When the U.S. housing market collapsed and foreclosures began to sweep the nation, many blamed predatory lenders, while others felt no sympathy for homeowners who took mortgages they couldn't afford.

There's been a lot of finger pointing and plenty of blame to go around as the economic recession deepens.

According to The Kansas City Star, three researchers at the Federal Reserve Bank of New York are now putting some of the blame on The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Did the New Bankruptcy Law Spawn the Foreclosure Crisis?

The 2005 bankruptcy act was pushed hard by the credit card industry and researchers argue that the law shifted risk from credit card lenders to mortgage lenders, thus spawning the foreclosure crisis.

Prior to the new bankruptcy law, debtors were able to have their unsecured debts discharged by filing Chapter 7 bankruptcy.

After debts such as credit cards and medical bills were erased, they could then apply their earnings to their mortgages.

With the new bankruptcy law came the means test, which excluded many debtors from filing Chapter 7 bankruptcy, which discharges unsecured debts, and forced them into Chapter 13 bankruptcy, which allows more time to catch up on debts but does not discharge debts.

Researchers argue that people who could have previously filed Chapter 7 bankruptcy and saved their homes are now more likely to face foreclosure.

New Bankruptcy Law Did Fuel Foreclosures: The Argument

Donald P. Morgan, a research officer at the New York Fed was the paper's lead author.

Morgan told The Kansas City Star that he was "99 percent confident" that the bankruptcy reform act of 2005 is a primary cause of the nationwide foreclosure crisis and free-falling home prices.

According to The National Association of Realtors, the average sale price of an existing home fell 12.3 percent, to $224,200, over the 12 months ending in November.

Morgan and the co-authors of the paper say that the tougher requirements imposed by the bankruptcy reform act have caused an increase in the number of homeowners who default on their mortgages or walk away from their homes rather than filing bankruptcy.

A group of academic experts studied 2007 bankruptcy data and found that debtors who have avoided filing bankruptcy in recent years seem to be ordinary people in financial distress and not the high-income debtors that the bankruptcy reform act was intended to exclude.

A growing number of experts say that families currently filing bankruptcy owe more debt than ever before and are simply unable to manage it all with their limited disposable income.

The Bankruptcy and Foreclosure Numbers

The Government Accountability Office reported that through the second quarter of 2008, more than 4 percent of mortgages were in foreclosure or more than 90 days past due.

This marks the highest reported levels of mortgage defaults in the 29 years that the Mortgage Bankers Association has been keeping such records.

Will Bankruptcy Legislation Help?

New legislation may be the key to slowing the rate of foreclosures.

The bankruptcy cram-down legislation, if signed into law, could help the mortgage crisis by giving borrowers more of an advantage and encouraging voluntary arrangements between borrowers and lenders.

If an agreement cannot be reached between the borrower and the lender, bankruptcy judges would be given the power to alter the terms of the mortgage.

Tags: bankruptcy legislation, chapter 13 bankruptcy, chapter 7 bankruptcy, foreclosure, new bankruptcy law