately predicting the collapse of the real estate market back in 2005, and the role that the passage of the 2005 Bankruptcy "reform" act (or BARF, as it has come to be known) in exacerbating the crisis. How badly the GOP-enacted law screwed things up, however, can best be seen in a more scholarly paper recently published by UC Davis, and co-written by Wenli Li, Economic Advisor to the Federal Reserve Bank in Philadelphia. The conclusion:

Before 2005 bankruptcy reform, homeowners in financial distress could use bankruptcy to help save their homes. Homeowners could have their unsecured debts discharged in Chapter 7, thus freeing up funds to make their mortgage payments. Homeowners who were in default on their mortgages could stop foreclosure by filing under Chapter 13 and could use Chapter 13 repayment plans to repay their mortgage arrears over several years. Most homeowners who filed for bankruptcy were not obliged to repay anything to their unsecured creditors.

But the 2005 bankruptcy reform made filing for bankruptcy less useful as a save-your-home procedure. Debtors’ cost of filing increased sharply after the reform. Also the homestead exemption in bankruptcy was capped at $125,000, thus making it impossible for homeowners with high home equity to keep their homes in bankruptcy. A new “means test” increased higher-income debtors’ obligation to repay their unsecured debt in bankruptcy.

Because these changes reduced homeowners’ gain from filing for bankruptcy, they reduce default rates on unsecured debt. And because homeowners’ ability-to-pay is fixedin the short-run, these changes are predicted to increase default rates on mortgages. In the paper, we test whether adoption of the 2005 bankruptcy reform led to higher rates of mortgage default. We use a large dataset of prime and subprime mortgages.

Our main result is that bankruptcy reform caused mortgage default rates to rise. Comparing default rates three months before versus after bankruptcy reform, the increase was 36% for prime mortgages and 11% for subprime mortgages. Using a longer period of one year before versus after the reform, the increase was 50% for prime mortgages and 7% for subprime mortgages. Homeowners subject to the cap on the homestead exemption were 50% more likely to default after the reform, regardless of whether their mortgages were prime or subprime. Homeowners with subprime mortgages were 13% more likely to default if they were subject to the new means test, but default rates of those with prime mortgages did not change.

The study uses a lot of complicated mathematics to make its point, but its well worth browsing through if you have the time.

Perhaps a more devastating land mine, however, is something that was hatched by the lending industry, at roughly the same time they created default swaps and high-risk adjustable rate notes. The Mortgage Electronic Registration Systems, or MERS, was invented by Big Banking as a way to cut costs on the production of legal documents, specifically recording deeds. In real property transactions, ownership is usually shown through the public recordation of deeds, which create a chain of title proving that the person who claims to be the owner has a legitimate case, based on a series of orderly transactions dating back to Adam for all to see. At the same time, any party that has a lien on property, whether it be from a mortgage or some other debt, can also record, thereby establishing a priority based on when the lien was recorded.

Of course, recording anything with the county costs money. The almost-entirely unregulated process of lending money to prospective homeowners, the fruits of which we have seen in the insane rise and precipitous fall of the market in the last five years, generated increasingly complicated arrangements by which trusts involving multiple investors financed these high-risk notes, which would then be bought and sold to other investors. A very complicated system, indeed, which was how MERS came to be.

The idea behind MERS was that rather than generating a new document every time a loan was transfered, and thereby having to repeatedly record (and repeatedly pay fees) mortgages, an entity would be created that would take on the role of "holder of the lien" as a "nominee" of the actual note holder. The lender would collect money from the homeowner, but if the borrower ever fell behind, MERS would step in, and initiate the foreclosure process. MERS, however, is never actually the note holder, has no right to collect money on debts, and has no privity of contract whatsover with the parties to the homeloan.

Which is problematic, since MERS does not otherwise have anything resembling a right to participate in foreclosures, and courts are increasingly rejecting their attempts to proceed on the sixty million mortgages to which they "hold title." In Kansas, for example, the state supreme court recently held that MERS had no standing to pursue foreclosures, and courts in that state have effectively given a free pass to homeowners whose loans were originally held in the name of MERS. It's a slip-up that has effectively put the brakes on foreclosures based on loans generated after 2005, since the right by MERS to foreclose can be challenged even after a sale has occurred; even in states where MERS' claim for standing has been upheld, the threat of litigation challenging it's right to foreclose has suddenly made the option of modifying the underlying loan to terms that better suit the borrower more palatable, and certainly better than anything dreamed up by the Obama Administration.

In this month's always fascinating Central District Bankruptcy News, we find out:

1. Fatburger, IndyMac Bank, and Lenny Dykstra have recently joined the Realm of the Financially Undead;

2. Bankruptcy has gone up 70% in the LA Area over the first eight months of last year; Chapter 13's, the favored avenue of homeowners threatened with foreclosure, is up 56%. Nationally, the number of Chapter 11 filings has nearly doubled over the same totals from last year; and

3. The Courts are closed on Columbus Day. Is that still a holiday?

"It was the big cop, Calahan, that did this to me. I have rights !! I have rights !!"

