Our active readers at Credit Slips already started debating the second controversy about the pending cramdown legislation: is the failure rate of chapter 13 too high to make mortgage modification in bankruptcy a very useful tool? To briefly reprise that discussion and add my own gloss, there are longstanding lamentations that chapter 13 is a poor system because a minority of debtors completes the repayment plan and receives a discharge. The academic studies suggest the number is about 33%; I believe the National Association of Chapter Thirteen Trustees thinks it is about 40% (one wonders why the US Trustee Program doesn’t carefully track this and publish it?)
So lots of chapter 13s fail. But what conclusion should we draw from that fact? This is a broad question and one that I’m exploring in a new empirical research project. I do not believe that chapter 13s “fail” just because they do not reach discharge. For now, let me narrow that concern to whether cramdown legislation is sound policy. A couple of observations:
- The failure rate for chapter 13 may be, at least to some unknown degree, a result of housing affordability problems. Tara Twomey, John Eggum, and I have a forthcoming paper showing that over 70% of chapter 13 homeowners in our 2006 sample spent more than 1/3 of their incomes on mortgage payments, the HUD benchmark for unaffordable housing. If cramdown lets debtors reduce their mortgage payments, it may permit more debtors to confirm plans and give debtors needed flexibility in adjusting their budgets to the normal ups and downs of life. Put another way, the low chapter 13 completion rate may be an effect of the inability under current law to modify mortgages, which is all the more reason to permit such modification.
- Lots of people are going to have upheavals in their lives just because that is life. As one of our Credit Slips commentators said: “Chapter 13 cases fail primarily because ‘_____ happens’ in the 3-5 year term of the plan. Debtors live and die; they change jobs; they lose jobs; they move; they buy and sell homes; they get married; they get divorced; they have kids; they lose kids; they get sick; etc. — all of which impact their financial circumstances.” These circumstances would occur and be problematic regardless of how we structured the mortgage relief–that is, they would hamper non-bk court modifications too.
- One benefit of modifying mortgages in bankruptcy is the potential to actually monitor what happens. IF the Administrative Office of the US Courts and the US Trustee Program release the needed data, scholars and advocates can track these cases. How many debtors are seeking modifications? What kinds of terms are courts granting? How are these debtors faring? Such data has been scarce of non-existent for the voluntary modification programs. What data do exist, such as those that Alan White examines, seem to me to indicate that a very high fraction of modifications are doomed to failure.
The pending legislation to permit courts to modify home mortgages is stirring up some controversies–even among its advocates. The key issues are operational and very important, I think, to the success of this legislation. Here’s the first brewing controversy: How will consumers make the payments on these modified mortgages (directly to the mortgage servicers or through the chapter 13 trustee?)
The pending legislation contains language that would require the payments on mortgages modified in bankruptcy to be made “directly to the holder of the claim.” In more than 2/3 of jurisdictions, chapter 13 trustees serve as conduits for at least many mortgage claims, meaning that the debtor pays the trustee the mortgage payment, along with their payment on their unsecured claims, and the trustee transmits the payment to the mortgage company. The legislation, apparently at the urging of some consumer advocates, would bar this practice. I think this is a bad approach for several reasons: Why change existing practices that are working well and add confusion? Some courts have local rules that require debtors to pay all claims through the trustee; the legislation would override such rules, which are growing in popularity becuase of problems with letting debtors make mortgage payments. Many debtors like the convenience of making only one payment–to the trustee–and letting the trustee disburse. It helps keep them on track financially and may improve completion of chapter 13 plans. Further, given the numerous and well-documented problems with mortgage servicers’ ability to correctly apply payments in chapter 13 cases, why put the burden of sorting all those problems out on the debtor or debtor’s counsel? If the trustee is the conduit for the payment, then the trustee can take steps to ensure the payments are applied properly and the debtor is being charged correctly. I suspect this stems from some concern that consumers shouldn’t have to bear the added costs of paying a trustee. Many trustees, however, take only 5% commission instead of the usual 10% for the disbursement on mortgages, and if Congress is concerned about this, they could amend section 586 to provide for a lower trustee fee for mortgages. Also, consumers who pay the trustee are getting services; the trustee is the one who must wait on hold with the mortgage servicer, try to reconcile the accounting, deal with RESPA and escrow issues, etc. I think it is fair to pay trustees for that work. I think debtors should have the option of making payments on a modified mortgage either directly to the mortgage company or through the trustee, as is currently the practice.
