Mortgage Meltdown

Actions often have unintended consequences.

The Federal Reserve Bank of New York just issued a report that examined the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This Act had some interesting consequences as reported on by Dan Margolies of the Kansas City Star.

In a nutshell, prior to the Act in 2005, someone facing severe financial problems could declare bankruptcy, wipe out their consumer debt (credit cards, etc) and then use the cash to get caught up on their home. The goal of the Act was to force "better off" borrowers to pay off all the debts and not escape through filing Chapter 7. Now they are forced to file Chapter 13 which means that they are much more likely to lose their home.

Bankruptcies did go down at first but I think this was probably due to the rise right prior to the Acts implementation of people wanting to beat the deadline for filing under the old law.

Currently this Act is contributing to the large rise in foreclosures. And it is not having an effect on the "high-income deadbeats", it is impacting the average income American most of all. These are the people who are most likely to be so far in over their heads that they can not pay their debts and their house value has fallen so that they have negative equity in their homes.

I don't like debt (especially consumer debt) in the first place and I firmly believe that we should pay our debts whether they are put aside due to bankruptcy or not. But this is a good example of a government imposed solution that caused more problems than it cured. Granted it is not the only reason the country is in the economic mess that it is in right now but it is contributing to the slow recovery in housing markets.

But now a proposal is gaining steam in financial and political circles to let bankruptcy courts alter the terms of a mortgage to keep people in their homes.

I wonder what problems this new proposal will cause if it is enacted?

As the article points out: "it is one of the Ten Commandments that those shalt not alter the terms of a mortgage."

Rather than try and fix the bad Act with a band aid, maybe the new law should just be scrapped and the old bankruptcy laws put back in place.

Of course, when has Congress ever gone for less regulation?

I strongly doubt the cure will work as cleanly as those who want this new revision expect.