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There is always some appetite in Congress for changes to the U.S. Bankruptcy Code, say those who watch that area closely, but will the subprime mortgage crisis entice enough lawmakers to the table for action this year? In the past few months, the Democratic-controlled Congress has held hearings involving the bankruptcy system on four different fronts, and some of the titles of the hearings leave little doubt about the majority party’s concerns. A hearing on the second anniversary of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was titled “Are consumers really being protected?” And a hearing on the operation of the U.S. Trustee Program was called “Watchdog or Attack Dog?” Also, there have been two hearings on the mortgage mess and bankruptcy-related solutions, and one on medical debt and bankruptcy. “Ever since BAPCPA was enacted, there have been rifle-shot efforts focused on general bankruptcy reform,” said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable. “There’s a perception among some congressmen that BAPCPA prevented some people from getting access to the Bankruptcy Code.” That perception, Talbott insists, is incorrect. But any reform efforts are unlikely to be as broad as the effort that culminated in the 2005 act, he added. Instead, Talbott said, there will be bills, such as pending legislation to eliminate the means test for military personnel – what he calls “rifle shots” or “message pieces” – targeting the 2005 act. Although one of Talbott’s usual opponents in bankruptcy reform debates agrees that recent problems, such as the mortgage crisis and student loan and medical debt problems, are unlikely to unleash another major reform effort, Henry J. Sommer, president of the National Association of Consumer Bankruptcy Attorneys, is more optimistic that substantive legislation will emerge from this year’s hearings concerning the act. “BAPCPA resulted in a lot of unnecessary costs that drive up the cost of bankruptcy and reduce access,” said Sommer. “That came out during the spring hearing in the House. We’re hoping that at some point Congress will address some of that.” Complaints that U.S. Trustee personnel have been expending resources excessively to deter consumer debtors and ignoring creditor abuses have been “heard” by Congress and the Executive Office for U.S. Trustees, said Sommer. “[The trustees] seem to be becoming a little more sensitive to our concerns,” he said. “They’ve been saying things that indicate they will go after abuses by creditors. We will see whether they do.” But for now, the only politically realistic opening for bankruptcy reform may come from the subprime mortgage crisis. Four bills amending the code are now at the heart of a debate that mirrors, on a smaller scale, the major war over the 2005 act between lenders and banks on one side and consumer groups on the other. Lenders and bankers oppose all of the pending bills for now, essentially arguing that the Bankruptcy Code is not the appropriate vehicle for addressing the mortgage crisis. They also worry that the legislative effort could reopen the 2005 act to additional amendments. “Bankruptcy law is not the area to address this problem because of the long-term harm it would cause the housing market, the American people and the economy,” said Talbott. But consumer groups call this opposition “misguided” and “hysterical,” arguing that the proposed changes are narrow and targeted to those in need, and that one change, in particular, is long overdue. “They’re making ridiculous claims, very reminiscent of the bankruptcy reform bill, claiming these bills will create a tax on every homeowner,” said Sommer. “It’s the same lobbyists and playbook.” The mortgage crisis generally involves two types of loans to homeowners: adjustable-rate loans that originally carried affordable “teaser” rates but are set to adjust two years after the loan is made and every six months after that, and fixed-rate high-interest loans by subprime lenders. Mortgage defaults could rise to 2 million or more in the next two years in the subprime mortgage market alone, according to some estimates. The four key mortgage bills amending the Bankruptcy Code – two sponsored by Democrats and two by Republicans – share one essential feature: They would eliminate or limit the prohibition on modification of a mortgage on the principal residence contained in Section 1322(b)(2) of Chapter 13. That is, they would allow “stripdown” of the mortgage, or modification of a home mortgage by reducing the amount of the debt to the fair market value of the property, if the property is worth less than the amount of the debt. They would also allow payment of that debt at reasonable rates, and two of the bills would allow that beyond the term of the mortgage. S. 2136, sponsored by Sen. Richard Durbin, D-Ill., and H.R. 3609, sponsored by Rep. Brad Miller, D-N.C., would eliminate the prohibition without restrictions. But S. 2133, sponsored by Sen. Arlen Specter, R-Pa., and H.R. 3778, by Rep. Steve Chabot, R-Ohio, permit it under certain circumstances, such as an agreement in writing between debtor and mortgagee and monthly income requirements. “Changing the Bankruptcy Code isn’t a panacea in solving the mortgage problem, but whether this change would be appropriate, I think it would be,” said bankruptcy scholar Robert Lawless of the University of Illinois College of Law. “This rule has been in the