House Swaps: A Strategic Bankruptcy Solution to the Foreclosure Crisis

Abstract

Since the price peak in 2006, home values have fallen more than 30%, leaving millions of Americans with negative equity in their homes. Until the Supreme Court’s 1993 decision in Nobelman v. American Savings Bank, the bankruptcy system would have provided many such homeowners with a remedy. They could have filed bankruptcy, discharged the negative equity, committed to pay the mortgage holders the full values of their homes, and retained those homes. In Nobelman, the Court misinterpreted reasonably clear statutory language and invented legislative history to resolve a 3-1 split of circuits in favor of the minority view. The Court ruled that debtors could not modify even the unsecured portions of the mortgages on their principal residences. Courts and commentators have since assumed that modification of home mortgages in bankruptcy is impossible.

This Article presents a legal strategy for modifying home mortgages despite Nobelman. The strategy requires that debtors move out of their houses, lease the houses for one year, file bankruptcy, and propose mortgage modification plans that pay mortgage holders the full current values of the houses. This Article argues that despite the artificiality of a move-out with the intention to return, bankruptcy judges will approve the plans. The judges will do so because existing precedent requires approval and because the modification plans will be in the best interests of not only the debtors, but also the mortgage holders and the American economy. The strategy may enable hundreds of thousands of homeowners to retain homes they would otherwise have lost to foreclosure.

Keywords: mortgage, foreclosure, bankruptcy, Nobelman, Enewally, negative equity, strip-down, cramdown, mortgage modification

JEL Classification: K11, K12, K19, K41