Study: bankruptcy reform act worsened housing crisis

In a new study released by a state Federal Reserve Bank, researchers claim that the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) may have unintentionally worsened the housing market crash and continuing crisis. This is because the BAPCPA makes it more difficult for homeowners to use Chapter 13 bankruptcy to make mortgage payments and keep their homes out of default and foreclosure, the study says.

Prior to 2005, a debtor could choose whether to file for Chapter 7 or Chapter 13 bankruptcy. Under Chapter 7, all unsecured debts would be discharged and all assets liquidated, allowing the debtor a fresh start. Under Chapter 13, the debtor’s unsecured debts would be discharged and his or her remaining assets would be diverted into a payment plan, generally allowing the debtor to maintain mortgage payments and keep his or her home out of default.

While that is still the general process of both forms of bankruptcy, the BAPCPA has largely taken away the debtor’s choice of whether to file for Chapter 7 or Chapter 13. He or she is now subjected to a means test to determine which form of bankruptcy will allow for the most creditors to be repaid, making the BAPCA especially tough on higher-income bankruptcy filers. In addition, the law has added new requirements such as mandatory credit counseling and higher bankruptcy filing fees, and has also decreased the types of debt that can be discharged through either form of bankruptcy.

Because a greater number of homeowners are not able to file for Chapter 13 protection, more homes are ending up in foreclosure. According to the study, an additional 200,000 homes went into default each year following the BAPCA, even before the housing crisis took hold.

Source: Examiner, “Did Bankruptcy Reform Increase Mortgage Defaults?”, Christopher Moore, 2 March 2011