Bob scooped me on an initial post about the deal between Citigroup and Senate Democrats on pending legislation to permit bankruptcy judges to modify mortgages in bankruptcy. But I have details. And commentary. And questions.
First, the letters from Citibank to the House and Senate outlining the changes that they request be made to the legislation are available in the middle of this WSJ article. They requested three changes to S.66 or H.R. 200 (both denominated the Helping Families Save Their Homes in Bankruptcy Act of 2009). First, that the legislation be limited to loans in existence when the legislation is enacted. This gives the bill a sunset, of sorts, but it could be a long one, given some people have 30 or 40 years left on their loans. Second, only when a violation would give rise to a right of recission under the Truth in Lending Act can the claim be disallowed. Given the relative difficulty and cost of litigating such claims, this is not, in my opinion, a large concession. Consumers retain their rights under the Truth in Lending Act to bring a claim under its provisions and recovery (puny) statutory damages. Third, a reduction in a loan’s principal balance is only available if the homeowner certifies they contacted the lender to modify the loan before bankruptcy. Note that the “reduction in principal” is only ONE of the options available to bankruptcy courts. Apparently, the court could freeze or adjust interest rates or extend the term of a loan even if a borrower had not contacted the lender. The only problem I see here is if lenders begin litigating whether the borrower has indeed contacted the lender. Borrowers who did so by phone won’t have great records of having done so. I would advise borrowers who call to also send a written letter and keep a copy asking for a modification.
Apparently, the news of the Citi’s support for the legislation traveled fast and yesterday at chapter 13 confirmation hearings around the country, debtors asked to have their hearings continued to see if the legislation passed. I also wonder what are the options for homeowners who filed chapter 13 a few years or months ago and were not able to modify their home mortgages. Can they ask the court to modify their plan if the legislation passes?
The Wall Street Journal is reporting that Citigroup is negotiating over the terms of a bill to give bankruptcy judges the power to adjust home mortgages in chapter 13. The article further reports that the National Association of Home Builders has dropped its opposition to the bill, although Citigroup says it still has not made a decision on what its final position will be. Credit industry opposition is the primary obstacle to passage of this legislation. If this opposition evaporates, the bill almost certainly will become law given its support among congressional leaders and the incoming Obama Administration. For background on how the law would work, see here.
UPDATE: Just as soon as I posted this, the news broke that a deal had been reached. This is a welcome development. Of course, the devil is in the details. If anyone has a link to the text of the legislation that would result from the deal, please post in the comments.
Yesterday new foreclosure and loss mitigation data was released by HOPE NOW in its “Loss Mitigation National Data July 07 to November 08” and by the OCC/OTS in their “Mortgage Metrics Report.” Combined the reports show a steadily increasing number of loan modifications and a slight decrease in foreclosures. That’s the good news. The bad news is a large number of loans that have been modified are redefaulting. The OCC/OTS report shows 37% of loans were 60 or more days delinquent after six months. Here’s an example to put this in real numbers. The HOPE NOW report shows nearly 870,000 loan modification in 2008. Using the 37% redefault rate means that just over 317,000 borrowers will enter the foreclosure pipeline again within 6 months.
The reasons that borrowers are falling back into default is the source of much debate. Industry representatives claim that every modification is affordable when it is made and borrowers redefault because their circumstances change. Consumer advocates argue that servicers are not creating long-term, affordable loan modifications.
Whose side does the data support?
A major legal development in the foreclosure crisis occurred today in Massachusetts. The Massachusetts Supreme Judicial Court, regarded as one of the finest state courts in the country, upheld a preliminary injunction against Fremont Investment and Loan for foreclosing on any “structurally unfair loan” without court approval.
