Our Riverside personal bankruptcy lawyers were very interested to see reports suggesting bankruptcy cramdowns may make their way back to Congress. Westlaw Journals reported Jan. 26 on a new plan by Sen. Jeff Merkley, D-Oregon, to deal with the ongoing foreclosure crisis. Merkley outlined his six-part plan in a letter to President Obama. The plan addresses what Merkley sees as the weaknesses of the Home Affordable Mortgage Program, which has far fewer participants than the federal government estimated it could help. One part of the new plan is a “lifeline bankruptcy option,” a bankruptcy cramdown for people in personal bankruptcy who would be eligible for HAMP.
Bankruptcy judges can “cram down” the principal owed on a loan to current market value for almost any kind of property — except a primary home. As Merkley pointed out, that includes luxury properties such as second homes and boats. This exception has been in the bankruptcy code since the 1970s, and Democrats have in the last few years attempted to remove it. However, it ultimately failed to pass in 2008 and 2009, thanks in part to fierce opposition from the financial industry. Merkley’s proposal (PDF) says this would be “one last lifeline for families about to lose their homes” and could also give banks an incentive to negotiate with borrowers in good faith. His other proposals include requiring a single caseworker for borrowers in foreclosure; ending the practice of foreclosing while negotiating for a loan workout; and a “short refinance” program for borrowers in default who still have a steady income.
As Escondido individual bankruptcy attorneys, we’re pleased to see another cramdown proposal on the table, no matter what it’s called. We strongly agree with Merkley that cramdowns would give lenders a stronger incentive to negotiate loan modifications than they apparently possess right now. Lenders dislike the idea of cramdowns because a principal reduction means they take a financial loss — and they cannot control its size or terms. Faced with that prospect, many businesses would prefer to negotiate a loan modification whose terms they can control. Unfortunately, there’s very little incentive right now for lenders to seriously negotiate loan workouts. In fact, some market forces reward loan servicers for pushing borrowers into foreclosure faster. The bankruptcy lifeline option Merkeley proposes would reverse that incentive.