Current bankruptcy law allows a person to restructure all kinds of debts, but it provides little shelter for a person's primary shelter: the home.
This isn't anything new. A provision in the U.S. Bankruptcy Code dating to 1978 does not allow bankruptcy filers to modify mortgage debt for their primary residences. A number of consumer groups, and at least one member of Congress, think the law should be changed to help people avoid foreclosure.
"There's not much a bankruptcy judge can do to set up a payment structure that would allow a person to stay in their home," says Minnesota DFL Congressman Keith Ellison.
He's working on legislation that would make it possible to restructure mortgage debt in bankruptcy. Ellison sees an urgency to this proposal, given the record number of foreclosures nationwide, including in his own district.
"Bankruptcy judges do have discretion with businesses, with second residences, and all sorts of other ways they can restructure debt on other things," he says. "But when it comes to a primary residence, they just don't have much flexibility."
Kris Wilson, a senior loan officer at Summit Mortgage in Bloomington, says changing the bankruptcy laws would make a lot of sense to her.
"I think that would be wonderful," she exclaims. Wilson originates loans; her business is not on the servicing side of lending. But she says she can readily imagine the kind of homeowner who would benefit from a change in the bankruptcy law.
Wilson tells the story of a borrower who recently came to her on referral. She says the client had received bad advice from another lender about how to handle his mortgage. His troubles compounded when he had major medical problems and couldn't work. Wilson says the man teetered on the edge of foreclosure.
"But then he got better," she says. "He had re-established his ability to pay the mortgage. I think it should've been required that the lender work with him on that. If bankruptcy had been the way for him to achieve that, it would seem to be that it would've been a good thing for him."
The possible benefits to homeowners facing foreclosure are clear. But Rep. Ellison says changing the bankruptcy laws to allow for debt restructuring would also help lenders.
"They'd be able to recuperate more from those houses that get in trouble, rather than writing them off as a total loss," he asserts.
That argument does not persuade Philip Corwin, who counsels the American Bankers Association on bankruptcy policy.
"I don't think and certainly my client doesn't think it's a good idea at all," he says.
Corwin objects to the idea of changing bankruptcy law for several reasons. For one thing, he points out that while homeowners might be getting in trouble with adjustable-rate mortgages, they willingly signed onto those deals and should carry the responsibility.
In addition, Corwin thinks renegotiating the terms of a mortgage is a matter concerning the mortgage lender and the borrower. He's not eager to see bankruptcy judges weigh in.
"They know the bankruptcy code. Most of them do, and most of them are very serious about their job," he says. "But I don't think they have the expertise to decide what's a fair rate of return."
Corwin acknowledges that using bankruptcy to restructure mortgage debt would provide relief to some borrowers. But he maintains that such a move would increase the overall risk involved in mortgage loans. And he says that would result in the general population paying more for mortgages.
Given opposition from as powerful a lobbying group as the American Bankers Association, it's unclear how far the proposed changes to bankruptcy law will advance.
But Congressman Keith Ellison is hoping other members of the business world, such as investors, would be interested in seeing bankruptcy used to thwart foreclosures.
"Wall Street has taken hits based on these securitized mortgages in the secondary market. And if there was a little more flexibility, if bankruptcy judges could help people stay in their homes, that would make those mortgage backed securities more stable," he says.
Ellison plans to introduce legislation to change the bankruptcy law within a matter of weeks.