“Bankruptcy reform” reform

… belongs on the early Democratic agenda.

If economic security and risk-spreading are to be an overarching Democratic theme, then an early candidate for attention might be undoing some of the damage from the new bankruptcy bill. Certainly, a soldiers-and-sailors-protection bill ought to hit the President’s desk within by the end of January. But I think we should go beyond that, no matter what it costs us in financial-services-industry contributions.

If the housing market continues to head South, as I expect it will, and especially if the slowdown in homebuilding leads to a recession, which is at least plausible, lots and lots of people are going to be in a world of hurt. When their Option ARMs reset, they will find themselves unable to make their mortgage payments, unable to refinance or sell because they have negative equity, and (thanks to bankruptcy reform) unable to walk away without having their banks come after them for the difference. Many of the people at risk aren’t Democratic voters … yet.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

12 thoughts on ““Bankruptcy reform” reform”

  1. The mortgage problem and bankruptcy law are connected, but not as strongly as the post suggests. Consumer bankruptcy has been made more complicated and expensive, but the options are essentially the same as they were for most people, and include the ability to discharge a mortgage deficiency in most cases.
    A major problem is structural changes that have changed mortgage lending from very conservative to stunningly undisciplined. In parallel, mortgage terms have gone from relatively simple to chaotic. The law has thus far made almost no effort to come to grips with this. It is much as if the FDA and drug prescription laws had been abolished, leaving all of us to fend for ourselves. Theorectical liberatarians may well like it, but it is a disaster in real life. Fixing this is going to be a long-term struggle

  2. As Ronald Reagan once said, "I paid for that microphone". The banking industry paid good money to a lot of people in DC, on both sides of the aisle, to get that bill passed. It ain't gonna be changed much less repealed. There may be some bitching and moaning but that bill is dug in for the long haul.

  3. Unfortunately, I tend to agree that lending reform and bankruptcy reform may be too complex for the average voter to understand and thus have difficulty gaining traction against the well informed, well financed financial lobbyists who have found the way to do for their clients what you are talking about in terms of risk spreading. They are now allowed to engage in completely undisciplined lending practices, particularly through credit cards and devices like arms and have persuaded the government to protect them from the consequence of their own follies–all of which may come at a great cost to many average Americans. I hope I am wrong and that some handle can be gotten on that industry before they take us all down once again.

  4. Colorado has started punishing the appraisers who gave overinflated appraisals. Due to the willingness of lenders to loan money to anyone, there are a large number of scams going around. One of which is to overinflate the appraisals, then split the difference between the seller and the "buyer" who frequently is an identity thief.
    Here is one:
    Some of the money went to bogus "home improvement" companies.
    Denver has the highest foreclosure rate in the nation. Last I heard, it was the highest for 7 months in a row.
    My belief is that the lenders will blame the Option ARM fiasco on the mortgage brokers. I agree with Cranky that the bankruptcy bill will not get changed or mitigated in the near future. The sort of financial crisis that will be needed to get congress to pay attention is going to be S&L or LTCM sized crash of major financial players.

  5. As I pointed out at the time (http://icouldbewrong.blogspot.com/2005/04/bankruptcy-reform-is-lot-like-tax.html), the really ridiculous thing about the "bankruptcy reform" bill is that we know exactly what an environment requiring a tightening of bankruptcy laws would look like–and it's the exact opposite of what we have today. The day lenders start refusing to lend to high-risk debtors, and charging everyone else extortionate interest rates, it might become worthwhile to tighten bankruptcy laws, in order to increase the availability of credit to ordinary individuals, and especially the poor credit risks among them. but does anyone today seriously believe that credit isn't widely enough available to risky borrowers?
    The increase in bankruptcies that was used to justify bankruptcy reform isn't a problem in itself–the lenders who lent to bankrupts knew exactly the risk they were taking, and in fact have figured out how to use sophisticated modern risk distribution techniques to yield them a tidy profit even from the risky loans that lead to a lot of bankruptcies. It's only when bankruptcies *decrease*–because lenders are afraid to lend to less-than-perfect credit risks–that we need to consider being tougher on bankrupts.

  6. Three possibilities seems to me both more helpful and more achievable than the changing the bankruptcy law back to one where future income is not an asset.
    1) Limit allowable late fees for national banks. The problem with late fees is that they need to be the same from bank to bank (else the bank with low late fees gets disproportionately bad risks), so they tend to escalate unreasonably.
    2) Make mortgages non-recourse loans, as they are in California.
    3) Make debts to the government dischargeable in bankruptcy.

  7. Just for clarity, there is no general rule that debts to the government are protected from being discharged in bankruptcy. Many (but not all) tax claims do have such protection, as do student loans and a few other specific categories. Debts to governments that don't fit in those specific categories can be, and routinely are, discharged.

  8. One thing that has not yet penetrated the general consciousness regarding tax debts and bankruptcy is that in the hypothetical case that you bought a house for $750k and then the bank ends up foreclosing and selling it for $500k because the market has tanked, the bank sends you (and the IRS) a 1099 for the $250k difference, which will almost certainly turn into an $80k tax bill. I'm not sure that changing this is a good idea, but someone should be thinking about it.

  9. "Limit allowable late fees for national banks."
    Yes. And maybe something limiting the delinquency rules many lenders use that regards any late payment to anyone else as equivalent to being late with them. "Universal default," I think it is. Completely unfair.
    Really, I think the route to take with this is getting back to predatory lending limits. Credit these days is being shoved at the people who can least afford it because it's the most profitable, what with 20+ percent rates and endless fees. That's predatory.
    Limiting that would be basically an expansion of the soldiers-and-sailors's protection and very hard to argue against.

  10. The debt-forgiveness issue identified by Jake is real, but does not arise when the debt is discharged in bankruptcy, or the debtor can establish insolvency. Consult your tax professional.

  11. Ken D,
    It's not just tax claims; none of the following are dischargeable by bankruptcy if my info is correct.
    1) Taxes
    2) Fines
    3) Student Loans
    4) Court settlements (tort settlements, alimony, child support)

  12. 1) Personal income taxes may be dischargeable if there is at least a three year gap from the due date to the filing of the bankruptcy, depending on some other tests. Otherwise, most taxes are not dischargeable
    2) Fines are generally not dischargeable.
    3) Student loans are the worst. Those folks have Congress in their pocket like you wouldn't believe.
    4) Alimony and child support are not dischargeable. Tort claims based on negligence — generally, no intent to harm — are dischargeable. Claims for deliberate torts are at least potentially not dischargeable. It usually makes no difference if the claim has or has not been settled or litigated prior to the bankruptcy.
    There is some simplification in there, hopping over miscellaneous issues, but that's the guts of it.

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