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Who Needs Bankruptcy Reform?

posted by Elizabeth Warren

When Eric Nguyen, a 3L at Harvard Law School, conducted his research on the disproportionate efforts of families with children to save their homes through bankruptcy, he seemed to be embarking early on a promising scholarly career. But events have made his research intensely relevant to national debates. In an op-ed in today's New York Times he reprises his central findings.  Eric endorses an amendment to the bankruptcy laws that would permit a bankruptcy judge to restructure home mortgages. 

Senator Dodd and Congressman Miller advanced this proposal early last spring, but the lobbyists from the American Mortgage Association fought them off.  Even as the bailout took shape, the banking lobbyists were still calling the shots to block bankruptcy amendments. Not surprisingly, mortgage holders prefer a government bailout over taking the write downs on their bad mortgages.  The McCain proposal offers just that: a payoff on bad mortgages at their full face value. The taxpayers--rather than the investors--would take all the losses. 

Eric's op-ed is timely--but time is running out.



Bankruptcy reform provision could return next year

The amendment would not allow "bankruptcy judges" to restructure mortgages, any more than the current law allows "bankruptcy judges" to restructure car loans. The amendment would allow debtors to propose certain modifications to mortgages in chapter 13 plans. If the proposed modifications conformed to the law, the plans would be confirmed -- end of story. I have never restructured a car loan, and under the amendment (should it pass) I wouldn't restructure mortgages, either.

In an era when judges are immensely unpopular and the administration repeatedly rails against "activist" judges (whatever those are), it's vital not to paint a picture of black-robed eccentrics whimsically playing around with people's contracts. It's vital, that is, if you want the amendment to have a chance of passing.

"Not surprisingly, mortgage holders prefer a government bailout over taking the write downs on their bad mortgages. ... The taxpayers--rather than the investors--would take all the losses."

How simplistic. Mortgage holders are not the guy on the cover of the Monopoly box, pockets bulging with surplus cash. They are highly leveraged themselves, whether headquartered on "Wall St" or "Main St". In overwhelming proportion, through the FDIC or through FNMA/FHLMC etc. "the taxpayers -- rather than the investors" will have to pay out the losses if a mortgage holder defaults on its debt. So it's not remotely a question of shifting loss from "investors" to "taxpayers." It's a question of where in the chain of debtors to position the bailout to minimize the direct and indirect losses to taxpayers. We had a field experiment 4 weeks ago where regulators moved the firebreak back past a big highly leveraged financial institution and it is pretty obvious that that doesn't work.

Anote just came out on the ap.today stating that 1.6.billions of the
bailout money from us the taxpayer's was used to pay bonusses to top
bank executives who is that? isn't anybody in the present adminis-
tration overlooking or watching the banks on how the money is spent
mos banks practice crook policies,they most likely come back to con
gress and ask for more bailout money for all of their wrong policies
I hope someone does something abouy this injustice done on the ame-
rican people,also in other issue the car maker will laugh at the go-
verment rules to provide viable changes in making more eficient ve-
hicles,or stop their overspending, or overproducing gas guzler's car

"Not surprisingly, mortgage holders prefer a government bailout over taking the write downs on their bad mortgages."

An interesting nuance that is rarely understood by those outside the mortgage business is that a broad cram down proposal (such as the bills currently offered by Durbin in the Senate and Miller in the House - and supported by Citi) could actually provide a windfall for the government in the case of FHA and VA loans.

FHA and VA loans carry government insurance which protects mortgage holders from losses in the event of borrower default. However,if the borrower were able to get a principal reduction through the bankruptcy court, FHA and VA would not pay a claim filed by the mortgage holder. In this case, what would actually happen is a private business would be "bailing out" both the borrower and the government!

I doubt that this transference of losses is what the authors of these bills intend. However,without some alterations to the language of the bills (or the statutes that govern HUD and VA), a bankruptcy court could help the government default on its promise to hold lenders harmless for making low cost, low down payment, government insured loans.

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