The Amazing but True Evolution of Bankruptcy Law

You’ve heard of debtors’ prisons. But that’s only one hideous part of the very colorful history of bankruptcy law.

American bankruptcy law was of course based on the law of England at the time of the colonies. Today’s blog tells how incredibly different pre-Revolutionary War bankruptcy laws were from current law.

  • The first bankruptcy law in England was enacted more than 450 years ago during the reign of Henry the Eighth, the one who had a habit of decapitating his former wives. Debtors were called “offenders” under this first law, essentially as perpetrators of a property crime.  The purpose of this law, and as if was expanded during the following hundred and fifty years, was not to give relief to debtors but rather to give creditors a more effective way to collect on the debts owed by their debtors.
  • Consistent with that, the law included no discharge of debts. After a bankruptcy was finished—with the assets of the “offender” seized and sold and distributed to creditors—separate creditors could still continue chasing the individual for any remaining balance.
  • Only creditors could start a bankruptcy proceeding. Creditors had to allege an “act of bankruptcy” by the debtor. Physically hiding from creditors was “an act of bankruptcy,” as was hiding assets by conveying them to others. Today’s very seldom used “involuntary bankruptcy” is a throwback to this.
  • Since credit was seen as immoral, only merchants were allowed to use credit, for whom it was seen as a necessary evil. So only merchants could become bankrupt.
  • For the following century and a half, Parliament made the law even stronger for creditors, allowing bankruptcy “commissioners” to break into the homes of “offenders” for their assets, put them into pillories (those wooden structures with holes for head and hands used for public shaming), and even cut off their ears.
  • The discharge of debts was finally introduced in the early 1700s for cooperative debtors, but was given only upon consent of the creditors. Furthermore, to induce cooperation, fraudulent debtors were subject to the death penalty (although it was very seldom used).
  • Cooperative debtors received an allowance from their own assets, a bit of a foreshadowing of Chapter 13 payment plans.

This was the English bankruptcy law in effect that the U.S. Constitution was adopted, with its Bankruptcy Clause giving Congress power to “pass uniform laws on the subject of bankruptcies.” More on that and the very rocky history of U.S. bankruptcy laws in my next blog.

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Foreclosure Rates Highest for Higher-Income Borrowers in Former Boom-Market States

In most parts of the country, foreclosure rates have been highest for low-income borrowers, and lowest for higher-income borrowers. But the exact opposite is true in “boom-market metropolitan areas located in California, Nevada and Arizona.

This is one of the most surprising finding of a report released a couple of weeks ago by the Center for Responsible Lending (CRL) called Lost Ground, 2011: Disparities in Mortgage Lending and Foreclosures. In my last blog I wrote about this report, focusing on its main headline story that 5 years into the foreclosure disaster, we’re not even halfway through it. But this conclusion that higher income homeowners are more prone to foreclosure in certain parts of the country is a real eye-opener.

This very thorough study of mortgages divided the borrowers into four categories:

Low-income: at 50% or lower than the area median income

Moderate income: at 50-80% of the area median income

Middle-income: at 80-120% of the area median income

Higher-income: at more than 120% of the area median income

Regional housing markets were also divided into four categories, based on appreciation in home prices between 2000 and 2005:

Weak-Market States:  Indiana, Iowa, Kansas, Kentucky, Michigan, Mississippi, Nebraska, North Carolina, Ohio, Oklahoma, Tennessee, Texas

Stable-Market States: Alabama, Arkansas, Colorado, Georgia, Illinois, Louisiana, Missouri, North Dakota, South Carolina, South Dakota, Utah, West Virginia, Wisconsin

Moderate-Market States: Alaska, Connecticut, Idaho, Maine, Minnesota, Montana, New Mexico, New York, Oregon, Pennsylvania, Vermont, Washington, Wyoming

Boom-Market States: Arizona, California, Delaware, Distr. of Columbia, Florida, Hawaii, Maryland, Massachusetts, Nevada, New Hampshire, New Jersey, Rhode Island, Virginia

For the weak-, stable-, and moderate-market states, the rates of foreclosure were highest among low-income borrowers, lower among moderate-income borrowers, lower still among middle-income borrowers, and the lowest among higher-income borrowers. But in the boom-market states, the foreclosure rates are completely opposite: highest among higher-income borrowers, lower among middle-income borrowers, lower still among moderate-income borrowers, and the lowest among low-income borrowers.

