In Staff Report No. 358, staff members at the Federal Reserve Bank of New York concluded that the amendments to the Bankruptcy Code embodied in the Bankruptcy Abuse Prevention and Consumer Protection Act (BACPA)   of 2005 has contributed significantly to the destabilizing surge of foreclosures in the subprime markets.

One of the key features of BACPA was the implementation of the notorious Means Test. The Means Test, according to the authors of the report, has prevented many families from obtaining the debt relief needed to preserve their homes by eliminating unsecured debt (such as credit card debt) to free up additional funds to make monthly mortgage payments.   Pre-BACPA, many families could seek the protection of the bankruptcy courts by filing under Chapter 7 and eliminate most unsecured debt.   Since the implementation of the Means Test many families facing foreclosure are unable to file under Chapter 7 because the household income for the family facing foreclosure often exceeds the state’s median income for the particular household size. The research presented in this report helps explain the current economic turmoil in the financial markets as well as unprecedented foreclosure rates.

The “destabilizing surge” of subprime foreclosures due to relaxed underwriting standards, the increased availability of mortgages stemming from policy changes at Fannie Mae and Freddie Mac, as well as increased fragmentation of the financial markets and collateralized debt due to securitization have been well documented but now a major contributing factor appears to be BACPA itself.

“BACPA is a small, exogenous, financial shock that caused seismic effects far from its epicenter”

According to the report, BACPA has prevented many families from filing for Chapter 7 bankruptcy to reduce unsecured debts and has had the effect of shifting the burden and risk off loss from credit card issuers and other unsecured creditors to secured creditors such a mortgage lenders.   By preventing households from filing under Chapter 7, many families are forced into foreclosure because the stringent requirements of Chapter 13 and the burdensome 60 month repayment Plan is often not a viable option.   If homeowners file under Chapter 13 and fail to make payments under the court confirmed plan the protection of the Bankruptcy Court is lifted and creditors can proceed with foreclosure.

Studies contained in the report have also concluded that the effect of BACPA in the subprime markets is even more pronounced in states with significant homestead protection.   In states that have generous homestead Exemptions Chapter 7 (pre-BACPA) allowed homeowners to file Chapter 7 and protect any equity in the home.   With the introduction of the Means Test many of these bankruptcy candidates are no longer eligible for Chapter 7 and are now at risk of losing any equity that they could have claimed.

With the rapid popularity of home equity lines and the use of such funds to make consumer purchases ordinarily made with credit cards, many debtors find that their homes are fully encumbered with debt secured by mortgages further threatening home preservation.   This problem is one that cannot be alleviated even if a Chapter 7 bankruptcy could be filed because now debtors have used secured funds to make consumers purchases that are not as easily discharged as compared to unsecured debt.

Prior to BACPA, debtors filed Chapter 7 specifically to save their homes from foreclosure according to the report not to merely surrender them.   BACPA has eliminated the ability of many debtors to file Chapter 7 and thereby free up additional income to save their homes during this economic crisis.

As a side note, and not contained in the report, BACPA was drafted by lobbyists for the credit card industry.   It seems that they have obtained what they thought they wanted at the expense of our collective interests in our economy.   The increase in late fees, penalties and interest as well as the reduction or freezing of credit lines by these companies have forced many into bankruptcy or have held those hostage who now cannot file Chapter 7 because of the law they helped pass.   The current economic turmoil caused by these types of predatory business practices and over securitization is a major factor putting downward pressure on our economy.   Thank your government for bailing these companies out….