Saturday, August 24, 2013

What the F*@# is Federalism!? Part II

But before we trace the evolution of politics in the United States, I want to illustrate my purpose and draw on some professional experience. I am a bankruptcy attorney. Bankruptcy in the United States has a unique purpose, especially today. It is a government promulgated system that prevents people from going bankrupt. I always stress to clients that by filing their bankruptcy petition, they are not going bankrupt but instead filing for bankruptcy protections. It may sound like a difference in semantics, but I mean to emphasize that difference in all seriousness.

Under state contract laws, property laws, and consumer protection law, there is still little protection for the debtor that is overwhelmed by creditors with unmanageable debt. That is were the power of the federal government comes in. First, the Supremacy Clause in the US Constitution is an important point of consideration. This is, in my opinion, the ultimate foundation for federal power, and this ties directly to the US Supreme Court case of McCulloch v. Maryland and the state government vs. federal government battle over banking and insurance regulation. This battle rages today. Look at any banking or insurance  regulation, ERISA, and even the bankruptcy laws with states opting out of federal exemptions. It is a political hot potato game of jurisdiction.

I can best speak on the bankruptcy laws. An they do a lot of good for a lot of debtors, but not all debtors. Business debtors have unique circumstances where they get almost a sort of preferential treatment. Here are some examples:

MEANS TEST

If you have primarily consumer debts you have I pass a means test to qualify for the usually quicker and easier Chapter 7. If you have primarily business debts, then you automatically qualify.

Sometimes their may be disadvantages for a Chapter 7, and a Chapter 13 (or Chapter 11 in the business context) does not require all assets (minus exemptions) be liquidated. But if you are not in a Chapter 7, you can hedge a good bet that your bankruptcy will be a long and drawn out process.

LIEN STRIPPING 

You can usually strip down and strip off liens for investment property. Not so if it is your homestead. If it is your homestead, then you can only strip off. Business debtors are more likely to have investment property than consumer debtors. And it would be very advantageous, especially in today's real estate crisis, or even just to accelerate recovery, to allow homeowners to strip down and strip off.

I will explain this is more detail for those completely lost. Liens are used to secure creditors with particular types of collateral. Think of mortgage, lien, or anything else the creates a right to repossess collateral as a security interest, and it is an actual property interest, it is what secures the creditor on the repayment of a particular debt. 

When you have a lien on your new car from the creditor that jut financed the transaction, that creditor should generally take a purchase money security interest away from the transaction. An off the cuff estimate is that when you drive your new car off the lot, it loses half its value. That creditor is now undersecured.

Say instead you finance a house with a bank. And the bank, as part of financing the transaction, receives a mortgage in your real property. If that house is your primary residence, it becomes your homestead. Your house goes up in value, now your creditor is oversecured. Now you want to renovate the house. You pull equity out of the house with a 2nd mortgage and the new bank gives you money to remodel. 

Now the housing market crashes, or hell your spouse pulls all the equity out and stops paying the bills and you do know, either way, and innocent but unfortunate debtor deserves bankruptcy protections. And then of course states like Florida have an unlimited homestead exemption. But even other states, if you owe more on your home than it is worth (underwater) there is no equity to claim exempt anyways. 

So now we have to determine whether these are secured creditors or not. In a Chapter 13, where most all jurisdictions allow consumer debtor to strip liens, and then in the 11th Circuit interestingly allows stripping in a Chapter 7, at least for the time being. If the lien is stripped, the creditor, or a portion of the creditors debt will be treated as unsecured instead of secured even though they have a security interest. This is determined by determining the value of the collateral at the time of filing. A creditor that owns a debt that is less than or equal to to value of the collateral is fully secured. They retain 100% of their security interest. All others are either partially secured or fully unsecured. 

Usually, consumers can only strip off liens if fully unsecured creditors. They cannot, at least with respect to their  homestead, strip down partially secured creditors. 

This lien stripping example should first serve as an example of federal law destroying state property rights in the interests of protecting debtors.

It should also demonstrate that bankruptcy laws are not perfect, and while jurisdiction difference allows us to compare and contrast the laws, it also means we must actually engage in contrasting and comparing and determine what we believe is best for self, group, and whole. 

Other places that need improvement:

STUDENT LOANS

The evolution of the law is interesting. Most used to be dischargable, but have changed since the federal government started guaranteeing. But the federal government subsidizes and guarantees particular housing markets, and these debts are dischargable and liens can be stripped. The difference between this housing crisis and the student loan crisis is minimal compared to the other dischargable debts, and the stark difference between the treatment of the various debts has lost touch with reality on multiple levels. There is a big difference between fraud, unpaid child support, unpaid taxes, and student debt. 

SOLUTION

No one should rant about issues with proposing a solution, and no solution is perfect but all can be amended. Ou have to start somewhere before Carl Popper's falsifiability can be put into motion. So here is mine with a millions flaws I have yet to think of.

I do not think this author has discounted the idea that most or at least some student loans should eventually be dischargeable, especially in a Chapter 13 type plan.

Same goes for treatment between consumers and businesses when it comes to qualifying for a Chapter 7 or stripping down liens in either a Chapter 7 or a Chapter 13. 

How do we balance this plans with the competing interest, longer disclosure and look back and claw back procedures, giving specific debts a reach forward power like that for probate/trusts/life insurance. The code could make a Chapter 13 look like a beefed up Chapter 7. This could solve all the problems including the numerous people that are scared if the Chapter 13 with a 5 year disposable  income commitment. This can all be remedied with federal law in one broad swoop. 

So what is federalism, but then it was strong federal government power. And in a lot of places back in the early days of the nation, that helped the merchants and bankers and creditors of the era. Today, systems like bankruptcy, do just the opposite, generally, but inconsistently.