I think that's how the line went in Dirty Harry. That scene, where the serial killer is being wheeled into a hospital after having just been beat up, comes to mind when I hear the whining coming from the dissenting creditors in the Chrysler bankruptcy. As it turns out, the speculators are going to make out like bandits anyway (come to think of it, the Scorpio Killer hired a third party to beat him up), and now that the judge has all but validated the sale, telling the dissenters to put up or shut up by matching or bettering the deal made by Fiat, it's impossible to say that they're "getting screwed."

Lastly, arguments that this is somehow contra to precedent or some sacred analysis of holy bankruptcy text are forgetting two essential points: first, minority interests in a class get the short end of the stick all the time; and second, even if the sale were to be defeated, and Chrysler was forced to propose a Chapter 11 plan rather than a quickie sale, the speculators would likely have their secured liens stripped (ie, treated as unsecured debt), since the corporate assets are almost certainly insufficient to repay all the secured claimants. For the speculators to get more than what they are being offered right now, the bankruptcy would have to be converted to Chapter 7, and the assets of Chrysler liquidated. Filing a bankruptcy, then selling the company to a third party right off the bat, happens all the time, and its up to the legal system to determine whether its in the best interest of the company and its shareholders.

Liquidation of the company may, in the long run, be the optimal result. But with the Chapter 11 process only now beginning, our legal system is going to allow Chrysler some time to see if it can reorganize. Contrary to what many on the right may have thought, bankruptcy is not automatically a system designed to screw uppity workers and their pensions; it is a set of rules and procedures geared to allow people and companies a fresh start. As libertarian editor Matt Welch puts it, better to give the "controlled force of bankruptcy" a chance, and let Fiat try to sell Jeeps for awhile.

UPDATE [5/7]: Mickey Kaus responds, asking why it was necessary for the government to allegedly "strongarm" the creditors into accepting the sale to Fiat without letting the bankruptcy run its course and simply let the judge do the strongarming. Perhaps the best answer to that is that there is well and truly a new sheriff in town, one who is not going to bend over for the interests of Wall Street. Indeed, Presidents make decisions to intervene (or not intervene, which would have the same effect on the parties) in corporate reorganizing all the time, but usually, its the union and its worker that feel the pressure to surrender their position. The law hasn't changed, it's the scales of justice that are tipped differently.

With this President, any resolution that keeps the company afloat is going to be less-disadvantageous to the workers, and the major creditors (as opposed to the small-time speculators who are challenging the sale) saw the writing on the wall: either give up some of their position, or prepare to see the company liquidated, and their position completely wiped out. Quickly resolving the Chrysler situation allows the company to get back to selling cars quickly, and allows the creditors of the company a chance to recoup some of their losses. And since the judge has (so far) approved of the procedure to quickly sell the company to Fiat, any allegations of "strongarming" by the President should be viewed skeptically, even if "strongarming" was in and of itself a bad thing.

American Royalty:

On Thursday, the Senate took up the issue of whether to eliminate the exception in the Bankruptcy Code which allows mortgage lenders to prevent the bifurcation of certain of their loans into secured and unsecured portions in bankruptcy, or in plainer language, the “cramdown” legislation. It was defeated, 51-45, with a dozen Democrats voting to preserve the Carter Era Valentine to the nation’s bankers. Ironically, it was the most liberal wing of the Democratic Party in the Senate who came out most passionately for the principles of Free Market capitalism, whilst their conservative counterparts on both sides of the aisle voted to maintain the subsidy.

Inevitably, the cramdown legislation voted down will pass, if not in this Congress, then at some future time, since the current law represents governmental protectionism at its most illogical and nonsensical, a business subsidy without rhyme or reason. To understand why, it is helpful to examine the absurdity through an example.

Let’s say an individual buys five identical properties. Each property is the same acreage, contains the same square footage, rooms, and looks exactly the same. Each property looks exactly the same, in fact, and is able to obtain identical mortgages for each property, a thirty-year adjustable-rate mortgage for $200,000.

However, the purchaser decides to use each of the properties differently. One property is going to be his home, where he and his newlywed bride will live out their days, surrounded by their 2.5 children and a lifetime of memories (they hope). As his family grows, he desires to build an extension to his home, so he takes out a second mortgage for $50,000. The second property will be rented out to tenants. His mother-in-law will live, rent-free, in the third home, while the fourth home, overlooking the Pacific Ocean, will be used as a vacation home for his family. Lastly, the fifth property will be used as his office.

