Reply #40: NY Fed: 2005 Bankruptcy Bill Led to Hundreds of Thousands of Unnecessary Foreclosures

[Demeter]

http://news.firedoglake.com/2011/02/09/ny-fed-2005-bankruptcy-bill-led-to-hundreds-of-thousands-of-unnecessary-foreclosures/

Three economists at the New York Federal Reserve have put out a paper laying the rise in foreclosures partially at the feet of the 2005 bankruptcy bill. Economists Donald P. Morgan, Benjamin Iverson, and Matthew Botsch find that the subprime foreclosure rate increased by 29,000 per quarter nationwide after the passage of the bill, which equals well over 200,000 foreclosures that may not have occurred otherwise.

http://www.newyorkfed.org/research/epr/forthcoming/1102morg.pdf

The bankruptcy bill of 2005, strongly supported by Republicans, bank lobbyists and the Democrats who own them (see Joe Biden, D-MBNA), forces households with higher incomes who file for bankruptcy into a means test that does not allow them to discharge their unsecured debts under Chapter 7, but instead puts them into Chapter 13, where they must still pay unsecured lenders. While mortgages are not unsecured, the money freed up through the discharge of the other debts could have gone to mortgage payments, thereby saving the home. In addition, bankruptcy judges were not allowed under the new reform to modify the terms of a primary residence mortgage, even though they could modify a yacht, a vacation home or the loan on most other assets. That was a longstanding practice that didn’t change in the 2005 law; however, under the new rules, bankruptcy filers under Chapter 13 are not able to cram down auto loans, either, again raising their monthly payments post-bankruptcy...

This does not lead the New York Fed economists to conclude that the bankruptcy bill was a bad deal; in fact they explicitly say that it may have been “wise policy that simply came at a bad time,” when the subprime market crashed and foreclosures spiked. But that’s the entire point. The bankruptcy process is designed for bad times. It’s supposed to provide a backstop for borrowers who cannot keep up and have become overwhelmed with debt. Elizabeth Warren has called this a bedrock principle of America that has existed for hundreds of years, one of the strongest parts of the safety net, the ability to start over. That only exists for large financial institutions nowadays, not everyday people. And this research from the New York Fed proves it.