Thank you for the opportunity to guest blog. As Bob indicated, I will blog about the stripdown of home mortgages for a couple days, take a brief hiatus and be back with you at the first of the year. Some of the things likely to be bloged about next year include the “so called” exemption of federal benefits from execution (sounds boring but boy does this ever work differently than what we’ve been telling our students), a little about my upcoming payday lending study, and perhaps a small taste of financial literacy/anti-consumerism to boot. Thanks and I look forward to conversing with you!!

Now on to the home mortgage issues……

It seems that most of the arguments against the current senate bills on stripdown of home mortgages boil down to one notion: when some people don’t pay their debts, others are disappointed. Bankruptcy laws, as well as state collection laws from real estate foreclosures to Article 9, all recognize that some debts simply will not be paid back. This is economic, rather than legal, realism.

As a realistic starting point for analyzing these bills, we need to essentialize secured debt vis a vis unsecured debt. Secured debt is only as valuable as its security, under all debtor-creditor systems.  Playing on the old adage, if you are a secured creditor, you can never be too rich, to thin, or have too much collateral. With insufficient collateral to cover your debt, you may be called secured, but you are only as secure or protected from harm as the value of your collateral. Why? Because
the main conceptual attribute separating secured debt from unsecured
debt is the right to recover payment from the collateral upon default.

Under Article 9 and state real estate law, if one sells its collateral and ends up with debt left over, the left over debt is  unsecured debt that is legally identical to other general unsecured debt. The fact that it was once joined in one loan with secured debt does not change the essential nature of the leftovers. This
state law theme continues into the bankruptcy system, and the secured
creditor’s claim is still no more secured than the value of its
collateral. As a result, in a Chapter 7 case, one can buy the collateral for its value, even if the debt is greater that the value. A debtor must do this in immediate cash because Chapter 7 does not involve a payment of debt over time.

Chapter 11 and 13 do involve payment plans. Thus, a debtor under one of these chapters is generally permitted to pay back the secured debt over time. By definition though, under bankruptcy or state law, the secured debt is still no greater than the value of the collateral. Thus,
if we are being conceptually consistent, we would not normally require
(or perhaps even permit) a debtor to pay back a secured party the whole
face value of an undersecured debt in a payment plan over time. This
would involve paying more to secured creditors on their deficiency
claims than would be paid to other holders of legally identical
unsecured claims and thus would violate the Code’s equality principle.

Thus, we generally allow the loan to be stripped down to the value of the collateral, in both Chapter 11 and in Chapter 13. In
1992, the home mortgage industry convinced Congress to change the
stripdown rule, essentially disallowing it in the home loan context
because it could cause crisis in the home mortgage industry. This
left us with a rule inconsistent with both bankruptcy principles and
state law principles for the stripdown of home mortgage. In 2005,
various personal property loans were added to the mix, and excepted
from normal stripdown rules. Yet neither of
these exceptions to the normal ordering of things was ever fully
justified. If the idea in the case of home mortgages was to protect the
home mortgage industry from crashing, limiting stripdown does not seem
to be accomplishing this goal.

Thus, it is time to fix this inconsisitency, and choose one of these bills. More on this tomorrow, when I address a few specific points made by Professor Scarberry before Congress.