House Swaps: A Strategic Bankruptcy Solution to the Foreclosure Crisis
LoPucki, Lynn M., Michigan Law Review
Since the price peak in 2006, home values have fallen more than 30 percent, leaving millions of Americans with negative equity in their homes. Until the Supreme Court's 1993 decision in Nobelman v. American Savings Bank, the bankruptcy system would have provided many such homeowners with a remedy. They could have filed bankruptcy, discharged the negative equity, committed to pay the mortgage holders the full values of their homes, and retained those homes. In Nobelman, however, the Court misinterpreted reasonably clear statutory language and invented legislative history to resolve a three-to-one split of circuits in favor of the minority view that debtors could not modify even the unsecured portions of the mortgages on their principal residences. Courts and commentators have since assumed that modifying home mortgages in bankruptcy is impossible.
This Article presents a legal strategy for modifying home mortgages despite Nobelman. The strategy requires that debtors move out of their houses, lease the houses for one year, file bankruptcy, and propose mortgage modification plans that pay mortgage holders the full current values of the houses. This Article argues that despite the artificiality of a move-out with the intention to return, bankruptcy judges will approve the modification plans. The judges will do so because existing precedent requires approval and because the modification plans will be in the best interests of not only the debtors but also the mortgage holders and the American economy. The strategy will enable hundreds of thousands of homeowners to retain homes they would otherwise have lost to foreclosure.
The nonmodifiability of home mortgages in bankruptcy is one of the many ways in which the American legal system is rigged against the middle class.1 The bankruptcy system allows debtors to strip mortgages and security interest debts down to the collateral value on virtually every kind of debt, except the two kinds that middle-class Americans are most likely to owe: (1) mortgages against individual debtors' principal residences and (2) security interests in individual debtors' automobiles if the debtors financed those automobiles within the 910-day period preceding bankruptcy. By contrast, corporations, large or small, can strip down and modify mortgages or security interests against any kind of asset-including homes acquired through foreclosure and automobiles financed in the 910-day period preceding bank- ruptcy. Wealthy individuals can likewise strip down and modify mortgages against second and third homes.
Contrary to popular belief, the inability to strip down home mortgages does not result from congressional action. It is the product of the Supreme Court's 1993 decision in Nobelman v. American Savings Bank.2 In that case, the Court ignored the plain meaning of Bankruptcy Code subsection 1322(b)(2) and invented legislative history to resolve a conflict of circuits against the majority view.3
This Article presents a legal strategy by which individuals can modify their home mortgages and retain their homes despite Nobelman.4 The strat- egy requires that debtors move out of their homes for periods of one year. In most parts of the United States, judges need only follow well-established legal precedent for the strategy to succeed.
The implementation of this strategy has important implications not only for individuals struggling to save their homes but also for the American economy. Five years after the onset of the financial crisis, the United States remains mired in the ensuing mortgage foreclosure crisis.5 Negative equity- debtors owing more than their homes are worth-drives the crisis.6 At the end of the first quarter of 2013, about one in five of the approximately 49 million home mortgages outstanding in the United States-about 9.7 mil- lion-still exceeded the value of the home.7
Homeowners with negative equity are more likely to default. For exam- ple, a recent study found that an additional 16% of homeowners who owed more than 140% of the values of their homes transitioned into default each year, as compared with only 2. …