Supreme Court Rules… Homeowners Can’t Strip Underwater Seconds in Ch. 7 Bankruptcy

Reversing a prior appeals court decision, the Supreme Court has ruled that homeowners with second mortgages that are “underwater” cannot strip those loans, thereby getting out of the indebtedness, by declaring Chapter 7 bankruptcy.  And it wasn’t a close call… the decision by the high court justices was unanimous.  (It appears that underwater liens can still be stripped in Chapter 13 bankruptcy.)

Oh well… so much for that idea.  So much for reducing the number of homeowners who are underwater, meaning that they owe more than their homes are worth… and so much for helping get the housing market actually get going again any time soon. 

I guess you could say… the debt reigns supreme.

According to an article in Mortgage Professional America Magazine (MPAMag.com) on June 3rd…

“The ruling will have the largest impact in markets with a high number of homeowners considered to be ‘underwater’ – owners who owe at least 25 per cent more than the value of their homes.”

(Really?  No kidding.  Well, thanks for that little pearl of wisdom, MPA Mag.)

Then the MPA article went on to list the states with the largest numbers of underwater homes, including Florida, which they said has 1.4 million such homes… California, which they said has 800,000 of them… Illinois at roughly 600,000 and Ohio at over 400,000 and Texas coming in over 300,000. 

Now, these are homes where the homeowner owes “at least 25 percent” more than the home values, so I can’t help but wonder what those numbers look like if you take the percentage down to zero… or even show the numbers that cannot sell at a price that would net enough to satisfy the 20 percent down payment requirement inherent to getting a new conventional loan.

How many homeowners would be shown as underwater then?  Because that’s the meaningful number when it comes to counting underwater homes, at least in terms of getting the housing market moving towards good health again.

If you raise the “underwater” bar to being able to sell at a price that nets the seller the 20 percent downpayment needed to buy another home, would that triple the number of homeowners considered “underwater” today?  Or could it even increase the numbers by four-fold?  It certainly could, but I can’t find anyone interested in doing that sort of math… just way too real, and therefore depressing, I suppose.

That would put California’s underwater population north of three million… and maybe north of four.  In Florida there would be upwards of four million… maybe five.  Illinois would have something like two million sunken homes… and even Ohio would have to come in over a million.

Do I have to mention what sort of percentages those numbers by state represent?  How about if we say the percentages would be considered… I don’t know… how about we say “large,” and leave it at that… save me some work looking up what is only going to end up being considered “large” anyway.

It would, however, go along way towards explaining the diminutive stature of the current housing market… in other words, how relatively small it is compared with prior and pre-bubble years.  “Inventory is low,” is pretty much all you hear these days in terms of complaints by active Realtors, and that means there aren’t many “normal” people selling, but nor are there many “normal” buyers.  It’s a housing market in which prices are being driven by scarcity… not demand.

All told, it’s anything but a “normal” housing market, and this decision will only make that market take longer to move towards recovery, it certainly won’t help anyone but the banks… and I’m not even sure it will help them much as it would seem likely to only increase the numbers of defaults going forward.

According to the Financial Times, the court’s reasoning was stated by Justice Clarence Thomas as follows…

“Under the debtors’ approach, if a court valued the collateral at one dollar more than the amount of a senior lien (debt), the debtor could not strip down a junior lien under Dewsnup, but if it valued the property at one dollar less, the debtor could strip off the entire junior lien,” wrote Justice Clarence Thomas. “Given the constantly shifting value of real property, this reading could lead to arbitrary results.”

And I do understand that reasoning, but what it means is that we need a bankruptcy law that makes more sense and handles this issue in a more productive way… and that would mean Congress acting to amend the bankruptcy code… and I don’t know about anyone else, but I just don’t see that happening any time soon.

So… in terms of the housing market, it’s nothing but the status quo ahead.  And if you have a second that’s underwater, there’s no getting out of it through Chapter 7 bankruptcy. 

Mandelman out.