A Critique of Congressional Proposals to Permit Modification of Home Mortgages in Chapter 13 Bankruptcy

Abstract

Although proponents of the amendments assert that forced mortgage modifications in Chapter 13 bankruptcy would benefit mortgage holders by preventing costly foreclosures, proponents ignore or minimize the serious risks that would be created by the amendments and the costs that would be imposed on mortgage holders. Proponents do not seem to recognize risks that are recognized by, and play a central role in, the "Net Present Value" (NPV) test, a test that in turn plays a central role in the Obama Administration's Home Affordable Mortgage Program (HAMP) under which homeowners are offered modifications of their mortgages9 in an effort to prevent foreclosures.

The proposed amendments to the Bankruptcy Code would substantially alter the risk characteristics of home mortgages, with likely substantial effects on future mortgage interest rates and future mortgage availability. Thus, the future societal cost of such a change in the law likely would be large. This Article, which flows from the author's December 2007 testimony before the Senate Judiciary Committee, from a presentation made at the annual meeting of the Association of American Law Schools (AALS) in January 2009, and from a presentation made at the Pepperdine Law Review symposium on the mortgage crisis in April 2009, explains and supports that thesis, primarily on the ground that the proposed changes would leave mortgage holders with all of the future downside risk in the real property market while denying them the benefit of future appreciation. This Article also explains why a common argument made in favor of allowing strip down as a matter of fairness is simply mistaken; enactment of the proposed amendments would not treat home mortgages the same as other secured debt in Chapter 13 bankruptcy, but in fact would treat home mortgages much less favorably than other secured debt. Home mortgages would be the only secured debts that could be stripped down and paid off at a court-determined interest rate, with monthly payments lower than those required by the credit contract, over a period of up to nearly forty years, rather than the no-more-than-five year period that would still apply to other secured debts.

Additionally, the Article provides a brief critique of Professor Adam J. Levitin's empirical studies.