Foreclosure Crisis Provides Opportunity for Bankruptcy Reform

It is tempting to look on the current foreclosure procedural moratorium as a reprieve for desperate homeowners, giving them more time in their homes. But a sustained backlog not only undermines any housing recovery, it threatens the entire economy, putting the country at risk for another recession — the dreaded double dip.


Today over thirty percent of home sales involve foreclosed properties. With today's low interest rates, there is a market for them. Keeping these houses off the market hurts would-be homebuyers.


Because of the foreclosure issue, the housing market is in a state of chaos. The influx of toxic mortgages with almost impossible terms created the initial problem. Now attorneys general (and soon courts) across the nation have called 'foul,' and our largest lenders have suspended tens of thousands of foreclosures. The problem is the process: lenders did not follow the rules they had established in a calmer, less electronic age, before mortgages were sold, bundled, and resold, often without the necessary paperwork.


However, the root of the problem does not lie with nefarious lenders swindling millions of homeowners out of their houses. In the majority of cases, these homeowners were not paying their mortgages. Their houses had legitimately (though regrettably) entered into foreclosure. Indeed, many of the homes have long been vacant.


The result is not a pretty picture. The houses clog the market, and throw everything into limbo. Banks cannot sell them, recoup some of their losses, and put the inventory back on the market. Furthermore, until lenders come up with legal yet efficient ways of handling foreclosures, houses that should be entering foreclosure are similarly stalled. Buyers sit on the sidelines hesitant to buy a foreclosed property whose title is in question.


Modifying loans one at a time is not a scaleable solution. What's really needed now is a call to reconsider bankruptcy reform. This isn't just an issue with the housing markets — distressed homeowners have generally defaulted not just on their mortgages, but on their car loans and credit cards.



To help solve the problem, lawmakers (and regulators) could identify appropriate debt-to-income ratios and prioritize the outstanding debts to give preference to first-lien home mortgages. Investors (and servicers) would thus be motivated to reconsider payment terms (including reduction of principle) that would enable many owners to stay in their homes and avoid the bungled, tangled mess of foreclosure. Safe harbors could be established to create templates utilizing target debt-to-income ratios for servicers to recalibrate and restructure mortgage terms, and when appropriate reduce the outstanding indebtedness.



Ultimately the best long-term solution is more jobs. A foreclosure reprieve may buy owners a few more months of delay, but in the long run, they need the jobs that will bring about a robust economic recovery.


Nicolas P. Retsinas is a Senior Lecturer in Real Estate at the Harvard Business School where he teaches courses in housing finance and real estate in emerging markets. Mr. Retsinas is also Director Emeritus of Harvard University's Joint Center for Housing Studies in 1998, a collaborative venture of the Graduate School of Design and the Harvard Kennedy School.