Let bankruptcy help fix bad mortgages
It's a powerful step back to financial stability.
I watched a middle-aged widow lose her home recently. Her story was familiar. She owned her simple brick residence outright until four years ago, when a mortgage broker stopped by and offered her a loan too good to be true. In exchange for taking on a modest monthly payment, she could make some needed repairs and consolidate other debts.
More sophisticated than many borrowers, she realized she was getting an adjustable-rate mortgage. What she didn't realize was that, in the biggest "bait-and-switch" ever pulled by an entire industry, her ARM was not tied to the prime rate or any other index, as adjustable-rate mortgages have traditionally been. Her rate adjusted periodically, ever upward. When it hit 14 percent, her social worker's salary could no longer cover the payments.
I watched this story unfold in court, from my seat in a bankruptcy judge's chair. While a Chapter 13 filing temporarily stopped the foreclosure on this woman's home, it did little more than buy a few months' time.
Under existing law, bankruptcy courts cannot modify the terms of home mortgages. To keep her home, this debtor needed to demonstrate sufficient income not only to make her ongoing payments but also to cover the payments she had defaulted on. Her proposed plan was clearly not feasible based on her salary, so I had no choice but to lift the stay and allow the foreclosure to continue.
Homeowners are the only ones who cannot modify the terms of their secured debts in bankruptcy. Corporate America flocks to bankruptcy courts to do precisely this – to restructure and reamortize loans whose conditions they find onerous or can no longer meet. Airlines are still flying and auto-partsmakers still operating because they have used this powerful tool of the bankruptcy process. But when the bankruptcy code was adopted in 1979, the mortgage industry persuaded Congress that its market was so tightly regulated and conservatively run that it should be exempted from the general bankruptcy rules permitting modification.
How far we have come. For more than a year, a number of legislators, academics, and judges have advocated removing this ban on home mortgage modification to help stem the increasing number of foreclosures.