This Article empirically tests the economic assumption underlying
the policy against bankruptcy modification of home-mortgage debt-that
protecting lenders from losses in bankruptcy encourages them to lend more
and at lower rates, and thus encourages homeownership. The data show that
the assumption is mistaken; permitting modification would have little or no
impact on mortgage credit cost or availability. Because lenders face smaller
losses from bankruptcy modification than from foreclosure, the market is
unlikely to price against bankruptcy modification. In light of market
neutrality, the Article argues that permitting modification of home
mortgages in bankruptcy presents the best solution to the foreclosure crisis.
Unlike any other proposed response, bankruptcy modification offers
immediate relief, solves the market problems created by securitization,
addresses both problems of payment-reset shock and negative equity,
screens out speculators, spreads burdens between borrowers and lenders,
and avoids the costs and moral hazard of a government bailout. As the
foreclosure crisis deepens, bankruptcy modification presents the best and
least invasive method of stabilizing the housing market.
