In a February post to Credit Slips, Katie Porter pointed out a recurring problem for U.S. debtors trying to deal with mortgage defaults through a Chapter 13 plan. They can make all of the payments needed to cure their pre-bankruptcy defaults and all of the principal, interest, and escrow payments that become due while the case is pending, but still end the case substantially behind on their mortgages, due to additional fees and charges claimed to have accrued during the case, such as mortgagee’s attorneys fees, inspection fees, and late charges. Professor Porter voiced support for proposed legislation—the Foreclosure Prevention Act of 2008—that would require mortgagees to give notice of such post-bankruptcy fees while the bankruptcy case was still pending, so that debtors could either challenge the fees or provide for their payment under bankruptcy protection. But the fee-notice provision was only one part of the proposed legislation. The legislation also provided for modifying the terms of home mortgages in bankruptcy, and with opposition from mortgage providers, it failed to survive a filibuster threat.
Perhaps a new bankruptcy rule on disclosure of mortgage fees—unconnected to mortgage modification— could deal effectively with the problem. Like the proposed legislation, a rule could require mortgagees to give reasonable notice of extra fees or charges that arise during the course of a Chapter 13 case and could provide that if the required notice is not given, the fees may not be assessed. A streamlined procedure for resolving any disputes over the fees could also be implemented by rule. Although the process of adopting a rule is long—generally at least three years—it has the advantage of being insulated from much of the political pressure brought to bear on Congress. Moreover, in contrast to their response to mortgage-modification legislation, mortgage providers might support a rule on notice of post-bankruptcy mortgage fees. Currently, local courts and individual judges have adopted a variety of methods for dealing with such fees (for example, Section B.2(b) of the model plan for the Northern District of Illinois). A uniform rule on the question would offer reduced costs of compliance for mortgagees, as well as a level of protection for debtors.
We’re starting to see the bankruptcy ripple effect of the housing crisis beyond the housing and financial services industry. Now municipalities are being forced to declare bankruptcy because property tax revenue has dried up while foreclosures have imposed significant strains on municipal resources.
While moral hazard concerns are a real issue for any government aid to borrowers or lenders, its worthwhile remembering a major exception to moral hazard–third-party costs. As Larry Summers summarizes: When the fire department rescues people who start fires by smoking in bed, it creates a moral hazard for in-bed smokers. But no one gets exercised about moral hazard, in part because we know that fires can spread and burn down neighbors’ apartments in “contagion” fires and that the in-bed smokers won’t take care to insure their neighbors. That’s what we’re seeing in foreclosure crisis–mounting third-party costs to neighbors and local government. If the municipal government goes bankrupt, it affects everyone in the community–indeed, those who had to relocate because of foreclosure escape this consequence. Foreclosure is a real problem for everyone, not just those who get kicked out of their homes or whose investment portfolios take a hit.
Elizabeth Warren draws our attention to an astonishing example of banking industry chutzpah–claiming preemption protection against state foreclosure laws. Not only has no one ever historically believed that state foreclose law was preempted; the OCC’s preemption reg’s specifically carve out state debt collection law from preemption. There’s no conflict preemption here, and given specific mortgage preemption laws like DIDMCA and AMTPA that preempt state usury limits on some mortgages and limits on exotic mortgage structures, it is hard to see how there is general field preemption or the like.
The preemption argument is even more chutzpadik, though, because banks hold only a small percentage of mortgages. Most mortgages are held by securitization trusts. The last time I checked, they are not federally chartered financial institutions nor are they operating subsidiaries or agents of federally chartered financial institutions. Thus it is utterly beyond me how anyone could claim that preemption applies to mortgages owned by securitization trusts, even if the mortgages were originated by national banks and are serviced by them. The preemption claim here doesn’t even pass the straight-face test. As unbelievable as it is, though, perhaps legislation should clarify this just to, um, foreclose possible preemption arguments.
I’m curious whether the same financial institutions pushing the preemption claim are also the same institutions that are members of the HOPE Now Alliance, who have supposedly committed themselves to working to modify loans rather than foreclose. The preemption agenda is simply inconsistent with a commitment to efforts to avoid foreclosure.
Just when you think the mortgage mess can’t get any worse, the banks come up with a new idea: They shouldn’t have to obey state law when they foreclose on someone’s home.
Pre-emption has been a gravy train for the national banks, insulating their credit card business from state laws. Some banks now want another ride on the pre-emption train, claiming that they shouldn’t have to follow local foreclosure laws when they take people’s homes.
Tomorrow Congressmen Brad Miller (D, NC) and Steve LaTourette (R, OH) will introduce HR 5380 to make it clear that the banks have to follow the state law foreclosure laws, just like they always have. Amazingly, this is expected to be a close vote.
We ended the first day of the conference with management professors, Professor Gerry McNamara (Michigan State University) and Professor Paul M. Vaaler (University of Minnesota). They discussed How and Why Credit Assessors “Get It Wrong” when Judging the Risk of Borrowers: Past and Present Evidence at Home and Abroad. Professor Vaaler observed that the subprime meltdown is just one of the latest mistakes the rating agencies have made in recent times (he also points to the S&L crisis, Asian financial crisis). He argues, however, that private, credit rating agencies are at the center of the current housing crisis.
Professor Vaaler stressed that the agencies almost always get it right when assessing the risk posed by individual securities. But, when they get it wrong they get it wrong in a spectacular way.
