November 20, 2007 - The House of Representatives is considering a bill that would allow bankruptcy judges presiding over Chapter 13 bankruptcy cases to adjust the mortgages of consumers filing for bankruptcy protection. A similar bill is being considered by the Senate. The bills, which are largely opposed by the banking industry, could save the homes of 500,000 families over the next year. And in what can only be described as a great irony, banks could be major benefactors if the legislation ever becomes law.

Bankruptcy law in the United States was "reformed" by Congress in 2005. Under the old law, virtually anyone could declare bankruptcy. Judges presiding over these cases could adjust the interest rates on mortgages, change the amount of money owed, or dismiss the debt entirely.

For years, banks had complained that judges had too much power over bankruptcy cases and that many consumers were abusing the law. Although this simply was not the case, and there was ample evidence to show that the two primary causes of bankruptcy were job loss and unexpected medical bills, the banks lobbyists won their argument.

Under the new law, those filing for bankruptcy protection have to pass an income litmus test. If you make too much money, or have too many assets, you can't file for Chapter 7 bankruptcy - the type which allows a judge to dismiss all of your debts. In this case, you have to file for Chapter 13 bankruptcy.

Those filing under Chapter 13 are put on a strict budget by the court and must make an effort to repay all or a portion of what they owe. And while the new law will bring any current foreclosure proceedings to a halt, it does not allow judges to adjust mortgage interest rates, the amount of money owed, or the terms of the mortgage on someone's primary residence. This means that anyone filing for Chapter 13 is forced to continue to make their mortgage payments, even if they are not affordable. If they miss one, foreclosure proceedings can start again and there is nothing the court can do about it.

The legislation currently being considered would change this. It would allow judges to intervene to help save the homes of those filing for Chapter 13. They would be allowed to adjust the interest rates on loans and the amount owed.

It may not surprise you to learn that banks don't like these proposals. But it may be just as surprising to learn that banks are likely to benefit from them if they become law.

As previously mentioned, banks and other lenders lobbied very hard to get the current bankruptcy law passed. But since August, when their started to be real problems in the mortgage industry, there has been growing evidence that the new law is actually hurting lenders. This is because consumers are now paying their credit card bills instead of their mortgages. In many cases, consumers have come to the conclusion that there is nothing they can do to keep their home, but they can at least keep their credit cards.

If this trend continues, many banks will wind up owning large portfolios of single family homes. They will have to sell these at a substantial loss, and they may find it very difficult to find buyers given the fact that mortgages are much more difficult to get now than they were just six months ago. It is in virtually everyone's best interest to reduce the number of foreclosures that will occur over the next year. This is especially true for banks.

The argument that many banks are using against the legislation is the same one that they used to get the new law put into place: That consumers will abuse a change in the law. They also argue that lenders and investors shouldn't have to bear the costs associated with such a change in the law. But the truth is that the lenders and the investors in subprime mortgage backed securities are going to bear that cost, as they should. The lenders are the ones that came up with risky lending products that they actively advertised to consumers. Now they don't like the market conditions that they were actually responsible creating. And the investors in subprime mortgage backed securities just added more fuel to the fire.

There is no question that lenders and investors will be hit with the costs of problems in the current mortgage markets. They will. The only real question is whether or not these problems will be made worse as hundreds of thousands of families lose their homes. If Congress does pass this legislation, it will help stabilize mortgage markets and property values nationwide. And from this absolutely everyone, including lenders and investors, will benefit.

by Jim Malmberg

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