Megan McCardle is almost always insightful and interesting, but I have to strongly disagree with her about the efficacy of changing the bankruptcy laws to allow the modification ("cram-down") of mortgages on residences.
A Chapter 13 debtor confirms a plan of reorganization under which she makes payments for up to five years, but not everyone ends up making all the payments for the whole term of the plan. (She believes that proportion of failed plans is 2/3, I think after we change the law, it will get better as a different class of debtor starts filing Chapter 13s). McCardle thinks these debtors will be worse off because their bankruptcies will be dismissed, tossing out of the frying pan of bankruptcy protection, and back in to the fire of foreclosure and state law remedies.
But McCardle's prediction makes two mistakes: one about bankruptcy law, and the other about how people respond to bankruptcy law. Legally, once a debtor fails to make payments under a Chapter 13 plan, the case is not automatically dismissed. Instead, the debtor has the chance to convert her case from a 13 to a 7. This has been made more difficult by the 2005 bankruptcy changes (Sec. 707(b)(3), 'presumption of abuse', and the special cicrumstances test - for those of you playing along in the home game). But not only is it a real possibility to overcome these tests, I'm finding significant 'word on the street' that the U.S. Trustee (the Gov't officials charged with overseeing these sorts of things) aren't challenging the conversions as often as vigorously as they might for fear of having the statute overturned or limited on appeal.
I also think McCardle fails to appreciate the impact outside of bankruptcy that the 13 Cram-down change would engender. Right now, or whole system for making and administering home loans assumes that the mortgage is an all-or-nothing proposition. Until recently, this kept mortgage service costs low and made them easy to securitize. What we see now is that there is some real number of people who ought to be able to refinance mortgages (especially if they were steered in to bad products before), but who won't be allowed to by 'the system.' This is a real economic deadweight loss to not only the borrower, but also the lender, not to mention the neighborhood. Let me rephrase. We are making things worse for no good reason in a lot of these cases.
I've advocated for 13 cram downs before, but under a slightly different rubric than the one Congress proposes. But the current proposal before Congress seems fine. Unfortunately, we've already missed the chance to help a lot of people and avoid some excess harm. But on the positive side, making these changes now will help even-out the rough spots ahead of the next economic decline.
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