Give bankruptcy judges a chance to fix home loans

You know you're in a tight spot when Bankruptcy Court begins to look like the least bad solution to a pressing economic problem. But the housing foreclosure situation is pretty ugly, so there we are.

Unfortunately, U.S. Bankruptcy Court isn't allowed to be part of the solution to rising foreclosures, thanks largely to the mortgage banking lobby. It's worth asking: Why not?

Consider the scale of the problem. The number of homes threatened by foreclosure today is estimated as high as 8 million, quadruple the number a year and a half ago. Nearly a quarter-million homes were lost to foreclosure last year in California alone. Experts agree that this is a massive drag on the economy. It undermines communities, drives home prices down, potentially below their fair market value, and creates huge losses for banks and mortgage investors.

Dozens of proposals to stem the tide have been tabled: Force lenders to dicker with every delinquent borrower, pay loan servicers more to avert foreclosures than to allow them, subsidize interest rates or principal values with taxpayer money. The solutions that have been tried, such as voluntary loan modification efforts by banks, all seem to help a tiny fraction of the expected number, in part because it's hard to distinguish deserving homeowners from those who should never have gotten a mortgage in the first place.

That brings us to bankruptcy. In Chapter 13, which is bankruptcy for working people who have fallen behind in their debts but don't want to stiff all their creditors, bankruptcy judges can help work out new terms on cars and boats and vacation homes. The process is known by the unlovely legal term "cram-down," evidently because from the creditor's standpoint -- well, you get the drift.

The only debt a judge is forbidden to cram down is a mortgage on a principal residence. Chapter 13 debtors either have to meet the loan's original terms, throw themselves on the mercy of their lenders (and we all know how gracious they can be) or give up the house. read more