Hard times ensue. His wife’s last pregnancy was a difficult one, and her hospitalization lasted longer than normal. Moreover, she had to take longer maternity leave than before, so the family income went down significantly. Not surprisingly, her HMO didn’t cover much of the costs, so he had to max out their credit cards to pay for her hospitalization. To make matters worse, his largest client went to a competitor, and now his business in drowning. He falls behind on each of the mortgages, and a foreclosure date is set. The value of each of his properties falls 40% in two years, leaving him unable to use his investments’ equity to cover his bills. Finally, after trying to scramble, scrimp, save and borrow for a year or so, he has to bite the bullet, and see a bankruptcy attorney.

After reviewing his assets and debts, his attorney sees a potential way out for his new client. In Chapter 13, a debtor may reorganize his position by repaying certain debts over a period of time. The procedure is relatively simple and quick, provided he is able to restructure his secured debts (ie., his mortgage) in such a way that he can repay the amount he has fallen behind. He is confident that his business will recover; he just needs a little breathing space. To make it work, however, he will have to seek a complete discharge of his unsecured debt, such as his credit card bills.

The reason why bankruptcy courts treat secured debt differently from unsecured debt is obvious. A secured creditor gets a lien on the property purchased by the consumer so as to make a loan in which only a small percentage of the overall principal is advanced by the borrower viable; if the borrower defaults, the lender gets the physical asset, which it can resell and thereby recoup its losses. In bankruptcy, the lender’s security interest in the physical property is protected, while anything above the value of the actual property (ie., the unsecured portion of the debt) is discharged, along with the other unsecured debts. In short, it is the free market’s way of ensuring that both the borrower and lender bear an equivalent risk. Bankruptcy lawyers call it a “cramdown.”

When the real estate market is stable, lenders rarely have anything to complain about. Since the value of property has historically gone up, the amount of the loan is usually at or below the appraised value of the property, so even if the borrower defaults, the lender doesn’t lose anything on his investment. Bankruptcy courts have traditionally honored the free market tradition of bifurcating claims from lenders into secured and unsecured portions, and explicitly give debtors the right to modify said claims in the context of reorganization of debts in Chapters 11 and 13, with one exception.

For our friend, his attorney proposes that he bifurcate the secured claims on his real properties. Concerning the property that he lets his mother-in-law live rent-free, the property his business operates out of, the property he rents out, and the property where his family summers every year, he can propose a plan in which he will repay the loans at the secured level, based upon an appraisal for each property. He keeps each of the properties he wants to keep, so long as he repays the secured portion over a five-year period. The one property he cannot do that for, and for which he will still owe the entire amount of the mortgage, secured and unsecured alike, is the property he lives at, his “principal residence.”

But even that’s not entirely true. Remember when he obtained a second mortgage on the property a few years before things went south for his family. He can get rid of that debt easily enough, simply by showing that the appraised value of the home is less than what he owes on the first mortgage, making the second completely unsecured. Many courts permit the vanquishing of such a debt to be accomplished with no more than a motion to the court, seeking declaratory relief that the value of the property makes the second lien totally unsecured. It’s only the first mortgage that receives privileged status in the bankruptcy court.

It is hard to justify giving certain loans special treatment in our courts. In the case of our friend, the lenders had no idea which property he was going to declare, on the eve of bankruptcy, was his “principal residence.” They simply loaned him the money, making what were presumably sound judgments based on his credit history, his ability to repay, the long-term predictability of the value of the properties, and other factors. In fact, had he and his family simply moved in with his mother-in-law’s estranged husband, they could cramdown all five properties under the existing Bankruptcy Code. Such are the advantages of property ownership and wealth in this society.

But of course, most people aren’t able to purchase five properties. For the ordinary Joe Schmoe, it’s hard enough to come up with one payment, much less five or six. Unless he is willing and able to move out of his home on the eve of bankruptcy, thereby allowing him to claim that his “principal residence” is somewhere other than the property he’s paying a mortgage on, he, and he alone out of all real estate purchasers, must repay the entire mortgage in bankruptcy, thereby defeating the purpose of “reorganization.”

Although I agree, generally, with Prof. Warren's advocacy against the 2005 BARF Act, there seems to be a real world perspective missing from her analysis, at least as it applies to the actual practice of bankruptcy law, that causes a blind spot in her writing. Here, she seems to argue that the 2005 law has exacerbated the meltdown of the housing market by making it harder for debtors to file Chapter 7, which enables a person to get a quick discharge of his unsecured debts (ie., credit cards).

I haven't seen much a decline, frankly; most of the people who want to file under Chapter 7 do so anyway, even if their income exceeds the state median, and most of the potential clients I meet who happen to own homes are looking to do a Chapter 13 repayment, not a straight Chapter 7. The reason why there was an initial precipitous decline in bankruptcy filings was due to the YBK panic on the eve of the new law in October, 2005. Everyone who ever thought about filing bankruptcy did so because they were led to believe that the new law would handicap them at the expense of their creditors. If anything impacted the currect credit crunch, it was the panic caused by the pending new law causing tens of thousands of people to file bankruptcy, and discharge debt, at the same time, not that those people can't file Chapter 7 cases now.