Martin Feldstein has been pushing a mortgage bailout proposal that has been getting some undeserved attention (see here and here, e.g.). Feldstein gets (here, and here) how central negative equity is to the economic crisis. Homeowners with negative equity have a reduced incentive to stay in their home if the mortgage is burdensome. Negative equity fuels foreclosures, which in turn force down housing prices, setting off a downward spiral. Feldstein is right to focus on negative equity as a key issue for housing market stabilization. The problem is in his solution–it is based on a few erroneous factual premises, all of which could have been discovered with very limited Google searches.
Just as public ire at the mortgage industry reaches a pinnacle, courts have offered the mortgage companies refuge from their mistreatment of consumers in some recent rulings. While these decisions may be aberrations, they have powerful lessons for consumer debtors and their attorneys that bear some discussion.
A bankruptcy court ruled last week that the United States Trustee (UST) lacked the authority to bring a complaint against Countrywide for abusive mortgage servicing practices. (Hat tip to Amir Efrati at the Wall Street Journal for bringing the ruling to my attention.)The In re Sanchez court concludes that the UST failed to state a claim for sanctions because the UST is not authorized to pursue sanctions. I disagree.
You can’t be serious! Federal Reserve chairman Ben Bernanke says what anybody with a passing interest in economics already knows — that it will take time for the economy to turn the corner — and the market tanks. The market seemed punch drunk on the massive stabilization packages — $2.5 trillion and counting — that the industrialized world was showering on failing financial institutions. A mere 36 hours later, though, Wall Street realized that it cannot regain its strength without a healthy Main Street. It was a weakening labor market, following a bursting housing bubble, that contributed to the massive foreclosure wave and to the crisis. No amount of tinkering with the stabilization package will detract from the fact that people and businesses need more income, not loans, to pay their bills and to invest in their future. It should be clear by now to everybody, even extremely myopic financial markets, that the next policy step lies in helping U.S. businesses and families back on their feet through a well designed second economic stimulus.
At this point, it is all too clear that financial markets can get things wrong. This is not an isolated phenomenon. No, getting it wrong tends to be the name of the game for financial markets. Understanding that financial markets regularly underestimate or overestimate the risks of investing is crucial to the proper design of financial market regulations.
Financial markets went into free fall in late September and early October. The third quarter of 2008 continued the wealth destruction that took place in the previous nine months. This wealth decline is large, broad, and quick.
The primary reason for wealth building is retirement. Many families nearing retirement, though, relied primarily on their homes for their retirement income. According to the Federal Reserve, only 62.9% of families between the ages of 55 and 64, had a retirement account, such as a 401(k) or IRA, in 2004. The typical holding in such accounts was $83,000 in 2004 dollars. In comparison, 79.1% of such families owned their own house with a total typical value of $200,000. In other words, policymakers need to take a comprehensive view at restoring family wealth in an effort to strengthen retirement income security. Much of the policy attention has been on protecting housing wealth. Policy responses, though, need to match the problem, specifically by fostering a pension renaissance and by vastly improving existing retirement savings plans in addition to protecting housing wealth.
The stock market just ended its worst week in history. This has sharply eroded families’ financial security. Under rather optimistic expectations it would take about six years before families can hope to achieve the same level of financial security as they had at the end of 2007, before the latest round in the financial market crisis took shape.
The LA Times ran an article earlier this week reporting that undocumented immigrants to the United States had generally lower rates of mortgage delinquencies than other types of borrowers. It is an informative read and should be of interest to Credit Slips readers. The article is here. Hat tip to Credit Slips guest blogger, David Yen, for alerting me to the story.
When Eric Nguyen, a 3L at Harvard Law School, conducted his research on the disproportionate efforts of families with children to save their homes through bankruptcy, he seemed to be embarking early on a promising scholarly career. But events have made his research intensely relevant to national debates. In an op-ed in today’s New York Times he reprises his central findings. Eric endorses an amendment to the bankruptcy laws that would permit a bankruptcy judge to restructure home mortgages.
