Yesterday I posted on the topic of the essential nature of secured debt and why we should be consistent in how we treat it across the board. Today, I wanted to address some more specific points brought out in ABI Resident Scholar Mark Scarberry’s testimony before Congress last week. The purpose of the post is to support passing a law allowing home mortgage stripdowns, with few limitations.

One argument Professor Scarberry made is that now that some personal property is excluded from stripdown, it would be wrong to treat home mortgage holders less advantageously than personal property loans. I totally agree that this would be wrong, but reach a different conclusion. Stripdown should be allowed in all undersecured cases, consistent with state law principles. Both the home mortgage stripdown exception and the 2005 limitations on stripdown are equally out of line with basic bankruptcy and state law collections principles. (see yesterday’s post). We can and should work on fixing this after the home mortgage crisis has passed, if not immediately.

In
arguing against enactment of any of the bills, Professor Scarberry
further argues that it would be unfair to investors to change the
nature of their debt securities part way through their investment. With this one I must respectfully disagree. It
seems we are choosing between people being able to keep the homes they
bought versus people being able to keep value in their obviously risky
investments. The risk in these investments of course is not stripdown, but default and foreclosure. This risk prevails no matter what happens to the law because these are very risky investments. Investors surely knew this, or, as we love to say in the law, they should have known.

While
it is true that changing the stripdown rules would deprive investors of
the benefits of the credit enhancement they bargained for, this is not
unfair. These investors are already being deprived of their bargain
because borrowers simply cannot pay. Whether the stripdown laws change or not, investors are in deep trouble. Financially
it makes little difference to the investor whether the loan goes from
default to foreclosure or default to bankruptcy stripdown. The investors lose big either way. Arguably,
the investors might even lose a little less under stripdown because a
larger portion of the loans in questions might be repaid.  Either way, it is likely a blood bath for investors.

From
the borrower’s perspective, though, there is a world of difference
between a loan that gets foreclosed and one that can be stripped down.
This is the difference between keeping the home and losing the home. Bankruptcy and state collection laws both disfavor displacement and waste. The law does not allow one to take from one party in the debtor creditor relationship without creating a benefit to the other.

For
example, we do not value a home at $200,000 for exemption purposes if
it can only be sold for $150,000. That would hurt the debtor without
benefiting the creditors. The argument against changing the stripdown
rules for home mortgages suffers from the same weakness, punishment for
borrowers with little corresponding benefit to lenders or investors.

Professor Scarberry also argues that without a change in the law, the loans could have future value for investors. Maybe and maybe not. Yet the changes will allow more borrowers to keep their homes. That is virtually a sure thing.

So my feeling is that we should reverse this ill-conceived limitation on stripdown. The sub-prime loans are in bad shape no matter what we do. Let’s at least let some people benefit (and keep a roof over their heads), rather than creating two classes of losers.