Of course, debtors have to jump through more hoops nowadays, thanks to the new law. If a filer's income exceeds the state median income, he is viewed as having presumptively filed in bad faith, which typically means...nothing. In some instances, the attorney will be sent an audit letter from the US Trustee, requiring him to produce certain financial statements and tax returns, as well as justifying certain monthly expenditures. But in most cases, debtors who make more than the median income who need to file Chapter 7 don't have a surplus income, once reasonable expenses are taken into account, and the present-day nightmare of skyrocketing adjustable rate mortgages is making the whole issue moot. According to the local US Trustee, less than one percent of all Chapter 7 filings that fall into this category are ultimately dismissed.

Moreover, Chapter 13 cases have become more routine, in large part because it is a more effective way to deal with secured debt, such as mortgages and car payments. Under Chapter 13, if the value of the home is less than the amount owed on the first trust deed, all deeds of trust that are junior to the first can be treated as unsecured debts, and potentially discharged completely at the end of the plan. Where I practice, this can be done with little more than a motion to the court seeking declaratory relief as to the value of the property; at a time when the housing market has been in free fall, such motions are infrequently opposed by lenders.

And that aspect of bankruptcy was unaffected by the passage of the 2005 BARF Act. That law has proved nothing more than an inconvenience to the experienced practitioner, since it only tangentially impacts a fraction of cases. In large part, that is due to the fact that it was drafted by lobbyists for the credit card industry, not attorneys with actual hands-on experience in the trenches of consumer bankruptcy.

Sure, there are more forms to fill out, but almost every practitioner has electronic forms that can be prepared within minutes. Potential filers have to take a pre-petition credit counseling course, but this step has proved to be ineffectual at providing debtors with non-bankruptcy alternatives, and the suspicion that many of these outfits have a conflict of interest in remaining on the good side of consumer attorneys is not unwarranted. And due to incompetent drafting, some of the more worthwhile provisions of the 2005 legislation, such as the attempt to terminate the automatic stay for repeat filers (which has proved to be illusory in Chapter 7 cases, since the law only halts the stay against debtors, not against the estate itself, which means that creditors still have to waste time seeking judicial relief), have been nullified.

The big winners of the 2005 BARF act, were, not surprisingly, bankruptcy lawyers. Its convoluted provisions took what was one of the few areas of the law that a smart, cost-conscious layperson could do by himself, and necessitated the hiring of licensed professionals at a much higher cost (try to fill out a Statement of Current Monthly Income at home if you don't believe me). And as I noted above, it hasn't done much to stem abusive filings, or check any of the shady abuses that existed before. But one thing the 2005 law didn't do was change how people could use Chapter 7 filings to save their homes, since it simply isn't an effective legal strategy, either before or after the law went into effect.

One of the beneficiaries of the President's stimulus plan: credit card companies. The IRS announced today that those $600 checks being mailed out this month will be considered property of the estate in all bankruptcies filed after the rebate was signed into law by President Bush.

Requiem for February:

An average of 3,960 bankruptcy petitions were filed per day nationwide last month, up 18 percent from January and up 28 percent from a year earlier, according to Automated Access to Court Electronic Records, a bankruptcy data and management company.

February was the busiest month for filings since Congress overhauled the bankruptcy law in 2005. Bankruptcy experts said the rise was particularly worrisome because those changes made filing for bankruptcy more complicated and expensive.

“This number of bankruptcies may be under-representative of the true financial distress consumers are feeling because of the steps Congress has taken,” said Jack Williams, a scholar in residence at the American Bankruptcy Institute and a professor at Georgia State University.

The latest figures show the financial pain is spreading from states like California and Florida, which exemplified the housing boom and subsequent bust, to those along the Eastern Seaboard like Maryland, Virginia and Delaware, which were among the 10 states with the largest percentage increase in filings in January and February. “You are seeing a good-size uptick everywhere,” said Mike Bickford, president of Automated Access.

Bankruptcy experts caution, however, that data from just one or two months can be misleading.

“The monthly bankruptcy filing rate has a lot of cyclicality,” Robert M. Lawless, a professor of law at the University of Illinois College of Law, wrote on Tuesday on the widely read bankruptcy blog, Creditslips.org. Some experts, for example, say bankruptcies often seem to rise in February as debts from the holiday season come due. Even so, the trend is definitely upward, Mr. Lawless wrote. States as disparate as Kentucky and Rhode Island joined the top 10 list, and the absolute number of filings rose significantly.

--N.Y. Times (3/5/2008). In fact, the cyclicality mentioned above normally increases even more in March, April and May, with the X-mas holiday and summer months being the slow time for filings. People like to hang on through the holiday season, max out their credit cards to insure that a Merry Christmas and a Happy New Year is had by all, then file after they get one or two bills behind (something like that also happens during the summer, when it's vacations and weddings for which debtors go all-in).