An economist, Professor Amir Sufi (University of Chicago), shifted our focus in the afternoon session from debtor, to lender, behavior. In discussing his paper, Lender Incentives, Credit Risk, and Securitization: Evidence from the Subprime Mortgage Crisis, Professor Sufi asks why lenders made such bad decisions when making subprime mortgages. He concludes that securitization reduced lender incentives to scrutinize borrowers, because lenders knew they would sell virtually all the subprime loans they originated and, thus, knew they would shed the credit risk associated with those loans. Professor Sufi argues that this is to be expected, since financial intermediaries overcome information frictions only if they have an incentive to properly screen and monitor borrowers.
Here’s a mortgage crisis chronology for this week, as reported by the New York Times and Washington Post. Can you guess what these articles have in common?
On Sunday, Michelle Singletary’s The Color of Money column discussed Treasury Secretary’s Henry Paulson’s recommendation to create a Mortgage Origination Commission that would promulgate standards for mortgage loan officers and would rate and report state efforts to license and regulate mortgage brokers. In her view, a new Commission isn’t needed. Instead, she argues that what we need to do is send some of these people to jail. Rather than have a commission talk about their fraudulent acts, she suggests that we need to criminally prosecute loan officers who have engaged in fraudulent lending activities.
As I argue in the earlier posting, the Sunday Washington Post article raises a number of interesting points about the value of homeownership as an investment device. I discuss many of these points in an article that will be published this Fall, and ultimately conclude that it is time to debunk some of the myths associated with homeownership.
An article in the Sunday Washington Post asks whether — given the current housing crisis — real estate or the stock market is the better investment. Of course, the answer is — it depends. Formulating a longer, more sensible answer happens to be something I’ve been thinking about for the last several months and is the subject of my current research. I’ll discuss this article in two posts. Here’s the first one.
As the title of one of my forthcoming articles suggests (“The Myth of Home Ownership, and Why Home Ownership Is Not Always a Good Thing”), I challenge this country’s obsession with Homeownership and the view that attaining homeownership is crucial to achieving the American Dream. I’ll discuss a few points raised in the Post article to explain how I’ve reached these somewhat heretical views.
In my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in “reasonable loss mitigation activities.” The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).
The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower’s information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.
In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point–mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn’t gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.
My buddy, Buce over at Underbelly, has a post up using the concept of option value to help explain why more people are not walking away from their underwater homes. By “underwater,” we’re not talking about Homer Simpson’s imaginary home under the sea, but situations where the mortgage on the residence is more than the value of the residence. A cool, rational economic actor would walk away from the home, leaving the lender to take a loss (assuming the lender has no legal or practical alternative to collect the difference from the homeowner). We’re not seeing that as often as the cool, rational economic model might predict. Buce points out, correctly, that ownership of the house is just like having an option to buy (i.e., pay off the debt and the house is yours) and even underwater options have value. Thus, part of the reason why more people don’t walk away from their homes is because of this option value.
Katie Porter makes an incredibly important point in her recent post about how securitization structures may be impeding mortgage modifications because the ultimate holders of risk on the mortgages are not the ones involved in the modification decision. Mortgage servicers, who typically hold a small interest (if any) in the loans are the ones making the modification decisions. When servicers do hold positions in the mortgage-backed securities, they are first lost positions, so the servicers likely takes a loss regardless of a modification or foreclosure, meaning that their interests are not aligned with the other MBS holders.
Let me take Katie’s post a step further and suggest that the relevant voices on the lending side of the mortgage market have not been heard. The ultimate risk on mortgages is held by mortgage-backed securities holders, private mortgage insurers, and pool-level bond insurers. These parties have been entirely absent from the conversation on modification and bankruptcy reform.
At the heart of a loan modification is communication between a creditor and a debtor that leads to an agreement on new contract terms. If the debtor cannot get reach a person with authority to negotiate, a modification won’t be possible. If the creditor can’t get the debtor to return its calls or read its mail, a modification also won’t be possible. The communication problems in today’s securitized mortgage market are very different than during past real estate downturns, such as the Midwest farm crisis of the 1980s or the wave of foreclosures in the 1930s. Why? Because of the widespread use of mortgage servicers, third-party agents who collect payments from borrowers and remit them to the mortgage note holders (usually investors, often via a trust). Mortgage servicers are responsible for enforcing defaults, including pursuing foreclosures, and for engaging in loss mitigation. Gone are the days of sitting down with the bank that originated your loan and negotiating a new deal. Why am I making this very basic point? Because I am concerned that policymakers, including legislators, judges, and regulators still do not understand the barrier that loan servicing presents to voluntary or consensual loan modification.
The UST has been turned loose on Countrywide. The United States Trustee has sought to conduct discovery on Countrywide as part of a motion for sanctions against Countrywide for abusing the bankruptcy process by filing claims that included fees Countrywide knew were not authorized. (See Katie Porter’s article on this troubling phenomenon here.) Countrywide sought to squash the discovery motion. Yesterday, the Bankruptcy Court for the Western District of Pennsylvania denied Countrywide’s motion. The bankruptcy court was unimpressed by Countrywide’s slippery slope argument that this will open up the door to discovery on the entire lending industry. I have to think, though, that if anythign shocking comes out of discovery, trustees (and debtors) elsewhere might think about taking a closer look at creditors’ claims. The decision can be found here.
