My comments here the other day about the harsh new bankruptcy code continue to elicit interesting responses. Below is a letter I received yesterday from a mortgage lender who thinks that narrowing the escape route for profligate borrowers will have a positive benefit for the rest of us. This may be true to the extent that the costs to prudent borrowers of subsidizing deadbeats who walk away from their obligations will decrease if there are fewer bankruptcy filings. However, my concern is that many millions of homeowners who have been reasonably careful about managing their finances could conceivably face bankruptcy if home prices continue to fall.

The crux of the problem is that a seemingly “low” 5.5 percent mortgage can become a crushing burden if the value of the underlying collateral decreases by even as little as three or four percent. That would subject the homeowner to an effective real-rate burden approaching 10 percent, which is more than most hedge funds are returning these days. Ominously, residential real estate prices across the U.S. have already fallen by more than 3%-4%, so it’s only a matter of time before the financial pain this brings about causes consumer buying to collapse. Here is the letter from the mortgage lender, who as I noted above is somewhat more sanguine than I:

We All Pay

“I’m not sure if a bankruptcy attorney qualifies as an insider, as he makes his money on filing bankruptcies. I would lament my income going down by 70% also. I have been a long time ‘lurker’ who has read every article you have posted for the last few years.  I subscribed today because I think you have been great at calling the market.  I think you are right concerning the deflation issue also; however, I think that you are way off on the bankruptcy issue. 

“I am a mortgage lender and have seen my share of credit reports.  The last ten years, it has been very few and far between when bankruptcy was used for a valid reason such as business failure.  Nine times out of ten it has been for overspending on credit.  You and I and all the rest of the bill paying citizens pay for this extravagance.  I frankly was getting sick of seeing people that spent, spent, spent and then filed bankruptcy, only to do it again in a short period of time. I think that some good old values of keeping your contracts and paying your bills would go a long ways in today’s world.

“I see filings for bankruptcies being down 70% as a huge positive!  The only thing that can help to put our houses back in order is to increase our saving rate and slow down consumption.  This will have a deflationary effect as much as anything else that you have spoken of in the past. But at some point, as you have said, all bills have to be paid.  Thanks, for putting great thought provoking information out. – J.M.”

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