Senator Dodd and Congressman Miller advanced this proposal early last spring, but the lobbyists from the American Mortgage Association fought them off. Even as the bailout took shape, the banking lobbyists were still calling the shots to block bankruptcy amendments. Not surprisingly, mortgage holders prefer a government bailout over taking the write downs on their bad mortgages. The McCain proposal offers just that: a payoff on bad mortgages at their full face value. The taxpayers–rather than the investors–would take all the losses.
Eric’s op-ed is timely–but time is running out.
Now it appears that the McCain plan is to pay 100% of the outstanding balance on distressed mortgages (and, presumably prepayment penalties if applicable). What isn’t clear is whether the government refinancing will be for fair market value or at the old outstanding balance. If the later, it really won’t help folks with negative equity.
If the McCain plan is going to buy mortgages at 100 cents on the dollar and then replace them with, say, 80 cents on the dollar mortgages, there’s good news and bad.
1 out of every 6 US homeowners is underwater. There’s probably no better indicator than being underwater of a mortgagor who is likely to end up in foreclosure. That’s very worrisome. And it means that foreclosure prevention plans that don’t address the problem of underwater homeowners aren’t going to help a lot.
Last night John McCain presented a “new” plan to deal with the financial crisis. Unlike the
bailout rescue bill, it is a bottom-up plan, not a top-down plan, meaning that it focuses on helping homeowners, not financial institutions.
It’s commendable that now in October 2008, over a year into this foreclosure crisis, John McCain has recognized that homeowners need some help and is proposing to do something for them. The trouble is that his proposal won’t help.
Bank of America has agreed to settle a deceptive mortgage practices lawsuit on behalf of its relatively new subsidiary, Countrywide Financial, the notoriously aggressive mortgage lender. The attorneys general of Illinois and California negotiated the settlement on behalf of their states and at least nine others. The settlement will cost BOA approximately $3.5 billion in California and $190 million in Illinois. The settlement funds will go towards reducing payments for Countrywide borrowers with subprime and/or adjustable-rate mortgages, waiving prepayment and late fees, paying damages to customers who have already lost their homes, and subsidizing the relocation of those who are now in foreclosure.
A BOA spokesperson said that the bank plans to introduce the program in December. Hopefully more details about who will qualify will be available soon.
An excruciatingly sad story about the human costs of the home-mortgage crisis: http://www.cnn.com/2008/US/10/03/eviction.suicide.attempt/index.html. A 90-year-old woman, Addie Polk, shot herself inside her foreclosed, Akron, Ohio home. It appears that she will live, although she is still in the hospital. Representative Dennis Kucinich, a member of her state’s congressional delegation, told her story on the House floor during today’s bailout debate, saying, “This bill does nothing for the Addie Polks of the world.” He voted against the bailout, which finally passed in the House this afternoon.
Katie Porter makes some excellent observations about the Carroll and Li study of homeowners in bankruptcy. There’s another crucial point to add: the study’s conclusions only tell us, at best, about bankruptcy today. It shouldn’t be much of a surprise that bankruptcy doesn’t have a huge impact on homeownership retention precisely because it is impossible to modify single-family principal residence mortgages in bankruptcy. The study is looking at a bankruptcy system with both hands tied behind its back. Given that bankruptcy already results in a 15% higher level of homeownership retention than foreclosure, one would expect a much greater impact if debtors could adjust their mortgages to make them affordable.
Consider–Credit Suisse has found that voluntary loan modifications that reduce monthly payments have an 83% success rate in the current market. Involuntary modifications could be even more significant than voluntary modifications. If bankruptcy modification were allowed and we saw a similar success rate in homeownership retention, that would be a big accomplishment indeed.
Thus, I think a fairer interpretation of the study’s findings are that currently bankruptcy helps a bit with homeownership retention, even though it is working with the very modest tool set of the stay and a chance to de-accelerate and cure, and that with a broader tool set to modify mortgages, bankruptcy could make a big difference in homeownership retention.
Amending bankruptcy law to permit judges to modify home loans for chapter 13 debtors does not seem to be gaining traction in Congress, despite the fiasco with the bailout vote and pressure to incorporate more “Main Street” provisions. For many reasons, I remain convinced that any bailout should attempt to limit losses at the family-level, rather than addressing only the end consequences for major financial institutions. That said, does filing bankruptcy improve a family’s chances of saving its home?