Beyond all the news on the causes of, and policy responses to the current US economic crisis focusing almost solely on financial markets, it’s worth paying more attention to causes and policy responses for households. One household-level cause fits with the implications of a host of other evidence about credit choices: consumer overoptimism.
Something that I had been wondering about re: the mortgage meltdown has been home equity loans. We’ve all been focusing on home mortgages (starting with sub-prime, but slipping up to Alt-A and conventionals), but what I was curious about was home equity lines: are those going into default too? The answer, it seems, is yes. In just today’s Wall Street Journal, Robin Sidel reports that charge-offs on home equity lines are doubling. J.P. Morgan Chase predicts first-quarter write-offs of $450 million (up from $248 million prior period) on its $95 billion portfolio. Delinquency rates are also up too, to over 4%.
The rub with these loans will be on under-water mortgage homes. The home equity lines, I suspect, are second liens to the PMSI mortgagee, so for the many homes where the superior-lien mortgage gobbles up most of the value of the home, will this result in foreclosures, or just losses? Either way, more bad news I guess.
The latest numbers are out: One in ten homeowners has no equity in the family home. The data show that about 15% will be below water if prices continue to slide, owing more than their homes are worth.
So what’s the plan here? One in ten homeowners could just walk away right now. Indeed, most of them, if they were the rational maximizers so prominently featured in classical economic analysis, would stop paying now, put the money in a savings account and wait the 90 days or two years or whatever until the lender could force them out by foreclosure. In non-recourse states, they could just pocket the money and walk away free and clear. In other states, they might need bankruptcy or a last-ditch deal with the lender for a short sale. The economics of the deal shift when the homeowner has no equity to protect.
If they walk, the national–and world–economy will seize up. The investors who hold those mortgages can avoid that if they are willing to share the pain and acknowledge that their loans are only partially secured. Like practical lenders have done for thousands of years, they could decide that getting a steady, partial payment is better than no payment at all. So far, however, the investors are holding tight, even as Fed Chairman Bernake asks them please please please renegotiate these crazy mortgages.
Katie Porter’s posts and scholarship about illegal fees tacked on by mortgage servicers to defaulted mortgages raise an interesting question: why aren’t states reconsidering non-judicial foreclosure? Non-judicial foreclosure is generally faster and cheaper than judicial foreclosure, which is a good thing, at least for the foreclosing lender as it reduces loan losses. And as Karen Pence has shown, there is a reduced supply of credit in states with judicial foreclosure. But as the name implies, non-judicial foreclosure lacks court oversight, and this raises the possibilities for abuse.
[UPDATED LINK 3.4.08 at 5:06pm]
HOPE Now, the government-encouraged alliance of mortgage servicers assembled to facilitate mortgage workouts, has released its January 2008 numbers. There’s good and bad news in these numbers.
Tomorrow, the Senate is expected to vote on the Foreclosure Prevention Act of 2008, Title IV of which would permit bankruptcy courts to modify home mortgages in certain ways if the loan and the debtor met specified criteria. We’ve described that idea before, but the bill has crucial implications for bankruptcy that are not related to loan modification. Specifically, take a look at section 421, which proposes a solution to a problem with current bankruptcy law. Many Chapter 13 debtors pay for 3 to 5 years on a repayment plan, doing everything the law requires of them, and only a week or two later, face a foreclosure. How does this happen? Because the mortgage servicers frequently assess charges during a bankruptcy case, but fail to disclose these fees. Courts don’t approve them; trustees don’t adjust the debtor’s payments to account for them; and debtors aren’t even given notice that these charges are piling up. Instead of emerging from bankruptcy with a fresh start, homeowners find themselves defending a foreclosure or having to immediately pony up hundreds or thousands of dollars. Just last week, Judge Brendan Shannon of the Delaware Bankruptcy Court addressed this issue, challenging lenders to disagree that these undisclosed “surprise” fees don’t “frustrate” bankruptcy’s home-saving purpose. The Foreclosure Prevention Act of 2008 tackles this problem by requiring mortgage companies to disclose all fees within the earlier of 1 year of assessing the charges or 60 days before the end of the bankruptcy. The law also specifies that a lender may only charge such fees if they are lawful, reasonable, and provided for in the contract. It’s sad that this latter requirement is even necessary–it essentially just prohibits mortgage servicers from violating existing law by overcharging consumers, a problem that an increasing body of case law and research suggests occurs with alarming regularity. I see lots of reasons why permitting bankruptcy courts to modify mortgages may be the best comprehensive solution to the foreclosure crisis, but I also hope Congress takes a hard look at the rest of the bill and considers its overall importance. If consumers do their part in bankruptcy and make every payment required by law, the system should honor its promise to give them a financial fresh start.
The Cleveland City Council is webcasting a foreclosure forum on Wednesday February 27th from 10am-1pm. Here’s the link to watch. The event is timed to coincide with the visits of the Presidential candidates and national media to Ohio. Senator Obama is sending adviser and law professor, Mark Alexander, and Senator Clinton’s representative will be Fred Hochberg. McCain has not yet identified who, if anyone, will attend. The foreclosure situation in Cuyahoga County may be the worst in nation, or certainly is a leading contender for that sad distinction. The city is taking some novel approaches, as I learned from Prof. Creola Johnson’s presentation at a symposium on Subprime Foreclosures at the University of Utah College of Law earlier this week. I was particularly interested in the problem of abandoned properties, and the practice of many lenders to not file deeds after purchasing a property at a foreclosure sale. That practice makes it very difficult for the city to figure out who is responsible for the upkeep on abandoned properties. The speakers at the Forum will include Cleveland Mayor Jackson, County Treasurer Jim Rokakis, Housing Court Judge Ray Pianka and several community organizations.
