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Mortgage, Bankruptcy, Nonsense

Not that long ago I wrote again about the pleas from banking to not allow bankruptcy judges the authority to modify mortgages, in limited situations, to allow people to stay in their homes and avoid foreclosure. See “Mortgage Bankers Association. A Bunch of Whiny Bitches?“.

Today an article in the Wall Street Journal has got me going again. Todd Zywicki wrote a piece titled “Don’t Let Judges Tear Up Mortgage Contracts: That’s the last thing troubled securities markets need.”

This is yet another classic case of how people just do not understand the crisis on Main Street. The last thing I’m concerned about is making sure that the securities market, which has royally screwed themselves and consumers, gets yet another subsidy on the back of average Americans by not standing up and working with their clients, in crisis.

Mr. Zywicki is a professor of law at the George Mason University law and a senior scholar at the university’s Mercatus Center but apparently he’s never had to live on the front lines of consumer debt problems. He should walk in our shoes for a month and see if he changes his ideas when faced with inflexible mortgage companies that do more to take homes than make modifications to keep people in their homes. He apparently does not understand or realize that consumers in debt have no government backed or legal rights to work out a solution to problem debt other than through bankruptcy.

Allowing mortgage modification in bankruptcy also could unleash a torrent of bankruptcies. To gain a sense of the potential size of the problem, consider that about 800,000 American families filed for bankruptcy in 2007. Rising unemployment and the weakening economy pushed the number near one million in 2008. But by recent count, some five million homeowners are currently delinquent on their mortgages and some 12 million to 15 million homeowners owe more on their mortgages than the home is worth. If even a fraction of those homeowners file for bankruptcy to reduce their interest rates or strip down their principle amounts to the value of their homes, we could see an unprecedented surge in filings, overwhelming the bankruptcy system.

While Zywicki postulates that a torrent of bankruptcies will ensue, he is right, but the only reason is because troubled homeowners can’t get any real assistance from their banks and are then left with their only other option, legal protection and assistance through bankruptcy. Oh boo hoo the bankruptcy system would be overwhelmed. Dude, the reason it would be slammed is because just that many people need help and intervention. You see the correlation, people who need help would go for help. So because a lot of people need that kind of intervention we should keep them from it?

Question: What is a reasonable risk premium for an already risky subprime borrower who has filed for bankruptcy and is getting the equivalent of a new loan with nothing down?

In a competitive market, such a mortgage would likely fetch a double-digit interest rate — comparable to the rate they already have. Thus, the bankruptcy plan would offer either no relief at all to a subprime borrower, or the bankruptcy judge would set the interest rate at a submarket rate, apparently violating the premise of the statute and piling further harm on the lender.

But you know why the rates would also increase, because many of these were risky loans to begin with and not appropriate or appropriately priced from the beginning. Don’t whine to me that interest rates would be higher for some if that is the appropriate interest rate based on the borrowers true risk.

If Congress wants to deal with the rising number of foreclosures, it should not create a new mess by converting the mortgage crisis into a bankruptcy crisis. Doing so will open the door to a host of unintended consequences that will further freeze credit markets, raise interest rates for new home buyers, and spread the mortgage contagion to other types of consumer credit. Congress needs to reject this plan and look for better solutions.

Spoken like a true banker pushing the risk elsewhere. Credit markets for people with good credit will not be frozen, interest rates should be raised to a level appropriate to the true risk of the borrower, and if bankruptcy judges could modify mortgages it would allow homeowners to remain in the home, preserving the neighborhood and furthering the consumers ability to repay on their other consumer debt while in their Chapter 13 bankruptcy. What congress needs to do is pass legislation which requires bankers to accept fair, reasonable and sustainable repayment offers from consumers instead of being inflexible and driving people towards Chapter 7 bankruptcy where nobody gets repaid.

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About the author

Steve Rhode

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

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