On the other hand (you knew that was coming), the fact that the number of filings reached a post-YBK peak last month is not particularly interesting. Almost every month since BARF went into effect in October, 2005, has seen an increase; the most noticeable thing YBK accomplished was that it created a panic before the new law went into effect, leading many people who hadn't planned on filing, or even desired filing, to head to the Bankruptcy Court to get their bankruptcy done before the change occurred. In the twenty-eight months since, it has taken the toxic combo of a collapsing real estate market and a massive credit crunch (brought on, in no small part, by YBK) leading to recession that has returned the monthly level of filings to its historic, pre-BARF norms.

Well, thank Kobe we still have brave Senators looking out for the interest of the sub-prime loansharks lenders....

Worth reading: Prof. Elizabeth Warren, on the changing nature of the bankruptcy debate since 2005. It's worth noting again that the measure before the Senate right now, which would permit the modification of mortgage terms on homes by the Bankruptcy Court, is not related to the 2005 BARF Act, which mainly dealt with eligibility. The public revulsion against the earlier measure is almost entirely due to other factors, which the professor spells out in her post.

One of the nice things about having a Democratic Congress (and having a bankruptcy "reform" measure that was sloppily written) is that we don't necessarily have to repeal bad legislation in order to neuter it. Case in point: the most recent budget appropriates nothing to the Justice Department for audits of schedules and statements filed with the Bankruptcy Court. This means that in those situations where a debtor's income exceeds the median income for his state, which is the standard the 2005 BARF legislation established as the template for determining that a presumption of a bad faith filing exists in Chapter 7, there is no way to independently challenge a debtor's claim of legitimate expenses above and beyond the IRS norms.

Bowing to reality, this week the United States Trustee suspended its auditing of new Chapter 7 cases. Considering how badly underfunded Chapter 7 Trustees are (most of whom consider the work to be pro bono, or a loss leader, for their law firm), the presumption of bad faith rule, which was the most controversial part of the BARF, is, for the time being, a nullity.

Having written an op-ed for the LA Times a few years back at the time the new bankruptcy law went into effect, I thought that a follow-up piece, about the ARM-caused home foreclosure boom would be in order. So I penned an offering, focused on the bill sponsered by Brad Miller and Linda Sanchez to allow bankruptcy courts to modify home loans through Chapter 13, and submitted it to the Powers That Be on Spring Street. Where it was quickly (and correctly) rejected without explanation.

Lo and behold, the Times did decide to publish a piece by another writer on the same subject yesterday, a former politico named Jack Kemp. It's an excellent piece, making the conservative argument for a more liberal bankruptcy law:

I applaud the White House efforts to encourage mortgage servicers to modify existing adjustable-rate loans for a limited number of borrowers who cannot afford interest rate resets. However, depending solely on the goodwill of an industry that bears no small measure of responsibility in this crisis is unlikely to be the full answer.

What is missing is a rational and urgent push to help the estimated 2.2 million families in danger of losing their homes to foreclosure in the near future. Congress is considering a small fix that would have more impact on these families than any other option under consideration: temporarily allowing bankruptcy courts to give the same relief to homeowners on principal-residence mortgages that businesspeople get on real estate investment loans, that farmers get on farm loans and that individuals receive on loans for vacation homes, cars, trucks and boats.

Bankruptcy law is wildly off-kilter in how it treats homeownership. Under current law, courts can lower unreasonably high interest rates on secured loans, reschedule secured loan payments to make them more affordable and adjust the secured portion of loans down to the fair market value of the underlying property -- all secured loans, that is, except those secured by the debtor's home. This gaping loophole threatens the most vulnerable with the loss of their most valuable assets -- their homes -- and leaves untouched their largest liabilities -- their mortgages.

In the absence of modification, many of today's loans will result in foreclosure. When servicers are unwilling or unable to voluntarily modify exploding, unsustainable home mortgage loans, Congress has a duty to consider involuntary modification in bankruptcy court, where the same relief is granted on all other secured loans. The proposed Emergency Home Ownership and Mortgage Equity Protection Act being considered by Congress would do just that. It is targeted at only sub-prime and nontraditional mortgages and will be available for only seven years after it is enacted in order to mitigate against the next wave of exploding interest rate resets.

I have a number of other proposals to reform the bankruptcy law to enable delinquent homeowners to keep their homes while paying down their default, here, here and here.

Always look on the bright side of life... Mr. Kaus notes the accelerating decline in home values, and sees a silver lining:

Are you impressed with a "drop in home values of 6.6% over a year? It doesn't seem like such a big correction, given the dramatic run-up in prices over the last decade or so. ... And don't declining prices make housing more... what's the word? ... affordable? ... This evening NBC Nightly News billboarded a "housing CRISIS." (Link available here.) I thought a "housing crisis" was when people couldn't find housing, not when it got cheaper. (NBC's expert: "It's very, very difficult to find any silver lining." No it's not.)

