The Problems With The Mortgage Bailout Plan

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Whatever the intended social equity underlying the idea of allowing bankruptcy judges to modify the mortgage on a chapter 13 debtor’s primary residence, it would obviously precipitate bank losses and the depletion of bank capital, thus impeding recovery in bank lending activities and economic recovery, according to a commentary in Bankruptcy Law360 on Friday. As recently as the Clinton administration, it was deemed indisputable that prohibiting the modification of rights of lenders and obligations of borrowers serves the collective greater good of providing access to mortgages on principal residences at reasonable rates. A unanimous Supreme Court in Nobelman v. American Savings Bank, 508 U.S. 324, held in 1993 that provisions of chapter 13 of the Bankruptcy Code (specifically 11 U.S.C. §1322(b)(2)) prohibited bankruptcy judges from modifying mortgages on principal residences. In that case, one of the more liberal Supreme Court justices, Justice Stevens, specifically noted that the prohibition on modifying mortgages on principal residences was “explained by the legislative history indicating that favorable treatment of residential mortgagees was intended to encourage the flow of capital into the home lending market.” Nobelman, 508 U.S. at 332. The current cramdown proposal would force lenders to acknowledge the uncollectibility of a portion of the eligible loans, and thus recognition of a loss for financial reporting purposes. Given the other problems (e.g., losses on investment securities) currently affecting banks, even a modicum of write-offs could certainly trigger capital impairment of a magnitude that would threaten these institutions with regulatory sanctions, or even seizure.

Read the full article here: Law360.com(Subscription required.)

Date published: Apr 17, 2009

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