The pending bankruptcy amendment that would let judges make a downward adjustment on mortgages when the loan exceeds the value of the property goes to a vote in the Senate tomorrow. It will take 60 votes to push the bill forward. The mortgage lenders think they can block it, giving the Republicans a chance to kill the bill through filibuster.
Larry Summers weighed in via his column in the Economist. He supports the bill as a way to create a mechanism to get the borrowers into deals that are good for the borrowers and cheaper for the lenders. He points out the the current ideas of jawboning the lenders just isn’t working. But he seems to be having some trouble with the details of how bankruptcy works.
The most recent attempt to roll back some of the BAPCPA’s limitations on the scope of the bankruptcy discharge seems to have faltered in the House. The House passed an education bill, but without a proposed amendment that would have made private student loans dischargeable in bankruptcy, as they were before October 2005, was voted down. A Senate bill (S.1561) sponsored by Dick Durbin (D-Ill.) that proposes making the private loans dischargeable is still in committee. (For a discussion of the legislation see here.)
I’ve been catching up on some reading and again found the statistic that 30% to 70% of early payment defaults on home mortgages can be linked to significant misrepresentations borrowers made on their loan applications. This most recent time I saw the statistic cited as coming from the U.S. Federal Bureau of Investigation. Enough! Can we stop this?
This statistic is misleading and when presented as a fact makes it seem like there is an easy solution to the mortgage crisis, which would be to let the fraudfeasors get the fate they deserve. If those numbers seem too high to you, it’s because they likely are.
Office of Thrift Supervision, I have a question for you. What in the world is this?
CNN reported that the OTS is in the early stages of a plan that would give some lenders an incentive to write down mortgages where the value of the debt now exceeds the value of the home. According to CNN, if a home was worth, say, $100,000 and if the mortgage was $120,000, the lender could write down the mortgage to $100,000 and get a $20,000 warrant. If the house later sold for more than $100,000, the warrant would entitle the lender to receive up to value of the $20,000 warrant plus interest. The OTS also is suggesting that these warrants could trade on a secondary market. The idea is the lender would be able to share in any recovery in the value of the housing market.
I don’t get it.
Economists tend to be pretty good at pointing out what is currently going wrong with the economy. But we tend to be rather hamstrung at offering solutions. In the current crisis, public policy needs to achieve three things: 1) help troubled homeowners and declining communities, 2) maintain liquidity and stability in the credit market, and 3) prevent another financial crisis of this magnitude from happening again. Lawyers, community activists, consumer advocates, sociologists, among others, have offered a wide array of proposals to address the first two problems. Little has been suggested in ways of addressing the chance of a repeat crisis in the future. Economists in particular are reluctant to go beyond simple proposals that call for more market transparency. A changed regulatory, environment, though, may help to reduce the chance of future financial crises. Specifically, a few economists have proposed a new regulatory tool called asset-based reserve requirements for more than three decades. This tool would allow the regulatory agency, often assumed to be the Fed, to force financial institutions to bear the cost of their investment decisions and not to unload them onto society.
Many wait for Ben Bernanke and his colleagues at the Fed to save the economy from further turmoil. The reality, though, is that monetary policy is limited in addressing the crisis. In particular, the economy is slowing because the housing boom is over, which was caused and fuelled by deteriorating mortgage quality that resulted from people no longer paying their mortgages. The rise in foreclosures followed higher interest rates on resetting adjustable rate mortgages, lower incomes in a weakening labor market, and declining home prices that put many mortgages “under water”. Monetary policy can only directly impact interest rates and even there its reach is limited.
We are headed for the Great Deflation – a period spanning a decade or more of very slow growth, rising unemployment, flat or falling real wages, fewer employer-provided benefits and increasing pressures on government finances.
Thanks to CreditSlips for inviting me to be a guest blogger and to share my views on credit and the economy.
By now, it’s obvious that the housing crisis is dragging down the economy. For the past eight quarters, the declining activity in the housing market dampened growth on average by 0.9 percentage points below where it otherwise would have been. This is the largest housing induced subtraction from economic growth since 1975.
Some observers argue that this is just a natural correction of the market and that policy makers should let market forces play themselves out. The logic is that a nice, quick recession will get rid of the debt overhang by forcing people to default. Once banks’ balance sheets are free of the excess loans, the economy will get a clean slate to start over again as a rejuvenated banking sector will once again pave the way for innovation and production and not for speculation and Wall Street greed. The way it is portrayed, it almost sounds like a day at the spa for the US economy.
The situation, though, is far more serious. A recession that would get rid of the debt overhang would have to be very deep, especially since the mortgage foreclosure rate would have to jump to unimaginably high rates.
The Treasury Department has yet another voluntary plan to fix the mortgage meltdown. This one gives families an extra thirty days to pack their belongings before they lose their homes to foreclosure. For the 2 million families estimated to go into foreclosure this year, the mortgage industry, backed by the current administration says, in effect, “Let them eat crumbs.”