I like that way of thinking, because, on a personal level, I certainly see a "silver lining" coming out of all this, in the way of more clients visiting my office. I suppose morticians get the same feeling every time there's a natural disaster; with bankruptcy lawyers, it's the thought of a member of the Bush family in the White House that gives us some serious wood.

For prospective homeowners looking for bargains, however, I don't think the declines we've seen to date are steep enough either to entice them into making an investment or to lure them into establishing a homestead for their families. And since so much of the economy's growth in the past decade has been the result of people being able to invest their home's equity, the current squeeze isn't a zero-sum game, where a homeowner's loss is a potential home buyer's gain; a 6.1% deflation in home values* means that there is 6.1% less money to pay off other debts, which means more defaults in other areas, which leads to more creditors losing their investments as well. It also means 6.1% less money will now be invested in the stock market, in construction, in tuition, in tourism, and in other branches of the economy that relied on the money people obtained after refinancing their homes.

But I bet it will mean at least a 6.1% increase in bankruptcy filings....

*Based on the twenty largest metropolitan areas. When focused on the ten largest metro areas, it comes to a 6.7% decline. Yikes.

One of my links in the previous post was to a Matt Stoller commentary entitled "Bush Dogs Move to Block Mortgage Reform." "Bush Dog," for those of you not hip to "netroots" lingo, is a term used by bloggers to describe the so-called "Blue Dog" Democrats whose opposition to the policies of the Bush Administration has been rather tepid, to say the least. However problematic I find the position of these conservative Democrats to be on its merits, Stoller's headline is misleading, at least based on the contents of the letter.

As I noted before, there are three provisions to the bill currently before the Judiciary Committee. The bill will permit the bankruptcy court to readjust home loans based on the actual value of the home, not on the total payoff balance of the outstanding mortgages, so that all loans which are above the current appraised value of the home are treated as "unsecured" debts, which can be forgiven in a Chapter 13 plan. It will also allow the payoff of the secured debt on homes to exceed five years, and it will waive the requirement that Chapter 13 filers who are seeking to save their home receive pre-petition credit counseling.

The first two provisions clearly involve a reform of the mortgage system as it has existed for hundreds of years, to reflect the modern reality of ARM's as well as to treat home mortgages the same way the bankruptcy courts treat second homes, investment and rental properties, commercial developments and family farms. The third provision, concerning credit counseling, is the only one that would overturn a portion of the controversial 2005 law (known as BACPA, or by the less elegant name my fellow practitioners have given it, BARF). I happen to believe that the requirement should be dumped altogether; I have yet to see a single instance, either in my practice or in the practice of a fellow attorney, where a credit counseling session led a prospective debtor away from filing bankruptcy. Obviously, a credit counseling service depends on the referrals from consumer attorneys to survive, and a service that actually proposed something that kept a debtor from using our services would cease to receive business from our end.

But opposition to ending that requirement is clearly not the same thing as "blocking" mortgage reform, since it isn't not a mortgage issue; it's a convenience issue for filers. Many people who file Chapter 13's do so at the last minute, so having to speak with a credit counselor before filing can be very difficult. But the courts are divided as to whether the failure to take a class before filing necessitates a dismissal, and even if the case is dismissed, a debtor can turn around and file a second time without too much trouble.

If the "Bush Dogs" are sincere that their only reason for opposition is to not tinker with the BARF Act so soon after passage, then I don't see this letter as problematic in the slightest. Certainly, there's no need to hold up the provisions that constitute real mortgage reform just to get rid of the silly debt counseling requirement.

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.

Prof. Kleiman examines the current fallout from the collapse of the real estate market, and states a rather obvious point, which is that Congress should revisit the 2005 BARF legislation to make it easier for delinquent homeowners to obtain bankruptcy relief. The first place to start would be to modify or annul 11 U.S.C. §1328(f), which forbids filers from obtaining a Chapter 13 discharge if they had received a Chapter 7 discharge in the previous four years (a so-called "Chapter 20"), or another Chapter 13 discharge within the previous two years. Or at least that's what it appears to say; the whole measure seems to have been drafted by the Regent U. Law School after a weekend kegger, and the courts have pretty much thrown their hands into the air trying to figure it out.

Chapter 13s are the preferred alternative for debtors who wish to keep their homes, while paying off the arrearage every month over a 3-5 year period. The standard bankruptcy, under Chapter 7, is geared toward protecting those who are current on secured loans (like houses and cars) but delinquent on unsecured debts (ie., credit cards). Section 1328(f) was designed to thwart those who had defaulted on everything except their mortgage from obtaining bankruptcy relief; a family with high medical debts or huge arrearages on their credit cards could no longer give priority to keeping their home over their unsecured debts, then filing again if their financial difficulties continued to the point that they fell behind on their home. With foreclosures spinning out of control, Congress will have to do something to save the mortgage industry, and the draconian features of the BARF legislation aren't helping.

