Bankruptcy Reform Act Finally Blows Sky High

Blog - Global Economic Trends ^ | 5/29/08 | Mish Shedlock

[nicola_tesla]

The Debt Slave Act, better known as the Bankruptcy Reform Act of 2005 has at long last blown sky high. We will get to "how" in just a moment but first let's review some of the provisions of the bill. Lenders asked for and received everything on their wish list as follows:

Wish List

* A strict financial means test that may prohibit many debtors from filing a liquidation bankruptcy under Chapter 7;

* A requirement that all debtors must receive a briefing from an approved credit counseling agency at least six months before they can file their bankruptcy case; Note: Check with your local bankruptcy court to determine if they will waive the time restrictions in the beginning months.

* A requirement that debtors take an approved class on debt management techniques before they receive their bankruptcy discharge;

* A provision making it easier for a court to dismiss a bankruptcy case outright or to convert a Chapter 7 case to a Chapter 13 case; and

* A provision permitting a court to impose sanctions on attorneys, or even on debtors, for filing a Chapter 7 case that is dismissed or converted to a Chapter 13 case.

After the fairy godmother (Bush) signed the bill written by industry lobbyists and passed by Congress as "reform", banks and lending institutions went on a credit binge of previously unimaginable proportion. The most ridiculous abuse of common sense was the so called "Liar Loans" more commonly referred to as "Stated Income Loans".

In addition, much of the subprime mess and the HELOC (home equity) can be attributed to lending institutions behaving as if Sixteen Tons was the new state of being.

You load sixteen tons, what do you get

Another day older and deeper in debt Saint Peter don't you call me 'cause I can't go I owe my soul to the company store...

Liar loans are now blowing up. I talked about this recently in "Bring On The Alt-A Downgrades".

Liar Loans Discharged In Bankruptcy

Debt Slavery is now in reversal. Inquiring minds should consider this extremely significant ruling: BK Judge Rules Stated Income HELOC Debt Dischargeable.

Tanta writes:

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been "foreclosed out" would be discharged in the debtors' Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not "reasonably rely" on the misrepresentations.

I do not always agree with Tanta, but I would say that I do over 85% of the time. And I certainly agree with her post this time. She is correct on two counts:

1) This was an extremely significant ruling 2) This was the correct ruling

What is interesting to me was some of the comments, some of which defended the lenders. I have zero sympathy for the lenders and the following comments are in line with my thinking.

Tanta Writes:

Nat City gets zero sympathy for me on this one. Talk about a case of "fool me twice."

Jas Jain writes:

Tanta: “I argued some time ago that the whole point of stated income lending was to make the borrower the fall guy: the lender can make a dumb loan--knowing perfectly well that it is doing so--while shifting responsibility onto the borrower, who is the one "stating" the income and--in theory, at least--therefore liable for the misrepresentation.”

Bingo: And the reason this was carried to such an extreme was the debt slave act of 2005 in conjunction with absurd interest rate policy at the Fed, the Fed's direct sponsorship of ARMs and derivatives, and the "Ownership Society" of the Bush administration. All of which are also blowing sky high right now.

Uncle Festus writes:

A few random thoughts on things which have been raised in these comments:

1. I don't think that the lender will appeal this, because at this point it's not "binding" precedent on any other court (though it will be cited as "persuasive" precedent in future similar disputes). I think the lender will not appeal it because there is a real risk that the higher court (either the 9th Circuit itself or the Bankruptcy Appellate Panel) could affirm it and it would then become binding on the entire 9th Circuit, which encompasses the whole West Coast plus Arizona and Nevada. The money at risk in this individual case (if there is any at all) is minuscule compared to the risk of this becoming the law in the largest Circuit in the country.

Binding or not, the die is cast. Furthermore, under a Democratic Congress and Obama as president the entire bankruptcy reform act is likely to be rewritten.

As ye sow so shall ye reap.

Banks and lending institutions are now bearing the fruits of their attempts to make debt slaves out of consumers. I salute the ruling of Judge Leslie Tchaikovsky.

[nicola_tesla]

I agree you’ll get the best rate by having the best credit, but even in the 70s people with good credit were paying in the teens for a loan. I shudder to think what people with mediocre credit were paying if they could even get a loan.

[nicola_tesla]

Search is your friend: http://calculatedrisk.blogspot.com/2008/05/bk-judge-rules-stated-income-heloc-debt.html

In case you are unaware, the 2005 BK law was supposed to “end” lien stripping. What this story says is that practice has returned even under the new law, at least in the case of 2ndary mtgs/loans. This is, as the article said, one judge making a ruling, which is likely to be cited in other cases and if challenged at appeal, will likely become precedent.

The author does not miss the point of stated loans. You need to read more of what this guy writes to realize he abhors the 2005-2007 tendency of bank to PREFER giving stated loans even to people who get W-2 as a way to loan up to 125% of the value of the house.

Heck, I’m self-employed and have been for 24 years. When I got my last mortgage in 2005 I took in my previous 2 years’ tax returns for a full-doc loan. There’s a good reason these were called liar loans - the people getting them were likely lying to the bank as well as to the IRS. However, even tho they lied, it doesn’t take away the bank’s obligation for due diligence before claiming harm.

Sorry you are having a hard time with reading comprehension. This guy writes succinctly and well. But if you don’t “get it”, read the calculated risk version - it says the same thing.

[nicola_tesla]

Even tho I’m not sick, I still just try to enjoy something about each day no matter what might go wrong, since we never know how many more of them we will get. :)

[nicola_tesla]

Newsflash right back - if you claim so many deductions/expenses that you show no/little income, then don’t complain that the bank thinks you can document none.

What you are saying is that a person should be able to fudge the numbers for the IRS, then unfudge them for the bank.

Sorry - one way or the other, you are still a liar. As any investigation into your bank account will prove.

[nicola_tesla]

Agreed there. Most likely they hid the ownership of the “toys” and used the exemptions part of the BK law to shield their home. In Florida, I believe, you can shield your home from being taken in a Ch 7 BK even if your home is worth millions.

[longtermmemmory]

nonsense.

allowable deductions are not illegal. It is not fudging it is a matter of having competent professionals.

If you need an analogy, look at major corporations that pay zero or next to no tax and yet investors see value in the corporation to buy their stock.

What you are missing is that the banks used to require a more substantial downpayment to have a larger equity cushion. The “bubble” was created with the use of overvaluing the collateral.

homes could be bought in the 80’s and 90’s and before without issue.

Also keep in mind according to news reports 90+% of loans are being paid on time.

[longtermmemmory]

in FL it is 1/2 acre in a municipality and 120 acres in unincorporated areas that is homestead expempt.

However you have to now live in fl for a set period. (2 years)

Even PRE=reform you could not buy an expensive home for an safehabor tool to evade creditors. (statute of frauds period 4 years, insider transfer period 1 year)

also that does not protect you for paying the first mortgage. (hence the inflated valuations)

[longtermmemmory]

You are still confused.

This issue is one of bankrucy reform.

The reform has been a failure. The means test is a joke as it only affects less than 25% of filers and then some legitimate preplaing avoids it.

The blogger has no knowledge of the law. They are misreading this in context of past law. There are other “luxury purchase” cases that were equally dumped.

This is just following established case law from even pre 2005 code.

But that is ok, amature do it yourselfers are good for business.