The administration plan is, once again, voluntary, and only a half-dozen lenders have agreed. What about the teaser-rate and sleaze-ball mortgages sold by everyone else? I guess those home owners had better pack fast.
The mortgage industry has been arguing against bankruptcy reform legislation that would permit the court-supervised modification of single-family principal home mortgages in bankruptcy. The industry argues that permitting mortgage modification in bankruptcy would result in higher interest rates and that its private efforts will solve the problem. In an earlier post and in a working paper, I have shown that we are unlikely to see higher interest rates as a result of allowing bankruptcy modification. Here, though, I want to take issue with the mortgage industry’s claim that its private efforts will solve the problem.
Hopefully the mortgage industry is correct about this. But there is good reason to doubt the efficacy of the industry’s efforts. To date, the mortgage industry’s efforts to fix the foreclosure crisis have been a lot of sizzle, but not much steak. Unfortunately, this seems to be the case with Project Lifeline, the latest half-measure to come out of the mortgage industry. As I explain below, the very structure of Project Lifeline means that homeowners in a significant number of states will be unable to take advantage of Project Lifeline’s meager offering because it will kick in only after their homes have been sold in foreclosure.
To my surprise, the second thing out of Hilary Clinton’s mouth, after “health care,” when asked about the differences between her and Barack Obama, was “mortgages.” It’s about time that the foreclosure crisis is getting prime billing in the presidential race.
The Mortgage Bankers Association released a study this month that touts the efforts of mortgage servicers and lenders to assist borrowers. The industry asserts that it “took major steps” to “help those borrowers who could be helped.” Therein, lies the catch. While apparently relying on self-reporting by mortgage servicers (an industry facing numerous accusations of misconduct (see here and here and here)), even assuming accurate data, the study’s methodology gives a big boost to the mortgage industry. How? The study begins by excluding as beyond help all loans on properties that servicers could not confirm the house was occupied by its owner (18%). It also excludes all loans in which the borrower defaulted despite a previous payment plan (29%). Notably, there is no evidence on the parameters of those plans–were debtors given an extra week to cure their mortgages or were these serious modification efforts? Given what we know about modification efforts from public securities filings, there is no way 29% of loans would meet a strong criteria of previous repayment plan. Most disturbingly though, from a policy standpoint, the industry points the finger directly at borrowers. It excludes 29% of loans from the group where it asserts modification is feasible because the “borrower would not respond.” In his post on the House hearing on the mortgage modification bill, Prof. Adam Levitin reported on a witness’ testimony that families in financial trouble may not respond to phone calls or open mail from creditors. My advice to homeowners–talk to your servicer or open mail from them. Better yet, contact them affirimatively to ask for a loan modification and keep records of your efforts in so doing. Don’t be an industry statistic! Beyond this practice advice, the fact that industry says it can’t reach 3 in 10 borrowers has important policy implications–including for the fate of the bankruptcy modification bill.
Two very thoughtful posts by Buce at Underbelly are worth reading. Both get at the question of whether “can pay” debtors are acting wrongfully when they don’t pay. The first post looks at the issue generally. The second post is a followup discussing the mortgage foreclosure problems in California and whether banks should expect debtors to pay more than they are legally obligated to pay. Good stuff.
A great thing about teaching in Washington, D.C., is the ability to drop in on legislative hearings. Today I went to a House Judiciary subcommittee hearing on the cramdown bill, also known as the Emergency Home Ownership and Mortgage Equity Protection Act of 2007(HR 3609). A report is below the break.
The past few months have seen story after story about fraud in the mortgage industry. Now we’re seeing a new type of fraud–mortgage lobbying fraud. The Mortgage Bankers Association has been claiming the proposed bankruptcy reform legislation that would significantly roll back the special treatment given to mortgage lenders in chapter 13 bankruptcies would result in residential mortgage interest rates rising 1.5 to 2 percent. (Somehow this number started at 2% and has drifted down to 1.5% without any explanation.) The MBA’s number is pure and demonstrable hokum. As Joshua Goodman, a Columbia University economist and I show in a new working paper, permitting bankruptcy modification is likely to have little or no impact on mortgage interest rates or origination volumes. Keep reading below the break for the proof.
Discussions of the kind that I stimulated by my suggestions on Monday (about what Congress might do) reveal widely different assumptions about the number and type of debtors that will default. Shouldn’t we look for the data? The data might keep conservatives from falling off the cliff to the right and the liberals from falling off on the other side- at last that is my hope. So who are the debtors and how many will default? Those are the questions for investors, legislators and lenders. But the answers are not easy to find, and, with incomplete data, each of us is the captive of his political bias. What about the defaulting debt and about the deserts of the debtors (Fools all? Every one defrauded?)
Last week, a class action lawsuit (Harris v. Fidelity National) was filed against Fidelity National Information Services, a huge player in the billion dollar world of mortgage servicing. “What? I’ve never heard of them,” you say. Fidelity is the company that provides default servicing to most of the large residential mortgage servicers. Their role is a shadowy one; unless you’ve delved deeply into how consumer mortgages are serviced, you probably weren’t aware of their existence–much less how they may be driving up costs for consumers. Foreclosure petitions, proofs of claims, and bankruptcy court motions never bear Fidelity’s name (instead they are signed by the regular servicers or by local counsel retained by the servicers.) But despite its invisibility, Fidelity is almost always part of the action in foreclosures or bankruptcy cases.