While we're on the issue of bankruptcy, and the ramifications of the 2005 legislation, here's an interesting way to neuter its negative impact: slash the budget for the entity that's supposed to determine whether a bankruptcy was filed in good faith.

Perhaps the most controversial aspect of the 2005 Bankruptcy Reform Act (BARF) was a provision that created a presumption that debtors who made over the medium income for a state were filing the case in bad faith if they chose Chapter 7 relief. That presumption could be overcome if the debtor were to show that after taking his monthly expenses into account, he would not have sufficient funds to repay at least ten percent of his unsecured debts over a five year period under a Chapter 13 plan. In reality, the presumption is almost always overcome, in large part because debtors who make just over the medium can show that their reasonable monthly expenses easily exceed their gross income, while many of those who make well over the medium have always filed under Chapters 11 or 13.

But it is, nonetheless, a hassle for debtors, who are charged a higher amount by their attorneys (such as me) for the burden of dealing with the U.S. Trustee's office, which has the mandate under the new law to raise the presumption whenever appropriate. That includes analyzing and preparing the schedules filed with the court, demanding further supporting documentation (in many cases, that entails credit card receipts going back a year), and filing motions to dismiss with the court.

This past week, the House Judiciary Committee sent a shot through the bows of the credit industry by slashing the funds available for the UST to enforce the act, stating

The Committee is concerned that excessive resources are being expended on efforts by the United States Trustee Program to dismiss cases for insignificant filing defects (thereby creating added burdens on the court and debtors associated with refilings); on the unnecessary use of U.S. Trustee personnel to participate in creditors' meetings that are already handled and conducted by private trustees; and on making burdensome requests of debtors to provide documentation that has no material effect on the outcome of bankruptcy cases. Such actions by the U.S. Trustee Program are making the bankruptcy process more costly and therefore less available for those who need it. The Committee directs the U.S. Trustees to immediately examine these problems and report back two months after enactment of this Act on efforts to remedy them as soon as possible.

Without funding, the Trustee will have to drastically reduce its investigation of debtors who are above the statewide median, making the controversial provision in the new law a practical nullity. Although I expect much of the funds to be restored, thanks in no small part to a certain powerful Senate Democrat (Biden, D-Visa), this is the first step towards overturning the noxious law. There is most definitely a new sheriff in town.

Three bits of miscellany, for your review: Countrywide Mortgage, one of the nation's largest prime lenders for homes, saw its profits fall by a third in the last quarter, with one out of twenty-two loans now being in default; in Southern California, a record number of foreclosures occurred in the second quarter of 2007, with 17,408 homes being lost, an 800% increase over last year; and bankruptcy filings have more than doubled in the Central District of California so far in 2007.

Of course, bankruptcy filings in 2006 were at historic lows, in the aftermath of YBK and the passage of the new law, and the current totals are still well off the figures from the pre-BARF era. But in some areas of the country, the collapse of the real estate bubble is sparking a renewed rush to the bankruptcy courthouse. Locally, Riverside and San Bernardino Counties are the new hubs of the debt relief bar, as those two rapidly expanding centers of exurban population growth witness a Perfect Storm: an oversupply of housing combined with an accelerating rate of defaults in mortgages, together with a sharp collapse in the value of homes which makes refinancing impossible. Anyone who refinanced since 2002, and/or has an adjustable rate loan, the only thing to do is pray.

Resistance Is Not Futile: A good exegesis of the 2005 Bankruptcy Reform Act (BARF), here. It's a good take on what an honest judge can do to when confronted by a statute drafted by morons:

The problems with the 2005 Act are breathtaking. There are typos, sloppy choices of words, hanging paragraphs, and inconsistencies. Worse, there are largely pointless burdensome new requirements, overlapping layers of screening, mounds of new paperwork, and structural incoherence. These are dark days for all bankruptcy professionals and both judges and debtors' lawyers are on the front lines. Resistance is key to self-respect as well as necessary to keep the system operating in ways that catch abuses while providing bankruptcy relief, at the lowest possible cost, to those who need it.

The main problem with BARF, the article notes, is that it was drafted by the none-too-bright hired guns of the credit industry, who focused primarily on granting their clients' wishlists rather than designing an intellectually consistent (but perhaps politically less palatable) law. By enacting a poorly-crafted law, Congress gave judges the freedom to interpret the law in a manner different from how the credit industry lobbyists and their vassals in Congress may have intended, relying instead on the reasons stated for its passage, on the record (ie., to "protect consumers" and "reduce fraud").

An opinion concerning the blogosphere:

Every conceivable belief is on the scene, but the collective prose, by and large, is homogeneous: A tone of careless informality prevails; posts oscillate between the uselessly brief and the uselessly logorrheic; complexity and complication are eschewed; the humor is cringe-making, with irony present only in its conspicuous absence; arguments are solipsistic; writers traffic more in pronouncement than persuasion.

