A recent LA Times blog (August 10, 2009) by Tom Petruno* highlights the highly controversial and divisive issue being debated in today’s bankruptcy circles. The problem surrounds homeowners with upside-down mortgages (i.e. those whose homes are worth less than they are mortgaged). The current mortgage crisis is systemic and nationwide and affects some 16 million Americans according to the Wall Street Journal. That number is up from 10 million a year ago, or 15%. The solution proposed in California is to offer ‘debt forgiveness’ to underwater homeowners. It also gives a powerful bargaining stick to lenders, by allowing full access to a debtor’s assets in the event that a homeowner cannot meet the terms set forth in the forgiveness agreement. The proposal would also prohibit a homeowner to outright walk away from the home should they be unable to financially survive the new terms of the debt forgiveness agreement.
This proposal, drafted by Harvard professor and former chairman of the Council of Economic Advisers under then President Ronald Reagan, has zero chance of actually becoming enacted. It creates more problems than it solves. As the blogger acknowledges, for the plan to work, bankruptcy laws would need to be changed. As it stands now, it is not possible for a debtor to waive his right to file bankruptcy law because under the current law it is not possible for a debtor to waive his right to file bankruptcy against a particular debt in advance. Any language in an agreement purporting to provide this leeway would be null and void under current law.
Additionally, changing the bankruptcy law to permit this result would be a disaster for many debtors. Life’s every day tragedies such as divorce, loss of job and medical issues will still happen to the well-intentioned people that sign up for this theoretical program, and when they do, it won’t be pretty. Punishing debtors for these ‘life circumstances’ by saying they have to lose all of their property, including the car they need to get to a job to earn money to pay this debt, doesn’t make a whole lot of sense. Moreover, the motivating theory behind this proposal of ‘stabilizing house prices at the present level’ in reality only has a miniscule potential of a 2% fall in housing values. Surely, this proposal wouldn’t have the desired effect on the industry overall for the significant and irreversible damage it would cause to struggling homeowners in need of a more practical and realistic solution.
*(New Mortgage Aid Idea: debt forgiveness but with strings – http://latimesblogs.latimes.com/money_co/2009/08/page/2/)