The lawsuit alleges that Fidelity receives illegal kickbacks from attorneys who work under contract with them. The exhibits to the class action are clear. Fidelity bills its clients–the servicers–for certain fees– for example, $100 to review a bankruptcy plan. The servicer includes those fees as due and owing on bankruptcy proofs of claims, many of which appear only as “attorneys fees” or “postpetition charges.” However, Fidelity requires attorneys to let it “retain” $50 of that $100. Fidelty characterizes these as “admin fees” paid by the attorney to Fidelity. The big problem with this practice is that bankruptcy law requires full disclosure of where the debtor’s money is going. If the service is getting the debtor to pay these fees, the bankruptcy court should be approving those charges and who is going to receive the debtor’s money. At least, that’s how the class action has framed the legal issues in the case.
One final note: the schedule of Fidelty’s fees includes a line item for “Drafting Missing Documents.” Hmmmm . . . If documents are missing, they are missing. I don’t see how “drafting” can appropriately play into this. It sounds like more evidence of “recreating” mortgage servicing documents like the actions by Countrywide exposed in the In re Hill case.
Eric Sevareid once remarked that a “chief cause of problems is solutions.”
From a libertarian perspective at least, I suspect that we will find “problems” in the “solutions” that Congress will enact to solve the sub prime mortgage mess. At this point it seems inevitable that the current Congress (and, even more so, the one that will likely sit in 2009) will be moved by heartrending stories of foreclosure of citizens’ residences at the hands of mortgagees who have charged excessive rates, misrepresented the terms of the loan and induced the debtors to take on too much debt.
It seems certain that Congress will allow stripping down of mortgage liens in bankruptcy. Doubtless Congress will try to shackle mortgage brokers with expensive certification and criminal liability. It may also go beyond abolition of holder in due course status for mortgage note holders to force persons in the chain of title of the notes to bear some of the credit loss that occurs when the debtor defaults. If Congress can find a way to do it constitutionally, Congress may also mandate some form mortgage modification. Congress might even take up my friend John’s foolish idea that lending too generously be a tort. Congress will justify the legislation by anecdotal testimony in televised hearings from pitiful wretches who knew not what they were doing.
If my lugubrious predictions prove true, there will be a measurable–possibly quite large–impact on the market. Such rules will make mortgage lending less profitable to everyone in the system-so the number of mortgages written will decline and those that are written will be marginally more expensive. It will winnow the number of mortgage brokers and so remove some who have committed fraud in writing mortgages. It will make investors upstream think twice about buying a debt that carries not only a fraud claim but also the possibility of tort liability for too generous lending, and even a lasting stain (for debt liability) that cannot be removed by assignment to another.
I am quite clear about what Congressman Paul would do to solve this crisis- nothing. He would note that the interest rate on 30 year mortgages in late January 2008 was lower than any time since mid 2005. He would point out that many mortgage brokers have gone into bankruptcy and that the gushing market for mortgaged backed securities has gone dry. He would point out that Countrywide rewrote more than 83,000 mortgages to alleviate pressure on its debtors in 2007 and that it expects to modify even larger numbers of mortgages this year. In short he would argue that Darwin’s rules are already at work and that, left to itself, the market will cure the excesses that we have observed. In his view adding harsh legislation on top of the market’s Darwinian response would cause the number of home loans to decline well below the optimum number.
By now you will have understood that I am sympathetic to the libertarian position, and I wonder whether the debtors’ friends in Congress have a covert agenda, namely to keep those with poor credit from taking on debt even when these debtors are fully informed of the risks and costs and quite willing to bear them. To protect consumers from fraud is worthy, but is it worthy to bar an informed consumer from economic behavior that Congress thinks too risky? What do you think?
Yesterday’s front page story in the Wall Street Journal was not the usual Paulson story about subprime mortgages—blah, blah Treasury Secretary Henry Paulson has organized mortgage companies to make blah, blah, blah unenforceable promises to offer short-term help to blah, blah homeowners. (Can you see that I share Prof. Elizabeth Warren’s skepticism about the “Sandbag” plan?)
This story about Paulson and foreclosures was much more interesting. It profiled John Paulson (no relation), a hedge fund manager who bet big in 2005 that the mortgage market was heading sharply south. Paulson’s take home pay in 2007 was reputedly $3 to $4 billion dollars (WOW!). What is he doing with all this money? Well, he’s given $15 million of it to the Center for Responsible Lending to fund legal assistance to families facing foreclosure. This is a chunk of change, even for someone with his paycheck, and it is a momumental gift for direct legal services, which typically struggles along on small gifts. Another surprise–John Paulson says in the WSJ that “bankruptcy is the best way to keep homeowners in the home without costing the government any money.” This bowled me over; a Wall Street maven backing the pending legislation that would let consumers modify their home mortgages in bankruptcy! I’d say this Paulson won’t be making the speaker’s list at the next Mortgage Bankers Association meeting, which has strenously opposed the legislation. They’ll have to content themselves with the Treasury Secretary.
The latest uproar about mortgage servicing in bankruptcy is an admission by Countrywide that it “recreated” documents related to the servicing of a consumer’s home loan. The short story is that Countrywide says a debtor’s monthly mortgage payment changed during the Chapter 13 plan and that the debtor didn’t make the increased payments. The problem is that the debtor, her attorney, and the trustee say that they were never told about the increase in payments, which is purportedly due to changing escrow requirements. Countrywide gave the debtor letters showing that the amounts changed; those letters were dated 2003, 2004, and 2007. The problem is that those letters were not copies of actual letters from 2003, 2004, and 2007. As Countrywide admitted, it “recreated” these letters as “evidence” of the change in the monthly payment. The judge had a few questions about that practice:
Elizabeth Warren’s recent post asked “What Can a City Do?” about subprime lending. The post prompted many thoughtful comments, both on Credit Slips and on the Calculated Risk blog. While readers were discussing the merits of various ideas, including a city-appointed “Foreclosure Investigator,” the city of Baltimore took a much more aggressive tact–it sued Wells Fargo on January 8th. Calling the city a “second victim” after the homeowners, Baltimore filed suit in U.S. District Court alleging that Wells Fargo engaged in predatory and discrimatory subprime mortgage lending. Wells Fargo denies the allegations, which focus on purported steering of black homeowners into high cost loans. The Associated Press reports that “two-thirds of Wells Fargo’s foreclosures occurred in neighborhoods that are more than 60 percent black.” The city attorneys apparently analyzed foreclosure data, finding that while most lenders had higher foreclosure rates in majority-black communities, that according to the AP, “Wells Fargo stood out having the most glarity racial disparity.”
I believe this is the first lawsuit filed by a city as plaintiff to grow out of the current subprime loan crisis, and it seems sure to be controversial. Past Credit Slips guestblogger and law professor, Kathleen Engel, has an article on SSRN for free download entitled “Do Cities Have Standing? Redressing the Externalities of Predatory Lending?” that addresses many of issues that the Baltimore v. Wells Fargo suit will raise.
Because subprime lending was not evenly spread around the country (or even around a state or city), individual neighborhoods are bearing the brunt of the meltdown. When several homes in one community go into foreclosure, a neighborhood can rapidly shift from a safe, comfortable area with well-tended lawns to a place where no one wants to live. Mayors are on the front lines in dealing with the fallout.
Like most academics, we at Credit Slips tend to talk about what the federal government could do to deal with the subprime crisis. The feds have the power, if not the will, to make some big changes. But what about mayors? Can anything be done at the city level? This isn’t an academic question, so put on your thinking caps and volunteer some ideas. Here’s mine:
The current home mortgage crisis is often referred to as a “subprime” crisis. That’s useful shorthand, but it really isn’t accurate and unfortunately obfuscates the scope of the problem. The mortgage problem isn’t just limited to subprime. It extends beyond it in (at least) two ways.
A few days ago, I had the bright idea of looking at the chapter 13 filing rate in the different states and seeing if that told us anything about what might be happening with home mortgage foreclosures. Generally speaking, homeowners often will find it easier to save a home in chapter 13, and thus changes in the chapter 13 rate could give us some understanding of the financial distress being caused by the home mortgage crisis. It’s a nice theory, but in practice the data are unilluminating on that point. There is great variation from state-to-state in the chapter 13 rate, making it difficult to draw meaningful conclusions from the data.
Nationally, 38.8% of all November 2007 bankruptcy filings were chapter 13s, but the table shows the national figures masks considerable state variation. (The data are courtesy of AACER.) Bankruptcy experts will not find the state variation very surprising. In an 1993 article, Professor (and upcoming Credit Slips guest blogger) Jean Braucher documented how consumer bankruptcy attorneys can influence chapter choice. (See Braucher, 1993. “Lawyers and Consumer Bankruptcy: One Code, Many Cultures,” American Bankruptcy Law Journal, 67:501-83.) On the heels of that article, Professors Teresa Sullivan, (Credit Slips blogger) Elizabeth Warren, and Jay Westbrook described important variations in bankruptcy practice that could not be explained by difference in formal rules but rather were likely the byproduct of differing cultures by local professionals. (See Sullivan, Warren & Westbrook, 1994. “The Persistence of Local Legal Culture: Twenty Years of Evidence from the Federal Bankruptcy Courts,” Harvard Journal of Law & Public Policy, 17:801-865.) From these studies and others, we know that local legal culture plays a significant role in bankruptcy chapter choice.
The persistence of local legal culture makes it difficult to use a snapshot of differences in state bankruptcy filings rates or the percentage of chapter 13 cases as a proxy for the financial distress of homeowners. To make such a measure meaningful, one would have to follow the filing rate of particular states across time. In statistics-speak, we need longitudinal (over time) not cross-sectional (across observations) data. Bankruptcy filing data by state are difficult to get and assemble, especially going back in time–why that should be probably should be the subject of another post–making the task beyond what I have time to devote to a blog post. Thus, I’m going to say that we can’t say a whole lot about the mortgage foreclosure crisis from the chapter 13 data.
On a different note, Buce also describes the similarities he sees between today’s mortgage crisis and the fraud fandango of the early 1970s. It’s not that Buce was around to see that, but he’s heard others talk of it. Buce’s post is worth reading. It reminds us that the fundamentals of our problems are not new, just the same dynamic with with different labels. Everything old is new again, especially when we’re talking about creative ways used to convince someone to part with his money.
There is SO MUCH interesting on this site and in the TPM Cafe’s posts today…not sure this stripdown thing is at the forefront of people’s concerns, but….here are two more thoughts, relating to the economics of home mortgage stripdown and to the comparative treatment of second mortgages. The long-term economic ramifications of allowing or not allowing stripdown are important, but I do not think they weigh against allowing home mortgage stripdown. Adam Levitin just posted on TPM Cafe about interest rates. Great post! What about that other idea out there that allowing home mortgage stripdown will dry up home lending. First, I doubt it. Second, maybe it is ok, even if it is true. If part of the goal is to improve the value and predictability of investments in these products, and to lend only to people who will likely pay the loan, more careful lending (and fewer loans) could be a good thing. In other words, it may indeed have been better to never have loved……That does not mean we shouldn’t help those who are in the bad loans. They may have spent all of their savings on a bad deal, and now be deserving of help. Second home mortgages in Chapter 13? I am not sure but I think Prof. Scarberry is saying that under the current Chapter 13, borrowers can strip down the second home mortgage, but only if they can pay the whole mortgage off in the 3-5 year plan period. If a bill is passed that allows the primary home loan to be stripped down and stretched out, he argues, lenders will be treated less advantageously for second home loans. Prof. Scarberry feels this would be a problem, though I am not so sure. I’d like to see all these mortgage holders treated the same, but if we had to favor one over the other, I’d favor the creditor in the second home loan and the borrower in the primary home loan. It seems indefensible that under current law, borrowers might have an easier time saving a vacation home than a primary residence. (I admit, most of the time, borrowers cannot pay the second home mortgage in 3-5 years anyway, but at least theoretically borrowers are more protected on the vacation home than the primary residence). That just seems wrong. (as Bob lawless noted a few weeks back….). Again, if I had to choose between giving people a break on a primary home mortgage and giving them a break on a vacation home mortgage, I’d choose to give the break (and yes, to treat the mortgage lender less favorably) on the primary home loan. But the main thing is…..The treatment of vacation or second home mortgages should not bear at all on what we do with the overall issue of home mortgage stripdown. I mean, how often is second mortgage stripdown an issue? Second home mortgages are rare in Chapter 13, are a small percentage of the overall home mortgage market, and do not play a big part in the current crisis. I would just hate to see the tail wag the dog, in other words to allow current second home mortgage treatment (surely an afterthought in bankruptcy policy in any case), to direct our decision on how to treat primary home mortgages.
Professor Mark Scarberry of Pepperdine University posted a comment taking issue with my statement that the proposed mortgage stripdown bills would do nothing more than put home mortgage lenders on an “equal footing” with other secured lenders in chapter 13. Given the criticisms of Scarberry’s congressional testimony in this space, at the least I should put his own words on an equal footing. Here is a link to Scarberry’s full testimony for our readers to examine it for themselves.
I appreciate Professor Scarberry’s engagement on this issue. Heck, I appreciate it when any one even bothers to read this blog, let alone post comments. It looks like that the two of us will just have to disagree. Scarberry states that “no other stripped down secured debt can be paid off over more than the five year maximum life of the chapter 13 plan.” I just disagree. Section 1322(b)(5) of the Bankruptcy Code clearly allows a debtor to maintain payments over the life of the original mortgage, beyond the 5-year provision. That is true even if the plan proposes stripdown of the mortgage. (See here for an earlier explanation of the concept of “stripdown” in bankruptcy.) Thus, I continue to think it quite apt to point out that the pending bills would do nothing more than put home mortgage lenders on an equal footing with other secured lenders.
Yesterday I posted on the topic of the essential nature of secured debt and why we should be consistent in how we treat it across the board. Today, I wanted to address some more specific points brought out in ABI Resident Scholar Mark Scarberry’s testimony before Congress last week. The purpose of the post is to support passing a law allowing home mortgage stripdowns, with few limitations.
One argument Professor Scarberry made is that now that some personal property is excluded from stripdown, it would be wrong to treat home mortgage holders less advantageously than personal property loans. I totally agree that this would be wrong, but reach a different conclusion. Stripdown should be allowed in all undersecured cases, consistent with state law principles. Both the home mortgage stripdown exception and the 2005 limitations on stripdown are equally out of line with basic bankruptcy and state law collections principles. (see yesterday’s post). We can and should work on fixing this after the home mortgage crisis has passed, if not immediately.
Have you heard that expression, “Don’t make a federal case out of it?” It’s usually used to caution against blowing something out of proportion. Two recent decisions from federal courts in Ohio explained why the courts have an obligation to take issues of standing seriously and made clear that if you want to make a federal case out of it, you have to follow the federal court’s rules. As Elizabeth Warren explained, the decisions are a reminder that the law matters. And in federal court, at least some judges are going to require the lenders to follow **all** the rules, an outcome that the lenders apparently asserted was not the situation in state court.
But why are these foreclosures in federal court? Foreclosure is a state law action, and a vast majority of such actions are filed in state courts. Apparently, the holders of the mortgages (or should I say “putative” holders of the mortgages?) are frustrated that some state courts in Ohio and other jurisdictions are taking a long time to adjudicate foreclosure cases. The cause of the delay is that the state courts are overwhelmed by the sheer number of foreclosure actions being filed. In many jurisdictions, foreclosures go to a specially-designated division of state court and as foreclosure rates have climbed rapidly, these judges and their staffs can’t keep up with the backlog.