(snip)

journalism as practiced via blog appears to be a change for the worse. That is, the inferiority of the medium is rooted in its new, distinctive literary form. Its closest analogue might be the (poorly kept) diary or commonplace book, or the note scrawled to oneself on the back of an envelope--though these things are not meant for public consumption. The reason for a blog's being is: Here's my opinion, right now.

The right now is partially a function of technology, which makes instantaneity possible, and also a function of a culture that valorizes the up-to-the-minute above all else. But there is no inherent virtue to instantaneity. Traditional daily reporting--the news--already rushes ahead at a pretty good clip, breakneck even, and suffers for it. On the Internet all this is accelerated.

The blogs must be timely if they are to influence politics. This element--here's my opinion--is necessarily modified and partly determined by the right now. Instant response, with not even a day of delay, impairs rigor. It is also a coagulant for orthodoxies. We rarely encounter sustained or systematic blog thought--instead, panics and manias; endless rehearsings of arguments put forward elsewhere; and a tendency to substitute ideology for cognition. The participatory Internet, in combination with the hyperlink, which allows sites to interrelate, appears to encourage mobs and mob behavior.

This cross-referential and interactive arrangement, in theory, should allow for some resolution to divisive issues, with the market sorting out the vagaries of individual analysis. Not in practice. The Internet is very good at connecting and isolating people who are in agreement, not so good at engaging those who aren't. The petty interpolitical feuding mainly points out that someone is a liar or an idiot or both.

Because political blogs are predictable, they are excruciatingly boring. More acutely, they promote intellectual disingenuousness, with every constituency hostage to its assumptions and the party line.

From WSJ assistant editorial features editor Joseph Rago, earlier this week. Although he's understandably concerned with the effect that blogs have on the practice and craft of journalism (and I concur with much of his criticism over what passes for political blogging), he seems to be missing the point as to why this new medium rocks. With few exceptions, such as Josh Marshall's growing online fiefdom, bloggers aren't in the habit of breaking stories or reporting news, and the third-party interview with a newsmaker is rare. Indeed, bloggers are commenters, akin to the op-ed section of a daily newspaper, where the standard rules of objectivity don't apply.

The blogosphere is an improvement over the ancien regime in two ways. First, it has expanded the universe from which "pundits" are drawn, going beyond the perspective of former journalists, speechwriters and Ivy League academics. To communicate an opinion to a large audience no longer requires a person to have paid dues at a newspaper, or to have attended the Kennedy School, or to have signed on to a political campaign in his youth; anyone who is motivated enough to spend time in front of his computer can opine away. The popularity of blogs stems from the discovery that the opinion of a grad student, or a retired software marketer, or a housewife, or even a West San Fernando Valley bankruptcy attorney, can be as weighty as any of the Sabbath Gasbags.

Of course, the big initial drawback has been to promote those whose violent rhetoric has been more conducive to attracting attention and building a large readership, with the result being what Mr. Rago said, a panoply of angry, dull, predictable and partisan blogs using over-the-top attacks to bully their opponents. As the sad story of Ned Lamont's general election campaign attests, it is a style that is clearly counterproductive. But with thousands of Americans, and hundreds of thousands of Iraqis, indicate, anything that shatters the elitist dominance of our public policy discourse, while expanding the realm of what ideas are considered "mainstream" or "acceptable" can't be a bad thing.

Second, even though the hyper-partisan rhetoric in most blogs can be deadly to the unconverted, not all partisanship is bad, as we can see when we examine the growing online empire of Markos Moulitsas. As any blogger who has a regular readership can tell you, the discovery that there are other people out there who feel the same way you do is a thrilling revelation indeed, and when multiplied exponentially, a site like Daily Kos can do remarkable things with that audience. The story of the 2006 election was that of a reenergized liberal base, taking the battle to the conservative ruling coalition that had governed this country since the late-60's, and against all odds, recapturing control of the engines of government.

This historic victory was accomplished because bloggers like Kos (IMHO, the person whom Time should have honored last weekend) and MyDD provided an outlet for people who otherwise would have felt marginalized by a political system that favors the interests of the wealthy and powerful, and gave them a chance to participate, one Congressional district at a time. These online bulletin boards alerted like-minded readers about needy, often quixotic challengers who needed money, canvassing, and assistance, and helped level the playing field.

In 2004, Kos got bageled in November, losing every race he focused on. This time around, that same energy and focus paid off big time for the Democrats. Bloggers are enabling millions of people to participate in our system of government, much as the old political parties did at one time, and are helping to discard outdated notions of what sort of grassroots politics is effective.

Sorry for the lack of posts lately; I have been quite busy working for a living, and the number of bankruptcy cases has risen dramatically in recent months (thanks, housing bubble !!) Since it is that time of year, I thought this essay by philosopher Peter Singer would be worth reading, on the topic of philanthropy.