Saturday, November 29, 2008

Bankruptcy and Redoing Mortgage terms

This was an interesting story. From a legal perspective, bankruptcy courts are courts of equity, and could, conceivably, be granted this power.

But there would have to be some limits. The story presented in this article is very real and the terms of the mortgage smack of fraud which could be rectified by the suggestion being made by Judge Leonard.
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 parts makers still operating because they have used this powerful tool of the bankruptcy process. Lehman Brothers will surely invoke it. 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. I have twice participated in briefing sessions organized by the House Judiciary Committee, where I was lectured by lobbyists for the mortgage industry about the sanctity of contracts. I have listened to their high-priced lawyers make fallacious constitutional arguments based on discredited cases from the 1930s. (This is, incidentally, an industry that is not particularly concerned about its own contractual obligations as it tries, through various Treasury-aided programs, to stay afloat.)
There are a couple of ideas presented here.

First, yes, in certain circumstances, the terms of a mortgage as a long term debt can be restructured, if the debtor can show 1) fraud or 2) inability to pay the current terms.

Second, if any mortgage lender wants government bailout help--see Countrywide--they don't get to oppose any effort by a debtor to restructure the mortgage loan.

Judge Leonard's proposal makes sense, but such a change will result in the flooding of the courts by supposed debtors who simply don't like the terms of their mortgage but othewise are not debtors.

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