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Housing crisis adds new wrinkle to bankruptcy reform

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It's been two years since the latest bankruptcy reform legislation was enacted and the results have been difficult to judge, according to local analysts.

The main reason: the unforeseen development of the housing collapse and subprime market crisis.

With foreclosures occurring at an alarming rate, bankruptcy attorneys have experienced a spike in business not seen since the fall of 2005, just before Congress tightened restrictions on the ability of individuals to relinquish debt.

"The consumer lawyers I know are much busier now than they were before," said David Osias, a creditors' rights attorney in the San Diego office of Allen Matkins.

There were 118,948 non-business bankruptcy filings in California in 2004, according to statistics compiled by the American Bankruptcy Institute.

When lawmakers reformed the bankruptcy code in 2005, consumers rushed out to file under the old provisions, raising the state's filings to 162,532 -- including nearly 58,000 in the fourth quarter.

"People were lined up at the courthouse and clerks were taking overtime to process the filings," said Dean Kirby, a creditor lawyer for the San Diego firm Kirby & McGuinn.

The following year, there was a steep decline in bankruptcy filings. In California, the number dipped to just 37,107 non-business bankruptcy filings in 2006.

Consumer bankruptcy attorneys, who were largely against the reform bill, said the dropoff was due to misinformation about who could file, while credit-card industry officials claimed it showed the law worked.

Kirby said part of the reason was the public's misperception that it was no longer possible to file a bankruptcy petition. But he also said bankruptcies decreased simply because everyone who would normally file had already filed in late 2005.

"It wasn't as if no one was eligible to file or were being prevented from filing," Kirby said.

The number of filings has picked up in 2007. In the first quarter this year, 15,041 had filed for bankruptcy in California. In the second quarter, the number increased to 17,050.

Kirby suggests those statistics are misleading because 2006 was extremely slow and individuals have been hit hard by the housing crunch. Plus, he noted, bankruptcy filings have yet to return to their pre-reform levels.

"Any lesson to be learned in the increase in filings has really been confused by the effect of the housing collapse and the subprime mortgage crisis," Kirby said. "There's no doubt that many people are filing bankruptcy petitions because their financial situation has been impacted by the increase in mortgage payments as introductory rates expire.

"There are a lot more people today than there were two years ago who need to file bankruptcy because of the housing crisis."

Interestingly enough, according to Osias, the 2005 bankruptcy reform put restrictions on single asset real estate cases, where property owners have difficulty developing a piece of real estate they bought.

"Under the law, it's very tough to organize those cases," Osias said, "and now we see more of a need for it. There's not a cause and effect there. The timing is just what it is."

The housing crisis has caused lawmakers to consider more reforms to the bankruptcy system. One proposal would allow homeowners to restructure the length and size of their monthly mortgage payments within the bankruptcy proceedings, a process that isn't currently allowed.

"It is in this climate where bankruptcy is becoming a consumer law issue," Kirby said. "It's a Democrat versus Republican issue."

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