Homeowners Lose as Bankruptcy Reform Fails In Senate
Efforts in Congress which would allow bankruptcy judges to change the terms of residential mortgages came to a halt yesterday by a vote of a 51-45. Of the 51 votes against the measure, S. 899 The Helping Families Save Their Homes Act of 2009, 12 were from Democrats, 39 from Republicans. Not one Republican voted in favor of the measure.
Earlier this year the House had passed a judicial relief bill — HR 1107, The Helping Families Save Their Homes Act of 2009 — by a vote of 234-191.
Homes Are An Exception
Bankruptcy judges have the right to reduce and even eliminate creditor claims in virtually all forms of bankruptcy — except when the debt is secured by a prime residence. For instance, if someone is bankrupt and owns a vacation house, a yacht or a private plane the judge has full authority to reduce the size of the debt and change the terms.
You can see this concept at work with the GM negotiations. As The New York Times has reported, the United Automobile Workers union took a substantial cut in wages and benefits in exchange for stock in the company. To clear out old debt it would be necessary for bondholders to also take stock for debt.
“The prospect of a big ownership stake for the U.A.W. in G.M. has angered holders of billions of dollars in bonds, who stand to get only a fraction of the restructured company,” according to the paper. “As for Chrysler, the banks, hedge funds and others that lent it money have been promised only cash, not stock.”
Is this a good deal for bondholders? No. But here’s a worse one: GM goes bankrupt and the judge gives each bondholder a bumper and two pounds of bolts.
Importance
Because mortgage lenders don’t have to worry about bankruptcy courts they have no incentive to modify home mortgages. Alternatively, if they knew that courts could re-work loan rates and terms you can bet that more mortgages would be modified and that the modifications would represent better opportunities for distressed homeowners to save their houses.
Different Deals
Notice that the GM lender and the home lender are treated differently. Both loaned money, both are supposed to get their money back, both earn interest but if it’s necessary to go to the bankruptcy court the GM bondholder is just a creditor while the mortgage lender is a protected species with a debt that cannot be touched.
1996
In fact, home mortgage lenders had no special rights in bankruptcy courts until 1996 when the Supreme Court, under the Nobleman Decision, determined that judges could not change the debts owed to mortgage lenders under The Bankruptcy Reform Act of 1978.
In 2005, a Republican House, a Republican Senate and a Republican President pushed through legislation, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which also gave special protection to credit card companies and required that borrowers get six months of counseling before they could even go to court. Of course, before the six months was up a home was likely to be foreclosed.
Practical Result
The practical result was that bankruptcy relief was closed off to most homeowners while a first loan on a prime residence was to be untouched if a borrower somehow did get into bankruptcy court. At the same time, the banking industry began marketing millions of toxic loans which are now at the heart of the mortgage melt-down.
The chief sponsor of the Senate bankruptcy reform measure, Sen. Dick Durban (D-IL), says that despite the defeat the matter remains open and he intends to pursue it. Given the fast-evolving political and financial changes now underway, the bankruptcy relief measure is hardly dead. Whether it will actually succeed is another matter.
Thinks Might Change
Why might the bill come back with more support? Look at some of the senators from hard-hit foreclosure states who voted against homeowner relief: May 1, 2009Bennet (D-CO), Bond (R-MO), Ensign (R-NV), Kyl (R-AZ), Byrd (D-WV), McCain (R-AZ), Voinovich (R-OH), Specter (D-PA) and Martinez (R-FL). If you assume these folks want to remain in office, then you can see why a new vote might produce a different result.
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