A half-dozen years ago, bankers were testifying to Congress about the need for a sweeping reform of bankruptcy law to make it more difficult for Americans to file for personal bankruptcy. They got what they wanted in 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act.

A team of economists now argues that the restrictive bankruptcy reforms helped lead the nation into its current deep recession by pushing the numbers of mortgage defaults and delinquencies up by almost 200,000 annually.

Among the problems with the tightened bankruptcy laws is the increased costs in filing for bankruptcy and a reduction in the debts that are discharged. The unintended consequence: homeowners are often unable to get bankruptcy protection and are instead losing their houses.

Types of Bankruptcy

In a Chapter 7 liquidation bankruptcy, most unsecured debts are discharged. The person filing liquidates assets (less their available exemptions) to repay their unsecured debt.

In a Chapter 13 reorganization bankruptcy, debtors agree to repay some of their debt over a three- to five-year period.

Economists Wenli Li of the Federal Reserve Bank of Philadelphia, Michelle J. White of the University of California at San Diego and Ning Zhu of the Graduate School of Management at the University of California, Davis say both kinds of bankruptcy can potentially help homeowners save their homes.

Filing for Chapter 7 bankruptcy can stop a foreclosure proceeding for a period of time, giving a person time to catch up on their payments. Chapter 13 has the same delaying effect on the foreclosure process. If a homeowner is far behind on mortgage payments, Chapter 13 could allow a debtor catch up on missed payments with a court-approved plan.

Increased Costs and Barriers

The 2005 bankruptcy changes added new costs to bankruptcy: filing fees have risen more than 50 percent, according to a government study. There are also fees for credit counseling and debt management and the costs of mandated documentation of income and assets.

The 2005 reform also introduced a means test, forcing some homeowners with high incomes to file under Chapter 13 rather than Chapter 7. That forces the debtors to repay some of their unsecured debt from their future income; again harming them financially and hampering their ability to pay their mortgages in a timely fashion.

The new bankruptcy law also imposes a cap of $75,000 (basic), $100,000 (family) and $175,000 (elderly, low income or disabled) on the homestead exemption, making bankruptcy "much less attractive after the reform," wrote economists Li, White and Zhu.

The three economists concluded that before 2005, homeowners in dire financial straits benefited from filing bankruptcy whether they wanted to keep their homes or not. They also say that the economy and homeowners would benefit by rolling back bankruptcy laws to their pre-2005 state by lowering the number of mortgage defaults and underwater loan walkaways.

If You Face Foreclosure

If you're a homeowner facing foreclosure, talk to a California bankruptcy attorney who can help you understand all of your legal options and help you choose the course of action that will protect you and your family best.