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Resolving the Foreclosure Crisis: Modification of Mortgages in Bankruptcy

Adam J. Levitin

Georgetown University Law Center

April 24, 2009

Wisconsin Law Review, p. 565, 2009

For over a century, bankruptcy has been the primary legal mechanism for resolving consumer financial distress. In the current foreclosure crisis, however, the bankruptcy system has been ineffective because of the special protection it gives most home mortgages. Debtors may modify the terms of all debts in bankruptcy except those secured by mortgages on their principal residences. A bankrupt debtor who wishes to keep her house must pay the mortgage according to its original terms down to the last penny. As a result, many homeowners who are unable to meet their mortgage payments are losing their homes in foreclosure, thereby creating significant economic and social deadweight costs and further depressing the housing market.

This Article empirically tests the economic assumption underlying the policy against bankruptcy modification of home-mortgage debt—that protecting lenders from losses in bankruptcy encourages them to lend more and at lower rates, and thus encourages homeownership. The data show that the assumption is mistaken; permitting modification would have little or no impact on mortgage credit cost or availability. Because lenders face smaller losses from bankruptcy modification than from foreclosure, the market is unlikely to price against bankruptcy modification.

In light of market neutrality, the Article argues that permitting modification of home mortgages in bankruptcy presents the best solution to the foreclosure crisis. Unlike any other proposed response, bankruptcy modification offers immediate relief, solves the market problems created by securitization, addresses both problems of payment-reset shock and negative equity, screens out speculators, spreads burdens between borrowers and lenders, and avoids the costs and moral hazard of a government bailout. As the foreclosure crisis deepens, bankruptcy modification presents the best and least invasive method of stabilizing the housing market.

Number of Pages in PDF File: 91

Keywords: mortgage, bankruptcy, modification, cramdown, lienstripping, lien-stripping, Nobelman, GSE, chapter 13, 1322(b)(2)

JEL Classification: G21, K00, K20, K29, G33

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Date posted: August 26, 2008 ; Last revised: April 20, 2010

Suggested Citation

Levitin, Adam J., Resolving the Foreclosure Crisis: Modification of Mortgages in Bankruptcy (April 24, 2009). Wisconsin Law Review, p. 565, 2009. Available at SSRN: https://ssrn.com/abstract=1071931

Contact Information

Adam J. Levitin (Contact Author)
Georgetown University Law Center ( email )
600 New Jersey Avenue, NW
Washington, DC 20001
United States
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