Bankruptcy

2005 Bankruptcy Reform Legislation Responsible for Foreclosure Crisis?

By Richard K. Gustafson

An article in the Kansas City Star by Dan Margolies reported that researchers at the Federal Reserve Bank of New York recently argued that Bankruptcy Reform Legislation that went into effect in October 2005 helped trigger the surge in home foreclosures.  The researchers argued that the legislation shifted the risk from credit card lenders to mortgage lenders.  “The new law blocks that escape route (chapter 7) and forces better-off households to continue paying credit card debt, which makes it harder than before to continue paying the mortgage.”

Before the 2005 legislation many homeowners could eliminate unsecured debts and free up income to make mortgage payments.  The 2005 legislation forced most households with income in excess of the domicile state’s “median” are unable to qualify for chapter 7 relief and now must seek protection under chapter 13.  In chapter 13, the amount paid to unsecured creditors is often determined through the application of a fictional means test where Congress designates the proper income and expenses to use in calculating the “means” to repay debt.  This fictional “means” test not only denies many homeowners chapter 7 relief that could have allowed them to free up monthly income to maintain mortgage payments, but also forces them into chapter 13 plans that require burdensome and unaffordable paybacks to unsecured creditors.  This results in more homeowners facing foreclosure. 

“Is it just coincidence that the surge in subprime foreclosures that has rocked the financial markets came right after the bankruptcy reform in 2005?” they asked.  “Is that surge just about falling home prices, bad mortgage decisions and weak economic conditions?  “No and no.” 

The lead author of the paper, Donald P. Morgan, is a research officer at the New York Fed.  He said last week in a phone interview that he was “99 percent confident” that the bankruptcy reform law was a major reason for the foreclosure crisis and the falling housing prices that have affected virtually every homeowner in America.  Home prices have fallen 12.3 percent over the 12 months ending in November, according to the National Association of Realtors. 

The conclusions of Mr. Morgan and his colleagues at the Fed agree with other earlier findings that also point to the 2005 reform as a cause for increased mortgage defaults.  Treasury Department economist, David P. Bernstein wrote in a recent paper that one of the ironies of the 2005 law was that many of the financial institutions that lobbied for the reform have been weakened by it.  Academic experts reviewing 2007 bankruptcy data recently suggested that those purged from the bankruptcy rolls “appear to have been ordinary American families in serious financial distress.”

It appears opponents of the 2005 legislation, including this author, have been proven right.  We predicted that the legislation would only temporarily halt bankruptcy filings and that the increased payments to credit card companies would simply hurt secured lenders.  Given the financial troubles of auto manufacturers and the foreclosure crisis that has occured since 2005, our predictions have unfortunately borne out.  It’s time to reverse the 2005 legislation and repeal the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005!  Let’s stop the bleeding!

Full post as published by Consumer Bankruptcy Blog from Legal Helpers on January 14, 2009 (boomark / email).