Reforming “bankruptcy reform” for housing-bubble victims

If people have to walk away from their homes as the bubble bursts, let them walk away. Don’t make them keep paying for housing they’re no longer living in.

Most of the damage that’s going to be done by the bursting of the real estate bubble can’t, now, be prevented. Lots of people are going to take a financial beating. Some are going to lose their homes. (And, on the other hand, housing prices in hot markets are going to come down from the stratosphere, which means that some people who couldn’t afford a house at the old, insane prices will now be able to afford one.)

But some of the damage still avoidable. In particular, some people who lose their homes are going to find themselves still stuck with some of the debt, and thanks to “bankruptcy reform” it will be difficult and expensive for everyone, and impossible for many, to discharge that debt through bankruptcy.

It shouldn’t be hard to craft legislative language to fix that problem (without giving relief to the people who have been using refinancing and lines of credit to, in effect, spend the housing equity they didn’t earn on SUV’s and other toys).

From the viewpoint of Democrats, and especially Democratic Presidential candidates, this is just about the perfect issue. It will help lots of people, and not just those who actually go bankrupt. Changing the bankruptcy rules would give all eligible debtors better bargaining position with their creditors. Even those whose own homes aren’t at risk are likely to side with the homeowners against the lenders on this one. And of course Republicans will reflexively oppose it.

The one downside: Democrats as well as Republicans feed at the trough of the financial-services industry. (I’m looking at you, Max. And you, Joe. And you, Chuck.) But money isn’t our problem this year; it’s time to start working for the voters instead of the donors. My guess is that the leadership will see it that way.

Update Apparently the securitization process is both making it harder for homeowners in over their heads to renegotiate their mortgages and making it difficult or impossible for those who were cheated to get recourse through the courts. (What would sleazy companies do without the good old “holder-in-due-course” doctrine?) This strengthens the case for extending bankruptcy protection to the victims, but it also suggests legislative changes to make sure that the CMO buyers have to buy whatever fraud liability goes with the deal.

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: