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Mortgage Crises Far from Over – Time to Re-address First Mortgage Modifications in Bankruptcy

Last Sunday’s New York Times Op-Ed Lead reminds us that the mortgage crises is far from over, but it still neglects to address what has always been the fairest and most viable option – permitting Federal Bankruptcy Judges to restructure first mortgages, including rate and principal reductions, in Chapter 13 bankruptcy proceedings.

Early in the financial crises, a few members of Congress were brave enough to draft bills to modify the bankruptcy laws to permit modifications. Their efforts were shot down by the bank lobby and quickly died – never to be brought back to life in any viable form. Now is the time to put this option back on the table on a National level.

Many States, including New York, have put procedures in place, as part of their foreclosure process, to force lenders to the table to try to modify mortgages before a foreclosure is allowed to proceed. The process in New York, while laudable, has done nothing more than to “kick the can down the road” in that there are no mandates for lenders to do anything but to participate in the process. State Court Justices have absolutely no authority to truly force the issue on any meaningful level.

If the Bankruptcy Laws were modified, Bankruptcy Judges would have the authority to act as the arbiter (subject to the appellate process) to (a) set fair and equitable principal reductions based upon current market conditions; and (b) restructure mortgage payments based upon a homeowners’ actual ability to pay.

One of the underlying principals in Chapter 13 bankruptcy is that a debtor must be able to establish that they have the financial ability to make the payments proposed in a Chapter 13 Plan. This standard has to be met to the satisfaction of both the Chapter 13 Trustee and the Court. This is a simple, straight forward, requirement that all parties have worked with for over 25 years.

Bankruptcy is financial triage – not every debtor can be saved. Chapter 13 bankruptcy has always been, and will continue to be, a process to weed out the homeowners who truly cannot afford a mortgage on any level. In many cases, the current State Court processes are being abused by homeowners who, perhaps, never had the financial means to support home ownership from the beginning. Unfortunately, State Court Justices have not been provided with the tools to do what is necessary in these situations.

It is still not too late to revisit first mortgage modifications in bankruptcy proceedings. The filing of a Chapter 13 petition for this purpose could even be conditioned upon a homeowner having applied for a modification within a certain number of days prior to filing bankruptcy and having been turned down by their lender.

Fannie and Freddie are not the answer…