A new paper, The Homeownership Experience of Households in Bankruptcy, by economists Sarah Carroll and Wenli Li provides a tenative answer to this question. Before summarizing the findings, let me emphasize a few key points. The paper’s sample comes from Delaware. Yup, that’s it. That limits my confidence, and to their credit, the authors’ confidence, about extrapolating these findings to the whole nation. Another difficulty is that the housing market has changed so rapidly that despite the authors’ quick production of this study, the mortgages of today’s families may look very different from those of families that filed bankruptcy in 2002. Keeping those qualifications in mind, what do Carroll & Li report on how many homeowners that file bankruptcy avoid foreclosure.
Now that Congress has failed to act to stem the foreclosure crisis, it is up to states to try to protect their residents and economies. A few possibilities remain for state action, some of which states have either toyed with or started to do.
A draft of the bailout plan is out. And it contains nothing substantive for financially distressed homeowners.
The plan directs the Treasury Department to engage in reasonable modifications for residential mortgage loans it controls and to encourage servicers to do so for loans it doesn’t control. As I’ve explained in numerous posts (here and here, e.g.), Treasury is unlikely to end up controlling many distressed residential mortgage loans directly. And Treasury has been encouraging servicers to do loan modifications since last fall, but with very limited success. There is no reason to think that the bailout suddenly changes anything. In short, Congress enacted some show provisions about consumer relief, but nothing of substance. This is the same move Congress pulled when it enacted the HOPE for Homeowners Act in July. All sizzle, no steak.
I’ve written a short explanation of the why even if the Treasury buys $700BN of MBS it will be unable to modify the underlying mortgages. The explanation, which is more detailed than any of my previous postings on the subject, is available here.
At core it is a Trust Indenture Act problem, where the bonds cannot be modified absent a specified majority vote and consent of bondholders whose payment rights are affected. And here is no possibility of doing an exchange offer to get around it; there is simply no mechanism for an MBS trust to do an exchange offer. (For the classic discussion of Trust Indenture problems, see Mark Roe’s article, The Voting Prohibition in Bond Workouts.) The solution of Trust Indenture Act problems with corporate bonds is…you guessed it, bankruptcy modification!
I have received several inquiries about the Mortgage Bankers Association’s spurious claim that permitting modification of mortgages in bankruptcy will result in higher interest rates or less credit availability. I have drafted a very short explanation of why the MBA’s claim is patently false and in fact disprovable. It is available here.
The Dodd and Frank bailout proposals have both put the possibility of modifying mortgages in bankruptcy back on the table. To some Credit Slips readers, this is old hat (see below for links to our past posts). But I want to provide a quick primer for those who are not well-versed in the issue.
First, I want to thank Bob Lawless and the rest of the Credit Slips folks for having me back yet again — I’m getting to be like the guest who would not leave.
I also think we need to avoid a whole lot of knee jerk reactions that are floating around out there — like the SEC’s ban on short selling, which is quickly becoming the Bad Management Protection Act of 2008. Of course, the notion that the administration can open the door on this issue “just a little” is also equally suspect.
I view the economy and the larger financial system as being at a Titanic like moment: post iceberg, per submersion. It is certainly reasonable to disdain those who got us into this situation, but I’m not going to let my feelings for them get in the way of saving as many people as possible.
That said, I understand why there is a good deal of skepticism about the bailout. In part chapter 11 is to blame — there has been almost no effort to explain why AIG is different from Enron, United Airlines, or any other really big corporation that has recently failed. And the financial industry needs to fess up that it blew its chance to self-regulate the credit default swap market — too many people, even myself to some degree, bought the “trust us, we’re experts” line from ISDA and other market players.
No wonder people aren’t buying that line in connection with the bailout — especially when the administration has its own credibility problems in this regard in connection with other big, complex projects in the non-financial area.
More on the chapter 11 issue, and why I think the administration has done a terrible job of selling this but still generally support the bailout, after the jump. I’ll save my thoughts on the CDS market for another post.
