The Housing Crisis and Bankruptcy Reform: The Prepackaged Chapter 13 Approach

In 2008, banks commenced foreclosure proceedings on 2.2 million homes. This year could be worse.1 While economists disagree on whether this is the worst economic crisis since the Great Depression, everybody agrees that this is the worst real estate crisis since the Great Depression. Foreclosure is not just a human tragedy, it is an economic tragedy as well. Foreclosed houses are poorly maintained if not looted. As a result, foreclosed properties lose a substantial fraction of their value, between 30 and 50 percent.2 If this was not enough, foreclosure has some very negative spillover effects. Forced sales depress the value of the surrounding properties. When forced sales become frequent, they undermine the value of a neighborhood, pushing other people to sell or default. Finally, widespread defaults reduce the social stigma of defaulting, leading to the possibility of a vicious circle of default causing other defaults, depressing real estate prices further and causing still more defaults.3

People’s Will or Wall Street’s Will?

2.25 million foreclosures were filed last year and at least 1.7 million are expected this year. This dramatic housing crisis is at the origin of the current financial and economic woes our country is experiencing. But if you were to look at Washington, you would hardly notice. Last February, Senator Dick Durbin (D-Ill.) introduced a proposal to redesign Chapter 13 in an attempt to help homeowners avoid foreclosure. In the past year his proposal was largely ignored. In the meantime, Congress approved a $168 billion tax cut for the first stimulus package, $700 billion to help banks, and even held an emergency session after the election to help General Motors and Chrysler. Compare it to HOPE, the limited program for homeowners approved only in October with nominal success to date.

Yes we can, Mr Geithner

This Wednesday Mr Geithner will be confirmed as the new Secretary of Treasury. Never before in U.S. history has this position been so important. Mr Geithner’s decisions in the next few weeks will have a dramatic impact on the length and the depth of this recession and will shape the financial sector for decades to come. Mr Geithner comes to this job with the best qualifications. But in the last several months he has constantly been in the eye of the financial storm and thus he might benefit from an outside perspective. Given that the prosperity of our country is at stake, I hope Mr Geithner will allow me a few suggestions.

A Bankruptcy to Save GM

Not long ago, Alitalia was one of the largest airline companies in the world. Today it is a shadow of its former self, having burned massive amounts of taxpayer money before finally entering bankruptcy with few assets remaining. The principal culprit of this debacle was the Italian government. Trying to avoid the political pain a bankruptcy would have caused, the government continued providing subsidized financing to the money-losing airline, delaying the necessary restructuring. Not only was a gigantic waste of taxpayers’ money, but it was a death sentence for the very company it wanted to save. Postponing the day of reckoning weakened Alitalia’s competitive position, making it lose market share it will never regain as a reorganized company.

Plan B

After pointing a gun to the head of Congress, threatening a financial meltdown in case his plan was not approved, Treasury Secretary Hank Paulson has finally arrived at the only logical conclusion: his plan will not work. Desperate for a Plan B, Paulson is slowly warming to the suggestion of many economists: inject some equity […]

Why Paulson is wrong

When a profitable company is hit by a very large liability, as was the case in 1985 when Texaco lost a $12 billion court case against Pennzoil, the solution is not to have the government buy its assets at inflated prices – the solution is Chapter 11. In Chapter 11, companies with a solid underlying […]