Since 2008 the U.S. real estate market has dogged our economic stability. The so-called Great Recession was largely caused by failed exotic mortgages fueled by mortgage-backed securities that created a false value of real estate. Years later, Americans continue to struggle with the resultant negative equity in their homes. Due to foreclosures of many of these doomed properties, home ownership is now the lowest since the great depression. The current low percentage of home-ownership should sound an alarm to American society. Home-ownership, after all, is the bedrock of the American Dream and fuels our economic stability. Yet, the current bankruptcy code is designed to further erode home-ownership.
Without action to reduce or eliminate negative equity, diminished home values will continue to plague the economy. Negative equity in real estate prevents families from selling their homes to upsize as their family grows or to move and take a new job for the foreseeable future because they can’t sell their current under-water home. That sad fact will sustain foreclosures and economic instability-essentially preventing substantial economic improvement-for the foreseeable future.
The current bankruptcy code offers limited assistance to the current crises for homeowners. Section 1322 of the bankruptcy code permits bankruptcy courts to reduce or “cram-down” a wholly unsecured second mortgage of a principal residence in Chapter 13 bankruptcy. The unsecured portion is lumped with all other unsecured debt of the debtor, potentially receives some repayment under the Chapter 13 plan and then discharged upon completion of the plan. This is true because no portion of the debt is “secured” as defined by Section 506 of the code. If any portion of a mortgage of a principal residence is secured (based on its replacement value), however, the mortgage may not be crammed-down.
The same provisions also permit the debtor to cram-down negative equity of other under-secured debts such as automobile loans. Mortgages on investment and other non-principal residence property may also be crammed-down. Interestingly, however, the provision does not currently extend to first mortgages of a principal residence or any mortgage of a principal residence that is partially secured. In other words, there is a carve-out in the bankruptcy code that specifically undermines home-ownership.
If home-ownership is the bedrock of the American Dream and a stabilizing force, then the code should be amended to treat all unsecured debt the same-including under-secured mortgages on a principal dwelling. The flawed policy choice of the current bankruptcy code ensures that the US real estate mess will remain, home-ownership rates will continue to decline, and the economic instability of the nation will continue for the foreseeable future.
Congress should take decisive action to protect homeowners and home-ownership by amending the code to permit all unsecured debt to be crammed-down in a chapter 13 bankruptcy. By so doing, Congress would help stem the decline of home-ownership and help stabilize property values and the economy at large.