Bankruptcy is much in the news this week with the troubles of U.S. automakers. Most bankruptcies involve everyday people who just can't pay their bills. And right now, millions of homeowners can't pay their mortgages and are sliding into foreclosure.
The problem doesn't seem to be easing. This week, Fannie Mae reported that mortgage delinquencies continue to rise.
Democrats in Congress want to use the bankruptcy courts to try to help homeowners on the verge of foreclosure avoid losing their homes. Republicans, however, oppose allowing judges to set new loan terms.
Some people facing foreclosure are probably beyond help — they bought a house that is way beyond their means.
Others, who may have decent jobs to support regular mortgage payments, could be in a position to keep their homes if they could get their payments reduced.
A Large-Scale Problem
But the scale of the problem is overwhelming. And regulators say the efforts to help homeowners so far don't seem to be reaching most people.
Rich Leonard, a U.S. bankruptcy court judge in Raleigh, N.C., supports legislation that would let judges like him intervene.
Leonard can look at the evidence presented in court to distinguish a house-flipper who got in over his head from a legitimate homeowner who realistically can make mortgage payments, just at a lower monthly amount.
By declaring bankruptcy, a homeowner could be allowed to go before a judge like Leonard, who would decide whether it's fair to restructure the loan and lower the mortgage payments.
A Boost For The Economy?
The mortgage industry doesn't like the sound of that.
But homeowner and consumer advocates say a million people might get to keep their homes this way. And they say that could really help the economy by reducing the numbers of foreclosures and vacant homes.
But Leonard says he reminds his law clerks that "the bankruptcy courts are not social work agencies." He says it's a rigorous process: "Somebody who comes in here and attempts to do this has got to persuade me and my colleagues that they actually have a reasonable stream of predictable income that will let them pay this restructured debt."
Bankruptcy courts can already intervene in a variety of other loans for mobile homes and cars — just about anything other than a primary residence. "I see [loans for] farms, boats, fishing fleets, commercial real estate," Leonard says. He says not a week goes by that he's not involved in some sort of loan restructuring.
So let's say the borrower owes more than their mobile home is worth, and they declare bankruptcy. One thing the judge can do is reduce the amount owed to the current value of the property. That's called a "cramdown" of the loan.
Setting New Loan Terms
A recent case in Leonard's court involved a mobile home. The borrower, Cynthia Johnston, was behind on her payments. She owed $59,000. But the mobile home isn't worth that. In this case, the home was damaged during delivery: The frame was bent. That twisted everything inside the house out of whack.
"I could not get the windows and doors to open and close properly," Johnston says.
In court, she and her lawyer said the property was so damaged that it was worthless. But in cases like this, it's Leonard's job to listen to a professional appraiser and figure out what the property's real value is.
The judge then approves a payment plan with a reasonable interest rate that the person, in bankruptcy, has to abide by. In Johnston's case, Leonard valued the mobile home at $20,850. A borrower who accepts the bankruptcy payment plan can pay off the smaller "crammed-down" amount, and the debt will be considered paid.
Millions Of Homeowners Under Water
A lot of people like Johnston are struggling and owe more than their house is worth. But if you live in a regular house, not a mobile home, you can't turn to a judge to get help this way.
Many Democrats want to turn those judges loose on the foreclosure crisis.
Bankruptcy courts deal with more than a million people a year already. So proponents want to give them the power to modify all kinds of home loans, as judges see fit. Democrats have already pushed a bill through the House. But much of the financial industry is opposed to the legislation, and the bill may be stalling.
Scott Talbott, vice president for the Financial Services Roundtable, an industry trade group, says he's lobbying against the so-called bankruptcy cramdown bill.
Talbott says the bill "landed with a thud in the Senate." For one thing, he says, allowing judges to cram down the amount that borrowers owe will spook the lending industry. And, he says, lenders will respond by raising interest rates for all borrowers.
Proponents of the bill dispute that. Lawmakers will be working for the next couple of weeks — even though Congress won't be in session — to try to come up with a compromise.