September 23, 2008 at 1:49 PM in Bankruptcy Generally, Corporate Bankruptcy, Credit Policy & Regulation, Financial Institutions, Mortgage Debt & Home Equity, Pending and New Legislation | Permalink | Comments (6) | TrackBack (0)
When the government bailout of the financial industry was first announced, we were told more details would be forthcoming. The weekend has passed, and we still have few details. We’re being told that there is a big threat, things have to happen quickly, and we give the Administration broad powers and trust them to do the right thing. When have we heard that before? Rather than being steamrollered again, Congress should demand some accountability rather than giving Treasury and Hank Paulson unfettered powers.
To the extent we have more information than we did on Friday, the proposal has become vaguer. Instead of mortgage-related securities, Treasury now would be authorized to purchase “any financial instrument.” Instead of the buyout being limited to institutions with headquarters in the United States, Treasury could buy “any financial instrument” from an entity with “significant operations in the United States.”
I’m a little miffed about the recent FTC settlement with Bear Stearns and its subsidiary, EMC Mortgage Corporation. The complaint alleged that EMC engaged in unlawful practices in servicing consumers’ home mortgage loans, including violating the Fair Debt Collections Practices Act, the Fair Credit Reporting Act, and the Truth in Lending Act. The FTC brought the complaint pursuant to its enforcement authority to regulate unfair and deceptive practices. A recently announced settlement requires Bear and EMC to pay $28 million to the FTC and enjoins the company from engaging in the alleged illegal practices. Given my concern about poor mortgage servicing, you might expect me to have nothing but praise for the FTC.
Once the Treasury bailed out Bear Stearns with government guarantees, the next buyer of a major US financial institution might expect similar help. Barclay’s was the last likely buyer of Lehman Brothers. Minutes ago, it announced that without the US taxpayers putting their money on the line, Barclay’s isn’t interested in buying.
We can debate whether the government should have bailed out Bear Stearns, but surely the current mess tells us one thing we should not have done: Bail out Bear Stearns and then return to business-as-usual. So long as the only tool the government seems to have to halt this crisis is a bailout, then we are in trouble. More bailouts will be needed, and, at some point, even the American taxpayer can’t handle it.
With both political parties are focused on Michigan this fall, high foreclosure rates and the neighborhood fallout from those foreclosures are likely to become a political issue. The GOP has announced a new way to deal with the problem: challenge the voting eligibility of people whose homes have been posted for foreclosure. Evidently the GOP thinks those people are more likely to vote Democratic, so it can neutralize the impact of a sour housing market by barring votes from those who are losing their homes.
It isn’t clear from the report whether the challenge is based on posted foreclosures or homes that have already been transferred from the homeowner. Presumably the challenge is based on no longer living in the area. Depending on how the list is constructed, this means challenging some larger or smaller number of people who are in financial trouble, but who are in their homes and are certainly eligible to vote in their local precincts.
The other day I heard an alarming advertisement on the radio. It began by warning that a new federal law could cost “you” thousands of dollars. It then proceeded to say that, if you want to avoid paying this money, you’d better hurry, hurry, hurry and purchase a home by September 30, when the statute goes into effect. The ad had the tone of a going-out-of-business sale: “Think you have all year to buy a home? Not anymore! Act now while you can still afford to make your dream of home ownership a reality! Offer (or law, in this case) expires on September 30, 2008.” (Not an exact quote.) By this point, I was waiting with bated breath to find out how Congress was going to drain potential homeowners of so much money. Didn’t it just pass a law designed to help homeowners weather the mortgage meltdown?
Well, it turns out that the thousands of dollars new home buyers will be paying are their own down payments. After some careful listening and some less careful inference based on the September 30 date, I came to the conclusion that the ad was referring to the ban on seller-financed down payments in the Housing and Economic Recovery Act of 2008. The bill was signed into law on June 30 and will go into effect on the October 1 (hence the rush to sell before then). The law’s main focus is providing help for current struggling homeowners, but it gets just a little bit proactive about prevention by banning sellers from lending money for down payments. This provision is intended to protect homeowners in the long run. It forces buyers to do a sticker-shock test on whether they can really afford their new homes. And it eliminates some incentives for seller-lenders to overprice houses. When a seller is financing the down payment, there’s a temptation to overstate the price because, in the company’s role as a lender, it will have the final say over whether the buyer can really afford to spend that much. The only pricing obstacle left to overcome is the buyer, and it’s reasonable to think that buyers will be slightly less sensitive to price when they’re not paying as much of it right away.