While it seems intuitive that the lower income borrowers would be less able to weather the storms of a harsh recession, why are the results topsy-turvy in the boom-market states?

Start by remembering that by the report’s definition most “higher-income borrowers” were not that wealthy:

While these borrowers may have had higher incomes (with a median of $61,000 for middle-income borrowers and $108,000 for higher-income borrowers), the extremely high cost of housing in these boom markets, even for modest homes suggests that the majority of these borrowers were not the very wealthy buying mansions, but rather working families aspiring to homeownership and the middle class.

But then the report made a fascinating discovery in looking at the incidence of high-risk features within mortgages, such as hybrid or option ARMs, prepayment penalties, or higher interest rates:

While in weak market areas, low-income and moderate-income families have the highest incidence of mortgages with at least one high-risk feature, the pattern is reversed in boom markets.

I suspect that because housing was so expensive in these boom-markets, even home purchases made by those in the higher-income categories used higher risk mortgages because a) they needed to stretch their housing dollar to afford what they were buying, b) property values were climbing so fast that everybody figured they could refinance later into a better loan, and c) sales were happening so quickly that the entire process got sloppy.

The end result is that mortgages with “high-risk factors” are resulting in more foreclosures, even if they belong to higher-income borrowers. There could be many explanations for this–for example, homes in those regions’ may be deeper “underwater,” or the unemployment rate may be higher there, either of which could push up the foreclosure rate. But overall the results seems to imply that a borrower’s good payment history is better predicted from the existence or absence of “high-risk factors” in the mortgage than from the borrower’s amount of income.

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“Not Even Halfway through the Foreclosure Crisis”?!

Going on five years into our foreclosure disaster, a major report is now authoritatively giving us that sobering news.

The Center for Responsible Lending (CRL) is a respected non-partisan research and policy organization with the mission of “protecting homeownership and family wealth by working to eliminate abusive financial practices.” In mid-November it released the results of its comprehensive analysis of foreclosures called Lost Ground, 2011: Disparities in Mortgage Lending and Foreclosures. This study reviewed and tabulated 27 million mortgages originated from 2004 and 2008, and looked at the borrowers’ performance on those loans through last February. As its title signals, the study addresses at how different socio-economic groups, different parts of the country, and different racial groups have been affected by the flood of foreclosures. Its findings contain a number of meaningful surprises, which I’ll tell you about some other time. But its first finding—that we’re not even halfway through these foreclosures—is what most caught my attention.

The analysis shows that of all mortgages entered into from 2004 through 2008, at least 2.7 million of them have been gone all the way through to completed foreclosure. This is about 6.4 percent of all mortgages entered into during that period of time. And this 2.7 million does not include foreclosures that have occurred in these last few years on earlier mortgages, those entered into before 2004.

Of this same set of 2004-2008 mortgages, another 3.6 million households are “at immediate, serious risk of losing their homes.” The study defined this category as those mortgages already in the midst of the foreclosure process, or more than 60 days delinquent. Not all of these will result in completed foreclosures, but a large percentage likely will.

So, about 2.7 million foreclosed, 3.6 million to go.

It’s important to realize that this 3.6 million in seriously troubled mortgages does NOT include other troubled mortgages which originated outside the 2004-2008 period, nor those which are performing decently now but will nevertheless go to foreclosure in the near future because of new unemployment, etc. So it is very likely that there will be more than that 3.6 million number.

 

I realize that for many people, this constant talk about foreclosures gets tiring, frustrating, even maddening.  Unless you are dealing with a foreclosure yourself, or are close to someone who is, it’s one of those things that’s in the news so much, year after year, that the stories start sounding the same so you start tuning it out.

But I can’t tune it out. I don’t want to tune it out. Much of my job is to listen attentively to those stories, told to me virtually every day by hard-working men and women who are fighting to save their family home, their place of shelter and stability and dignity. Behind every single foreclosure, and every threatened foreclosure, there is a very human story. Some of the stories are rather straightforward, but most are messy. Human beings being who we are, our lives don’t tend to travel down a neat and tidy path. My job is to take your financial story, lay out your options, and help you chose among them to get to the best place you can get to. Including with your home.

The country is nowhere close to working through its foreclosure epidemic. But let me help you get through your own personal part of it.

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