Detroit’s Chapter 9 bankruptcy has exposed a double standard in federal bankruptcy law – one that might need urgent congressional reform.

Pensioners v. Big Banks

A judge has ruled that in Detroit, under Chapter 9 bankruptcy law, the list of the city’s creditors include municipal pensioners. Their payouts are guaranteed under the Michigan Constitution. The pensioners have also tentatively reached a deal that will reduce retiree benefits. That deal along with other creditors’ concessions, have been made with the goal of helping Detroit move forward. Contrast that with the creditors during the housing bust (which included powerful banks), who were not forced to cut deals with bankrupt homeowners because under Chapter 13 of the bankruptcy law, lenders cannot be forced to rework most residential mortgages. Chapter 13 is a section of bankruptcy law heavily influenced by the financial industry.

Double Standard

So here’s where the double standard lies. In Detroit’s bankruptcy, even pensioners are being forced to negotiate new terms. But during the housing bust big banks did not have to negotiate with struggling homeowners. Currently, 8.6 million homeowners owe more on their mortgages than their homes are worth. According to Moody’s Analytics, this is a total of $430 billion in negative equity. Close to 2.1 million of those underwater homeowners are in or near foreclosure. Since 2007, 9.6 million have lost their homes since. Congress could have enacted changes earlier in the financial crisis to allow for relief for homeowners. Its refusal to do so has left the economy with a weak recovery.

Moving Forward

Going forward, Melvin Watt, the new regulator of Fannie Mae and Freddie Mac, could consent to bankruptcy court relief for loans controlled by the mortgage agencies. This could help many struggling homeowners with their troubled loans. But it will come down to Congress to make changes to bankruptcy law that will ensure that banks be forced to modify mortgages held by bankrupt borrowers. Only then can the law hold up to the tough principles of shared pain for creditors and second chances for debtors.

For information and guidance on bankruptcy, you need the experts at RHM LAW LLP.

Source: New York Times, Double Standards in Bankruptcies, April 25, 2014