Developments in Detroit’s bankruptcy have exposed a double standard in federal bankruptcy law — an injustice in urgent need of congressional reform.
In Detroit, a judge has ruled that under Chapter 9 of the bankruptcy law, the city’s creditors include municipal pensioners whose payouts are guaranteed by the Michigan Constitution. The pensioners have reached a tentative deal to reduce retiree benefits. Along with concessions made by other creditors, the goal is to help the debtor — the city of Detroit — get a fresh start and move forward.
Contrast that with what happened in the housing bust. The creditors in that fiasco, including powerful banks, did not have to cut deals in court with bankrupt homeowners. Under Chapter 13 of the bankruptcy law, a section heavily influenced by the financial industry, lenders cannot be forced to rework most residential mortgages in bankruptcy.
In Detroit’s bust, even pensioners have to negotiate new terms. In the housing bust, big banks did not have to negotiate, leaving many homeowners in the dust. That special treatment for banks may have helped them recover from the financial crisis. But it made things worse for borrowers and the economy.
Today, 8.6 million homeowners still owe more on their mortgages than their homes are worth for a total of $430 billion in negative equity, according to Moody’s Analytics. Some 2.1 million of the underwater homeowners are in or near foreclosure, on top of 9.6 million who have lost their homes since 2007.
Congress could have changed the law early in the financial crisis to allow for bankruptcy court relief for homeowners. Its refusal to do so has contributed to unnecessary impoverishment and a protracted weak recovery.
The new regulator of Fannie Mae and Freddie Mac, Melvin Watt, could consent to bankruptcy court relief for troubled loans that are controlled by the mortgage agencies. That could help potentially tens of thousands of struggling homeowners.
Ultimately, however, Congress must change the bankruptcy law to ensure that banks have to modify mortgages in court for bankrupt borrowers. Anything less violates bankruptcy’s tough principles of shared pain for creditors and second chances for debtors.
— New York Times