I. The Growth Of Government-Held Debt
The managing director of Economics1, a nonpartisan policy-research institute, reports:
In reviewing the latest Fed data, Investor’s Business Daily noticed that the total amount of government-financed consumer credit (the vast majority of which is mortgages) stood at $6.3 trillion, just slightly below the private sector’s total, $6.5 trillion. As recently as 2006, the private sector far outpaced the government: $8.5 trillion to $4.4 trillion.
Christopher Papagianis, House of Doubt, NATIONAL REVIEW, Aug. 15, 2011, at 21.
In addition, the various bailouts that have not been repaid mean that the government holds a great deal of non-consumer debt. For example, Mark Modica of the New York Post observes:
Taxpayers still own about 26 percent of GM, and it looks increasingly unlikely that they’ll ever get their money back: The share price would have to rise to more than $54, and it’s stuck in the low thirties.
Most important is the enormous debt the feds owe foreign countries who hold American debt – most notably, China. Moreover, the recent battle over raising the debt ceiling led to the downgrading of American debt, and the subsequent current scramble to lower the federal deficit, suggests we may be nearing the point at which the feds will no longer be able to fund any more bailouts.
With the reliability of the banks in question, is it any wonder that the loan modification has failed to produce the hoped for results?
II. The Bankruptcy Option
Bankruptcy is a federal law option that is administered by the federal government through the bankruptcy courts and the U.S. Trustee’s Office. Therefore, the cost is already part of the funding of the judiciary and the Justice Department, so there is no need for large subsidies or bailouts. Moreover, unlike the programs I discussed in the previous post, there is no doubt about the constitutionality of the bankruptcy system: it is explicitly authorized in article I, section 8, of the U.S. Constitution.
How does bankruptcy help a homeowner deal with mortgage problems?
A. Chapter 7
If the homeowner is way behind on mortgage payments, Chapter 7 will not save the house. If the debtor has been unable to make the payments, a modification will probably not change that. The best a modification will do – if it is even possible: the track record is poor – is postpone the inevitable foreclosure. However, Chapter 7 provides some important protections.
1. The Automatic Stay
The filing of bankruptcy papers triggers the automatic stay of 11 U.S.C. § 362(a), which stops the foreclosure process dead in its tracks. If the lender wants to resurrect the foreclosure, it must obtain the bankruptcy court’s permission by having a motion for relief from the automatic stay granted. This can take at least a month, giving the debtor time to find alternate housing.
2. The Discharge
Although the lender still retains a security interest in the property, the debtor’s personal liability is extinguished when the Court issues the discharge. Therefore, even if the debtor eventually loses the house in foreclosure, there will be no post-sale liability, either to the lender, or to the taxing authorities.
B. Chapter 13
The automatic stay applies to any bankruptcy, not just Chapter 7.
1. Catching Up On Mortgage Arrearages
Chapter 13 involves a multi-year partial debt repayment plan. If the debtor is behind on the mortgage, the arrearage can be included in the plan. Thus, the debtor can spread the arrearage repayment over several years. However, the arrearage must be paid in full, plus contract interest, since the debt is secured by the debtor’s home.
2. Stripping Off A Second Mortgage
A Chapter 13 plan can modify the rights of secured creditors, unless the collateral is the debtor’s primary residence, or a car purchased within the 910 days prior to filing. This doesn’t sound too promising for a home mortgage.
However, if the current fair market value of the house is less than the current balance on the first mortgage, the second mortgage has no house behind it. In this situation the second mortgage is de facto unsecured and can be treated like credit card debt. At the completion of the plan – every Chapter 13 plan payment must be made for this to work – the second mortgage is gone, even though the second mortgage holder may have been paid chump change. This serves as a sort of super second mortgage loan modification, that is unavailable in either Chapter 7, or in the programs discussed in the last post.
C. Chapter 11
Everything I just said about Chapter 13 has an analogue in Chapter 11. However, Chapter 11 is best avoided by the average consumer debtor because of its complexity and concomitant high cost. The only reason for a consumer debtor to use Chapter 11 is if the debtor’s debts exceed the Chapter 13 debt ceilings of 11 U.S.C. § 109(e) (the gist: secured debts must be less than $1,081,400 and the unsecured debts must be less than $360,475 for Chapter 13 eligibility).
Bankruptcy affords the homeowner much better and more permanent relief than the programs currently being peddled by the federal government. Is bankruptcy the ideal? No. But welcome to the non-ideal world. Real life is messy. Bankruptcy can clean up a lot of the financial mess of life.