Opinion – Voices Sunday, May. 31, 2009 Senate whiffs on bankruptcy, mortgage reform

Special to the Ledger-Enquirer

One of the worst votes the U.S. Senate has made recently was on April 30, when it defeated the bill that would have allowed bankruptcy judges to modify home mortgages to reflect the true value of the home, rather than what that value might have been earlier.

This one vote would have saved more people’s homes from foreclosure, and them from the streets, than any foreclosure protection legislation that has been proposed, and it would have done it without costing a penny of taxpayers’ dollars.

The way it works is this: If you buy an item and finance it, you have entered into a “secured” transaction. That means whoever loaned you the money, or financed your purchase over time, has a security interest in the item purchased, i.e., if you don’t pay, they can come and get it. In other words, the property stands good for the debt.

This is of extreme importance in lending transactions, for people are more inclined to pay a secured indebtedness than an unsecured one, where someone just lends you $100 on your promise to pay.

It assumes even more importance in the event of bankruptcy, where secured creditors can repossess their security if you do not pay them, whereas unsecured creditors have a lower priority and are often left out in the cold. This is an oversimplified example, but it is close enough for government work.

The problem arises when you attempt to determine how much of an indebtedness is truly “secured,” which is coming into play a lot more often under present economic conditions.

For example, if you bought a house for $200,000, paid $20,000 down and signed a mortgage for $180,000, the creditor was owed on a secured basis $180,000. The rub comes when, with a crashing real estate market, the house is now worth only $150,000. (This is what is often referred to as being “upside down” or “under water” in a transaction: You started out “right side up” or “on top of the water,” because the thing you bought was worth more than you owed, but now it is not.)

Should all $180,000 of the indebtedness still be considered secured, even if the creditor after foreclosure could get only $150,000 for the house?

Reason would tell you that this indebtedness is secured only up to the value of the property, and that the remaining $30,000 is unsecured and would very rarely be collected after foreclosure

The legislation our Senate defeated, with the votes of our four senators from Georgia and Alabama, would have changed the bankruptcy law to allow the judge to declare that the creditor was still owed $180,000 in the above example, but only $150,000 was secured and the remaining $30,000 was unsecured

This would reflect reality. And it would also allow that bankruptcy judge to lower the debtor’s monthly payment to an amount which would reflect the real value of the property, and/or reduce the interest rate being charged and/or extend the length of the mortgage, say from 25 to 30 years. The debtor would have a better chance of paying the reduced monthly payment than the higher payment based on the now unrealistic, exaggerated value it originally had. The remaining $30,000 would still be owed the creditor, with a higher probability of being eventually paid, but in the lower priority unsecured claims category.

While most of our bankruptcies being filed presently are caused by catastrophic medical expenses and/or credit card debt, those types of indebtedness are unsecured claims. Over 46 million Americans are presently without health insurance, many because of layoffs from their jobs. Hardly a week goes by without my receiving half a dozen offers from credit card companies, begging me to take out another “pre-approved” credit card. I am not defending not paying your debts, but a lot of folks find themselves in financial difficulty for causes other than moral failure.

(This does not even take into consideration that many foreclosures are caused by adjustable rate, or “teaser” rate mortgages where the creditor “adjusted” the interest rate, and therefore payment, upward. While I agree the borrower should have understood what he or she was signing, at least recognize the lack of knowledge and/or sophistication of most borrowers compared to the banker or other lender.)

The whole thing becomes ridiculous when you realize that if I had a beach house, or a second home in the mountains, or a yacht, or an apartment building I had bought as an investment, or lived in a duplex I owned that had become “upside down”, the bankruptcy judge could “cram down” the portion of the indebtedness that was truly secured to its true value, and my payments would be reduced accordingly.

Not so for a single family home — the one thing that it is most important for them to keep, the one thing the loss of which will put them all, including the kids, out on the street. Still we talk about “family values.”

The irony of the situation is that this legislation would be in the best interest in most cases for the banks or other mortgage lenders to accept the reduced payments. If, under the present situation, they insist on the full value, which requires payments the debtor cannot afford, they will have to foreclose and end up with a house that they would be lucky to sell for the reduced $150,000, not to mention attorneys fees for the foreclosure, real estate commissions, fix up costs, etc. they will have to pay.

They would be much better off if they took the lesser monthly payments and kept their customers in the home, continuing to make payments, although admittedly for a lesser amount but for perhaps a longer period. And, best of all, if this legislation had passed, it would have encouraged lenders to modify these loans before the homeowners were forced into bankruptcy.

This would certainly be better for the community and neighborhood, for foreclosed homes, often with untended yards and “For Sale” signs in front of them, have a negative impact on the value of surrounding homes and the whole neighborhood. It would be better for local taxpayers, too, for the tax assessment after foreclosure would be based on the $150,000 foreclosure sale, not the $200,000 it was before foreclosure. Local tax collections would be less, meaning everyone else would have to pay more.

Lastly, the adoption of this legislation would not have cost the American taxpayer one penny. No stimulus money, no government program paying part of the homeowner’s mortgage to the bank, just allowing the bankruptcy judge to do for the home what he or she has the authority to do with that yacht.

It lost by a vote of 51-45, with 12 Democrats joining all of the Republican senators in defeating it. Even though President Obama had “talked the talk” by saying it was a key part of his plan to reduce the tide of home foreclosures, he did not actively lobby for the bill, which had previously passed the House with a wide margin.

What could have been a “win-win” for the homeowners, communities, neighbors, the American taxpayer and, in many instances whether they could see it or not, the creditors became a “lose-lose” for everyone except the banking industry lobbyists and those who receive their campaign contributions.

Milton Jones of Columbus is a retired attorney, former state legislator and former member and chair of the University System of Georgia Board of Regents.

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