code since its enactment. It has always struck me as undertheorized and without a lot of evidence that it’s necessary.” Lawless suggested that the present prohibition rests on the distrust of bankruptcy courts to value the property correctly. “All this would do would be to subject home mortgages to the rule for all other types of secured credit,” he said. “It wouldn’t make the home mortgage disappear or become unsecured.” The value of the bank’s claim against the property is the value of the property on the day of bankruptcy, which is what it would have gotten on foreclosure, he said. “Bankruptcy judges get the value of the property right. There’s no reason to object to this – people are going to get what they would otherwise have gotten.” Lawless added that the market value of the home is really not what the value of the home is to the person who lives in it. There’s a deep personal attachment to the home. “I think lenders know this and the provision that prevents stripdown allows lenders to collect more because they know people will pay more to stay in their home,” he said. “I don’t think it’s going to cost lenders a whole lot except leverage in the bankruptcy case – leverage people shouldn’t have.” But his colleague, Mark Scarberry of Pepperdine University School of Law, urged greater caution in amending the code and a more targeted approach to the problem. “Assistance that allows people time to make payments would be preferable to changes that would reduce the amount of the principal obligation,” Scarberry said. “In that sense, the Specter bill would be preferable because there is no stripdown.” The real estate market can go up and down, he said. To allow debtors to catch the market at bottom and then when the property may appreciate during the next cycle while the mortgage holder doesn’t share in that, he said, seems very problematic. Stripdown should be the last resort, Scarberry insisted. Provisions in the bills would allow a stripdown that then delays payment even of that lower amount over a much longer time than is allowed with other secured debts in Chapter 13, he said. “I don’t think any of the bills are sufficiently targeted,” Scarberry added. “It does seem to me they don’t recognize [that,] if this is a short-term problem, [there should be] a short-term solution, for example including a sunset provision.” It is upsetting to think that a lot of people will lose their homes, he said, “but it’s also upsetting to think something Congress might do will make it more difficult for other people to become homeowners in the future.” If banks and lenders had to rate them in order of preference, from most preferable to least preferable, they would list them as follows: Specter, Chabot, Miller and Durbin. The Specter plan and the nearly identical Chabot plan would permit modification of mortgages, but only in specified ways. They would also permit stripdown only if agreed to by the lender, and allow the Chapter 13 plan and not the bankruptcy court to determine home-mortgage interest rates to a limited degree. The plans do not allow the Chapter 13 plan to extend mortgage payments beyond the term of the mortgage. And finally, they waive the prefiling credit-counseling requirement until after the filing, and only in Chapter 13 cases. The Durbin plan reflects the Illinois senator’s concerns about, and opposition to, the 2005 bankruptcy reform act, which he has said greatly tilted the playing field in favor of creditors. Under the Durbin plan, the prohibition on modification of home mortgages is eliminated. The plan permits a stripdown of the mortgage lien, allows payment of the modified mortgage beyond the duration of the Chapter 13 plan, and may provide for extension of the mortgage payments beyond the term of the mortgage. Also under this plan, the court is allowed to determine the interest rate for the modified home mortgage. And it requires more upfront disclosure of fees and charges by the lender. It also allows the U.S. trustee or the debtor to pursue claims held by the debtor. Furthermore, under the Durbin plan, the court could refuse enforcement of an arbitration agreement generally, not just in Chapter 13 plans. And the entire mortgage claim could be disallowed for violations of the Truth in Lending Act or any other state or federal consumer protection law. Finally, a $75,000 federal bankruptcy homestead exemption would be created for debtors older than 55. “The Durbin bill does reopen and rework the Bankruptcy Code and we oppose that,” said Talbott of the Financial Services Roundtable. But consumer bankruptcy attorney Sommer countered: “The Durbin bill is probably the best crafted of the bills. The Miller bill also contains most of the same ideas. The key thing is modification of these mortgages so people can stay in their homes.” Durbin is the assistant Senate majority leader and is considered key to any legislative effort in that chamber. He reportedly is working with Specter on this issue. “There is the sense in Congress that something needs to be done and it’s likely to be some form of legislative development in the consumer credit area broadly,” Lawless said. “Whether that takes the form of an arbitration bill, a mortgage bill or the Bankruptcy Code, the only people who know right now are those who sit around the table in Washington.” This article originally appeared in the National Law Journal , a publication of ALM.

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