Change the Law

At the other end of the global financial crisis are those mortgage backed securities that are tanking, and at the root of that are the homes being foreclosed on. Home equity loans, lax borrowing standards and the bursting of the housing bubble have now left one in six homeowners "under water" on their loans:

The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults -- the very misfortune that touched off the credit crisis last year.

The result of homeowners being "under water" is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.

And having more homeowners under water is likely to mean more eventual foreclosures, because it is hard for borrowers in financial trouble to refinance or sell their homes and pay off their mortgage if their debt exceeds the home's value. A foreclosed home, in turn, tends to lower the value of other homes in its neighborhood.

And more foreclosures means more trouble for economy, as faltering banks become the reluctant owners of homes that they can only sell at a loss. Eric Nguyen, a student at Harvard, says in an op-ed in today's NY Times that it's time to reform bankruptcy law to make it easier for homeowners to keep their homes:

While the bankruptcy code Congress amended in 2005 allows a judge to modify mortgage terms for an investment property in order to make the monthly payments affordable, it expressly prohibits modification of terms on a primary residence without the foreclosing bank’s permission. A court can insist that creditors give more time and better terms for people in bankruptcy to pay back loans on cars, boats, rental property and vacation homes — but not on the family home.

For parents with children, of course, there is little relief in keeping the car but losing the home. Data that I have analyzed from Harvard’s 2001 Consumer Bankruptcy Project, a survey of 1,250 people who had recently filed for bankruptcy, indicate that a key reason families with children file is to keep from losing their houses. Having young children nearly doubles the likelihood that the average family in bankruptcy will continue making mortgage payments — to keep the children in the same school and stay in the same neighborhood.

Bankruptcy laws should be flexible enough to allow some parents who will regain their financial footing to continue to make house payments, while denying the same relief to financially irresponsible investors. In addition to helping families, this would help reduce the depressing effect of foreclosures on house prices. And it would cost the taxpayer nothing.

As Nguyen points out, Congress passed on a change in the bailout plan that would permit judges to modify the terms of mortgages that would allow those in bankruptcy to make more modest payments but keep their homes. They may presently feel like they have bigger fish to fry, but no rescue of Wall Street and the global financial system should take place without changes to bankruptcy that benefit the average homeowner as well. Not only is it the right thing to do, it's good for our economy as well.