Did people see the news reports a month or so ago about John Green, the Sheriff in Philadelphia, who has been exercising “civil” (“official”?) disobedience regarding home foreclosures? I’m torn between whether I think this guy is a shameless opportunist betraying the taxpayers who expect “The Law” to be the final line to enforce such unpopular decisions as a judgment of foreclosure or whether he’s a hero who who’s bringing a dose of common sense to the housing debacle. Here’s the webpage for his office. Thoughts?
In the last few weeks, several courts have issued opinions ruling that mortgage servicers’ actions have harmed consumers. Some of you follow this issue closely, but if you need an introduction, I’ve previously posted a bit on the basics of mortgage servicing and why it’s an important component of the foreclosure problem. After the jump, I summarize three recent and newsworthy decisions. Debtors won big in these cases, variously recovering sizeable damages, having the foreclosure action against their home dismissed, or getting a preliminary injunction issued against a servicer’s misconduct. Taken collectively, they all signal an increased willingness by courts at all levels (state, federal, bankruptcy) to take challenges to mortgage servicers’ actions seriously. While I’m convinced that legislation, regulatory enforcement, and different market incentives are necessary to stop the misbehavior of mortgage servicers, this trio of decisions shows how litigation can help real families and point the way for further policymaking.
In 2003, Chapter 13 trustee Henry Hildebrand III wrote a short piece for the American Bankruptcy Institute magazine entitled the Sad State of Mortgage Servicing. On the front lines of chapter 13 every day, Hildebrand was one of the first people to draw national attention to the problems of mortgage servicing in bankruptcy. The mortgage servicers didn’t like the characterization, but years later, even after a Senate hearing and major media coverage of the problem, the description is still apt.
A customer legally tape-recorded his conversation with his mortgage servicer, one of the nation’s largest financial institutions (and no, it’s not Countrywide!) His attorney shared it with me, and I’m posting some excerpts after the jump. I won’t give away all the fun, but as you read, remember that mortgage servicing agents are the people on the front-lines of purported foreclosure prevention efforts. Without better training of servicing agents and regulation of mortgage servicers’ financial incentives, is it any wonder that we continue to see loss mitigation stall while foreclosures spiral upward?
That’s the general idea, but the devil is very much in the details, as explained below the break.
Today was the “oh shit” moment in the mortgage crisis. (Hey, this isn’t a family-oriented blog…) Fannie Mae and Freddie Mac’s shares crashed because of fears that they are overleveraged and even balance sheet insolvent on a mark-to-market basis. And the FDIC shut down IndyMac, the ninth largest thrift in the country, and the first major bank failure since the S&L crisis.
As attention in the mortgage crisis starts to focus on Fannie and Freddie, I think it’s worth pointing out that they’re basically the same problem as the SIVs–Fannie and Freddie are the federal government’s off-balance sheet entities. They are the federal government’s SIVs. And like the SIVs they got overleveraged, and the question is whether to pull them back on the balance sheet in some way or not.
Today (July 1) is supposed to be the closing date for the Bank of America/Countrywide merger. In recent weeks, the states of Illinois, New York, and Florida have sued Countrywide for various wrongs committed to the citizens of their states. People are lining up to sue Countrywide. As the deal has been going through the approval processes, numerous commentators have wondered about why Bank of America is willing to expose itself to such liability.
Once the merger goes through, I wonder whether Bank of America is going to claim these lawsuits are preempted by the regulations of the Office of the Comptroller of the Currency (OCC). This obscure federal agency has regulatory authority over national banks and has issued regulations exempting national banks like Bank of America from state laws and regulations governing lending. To legal types, this concept is known as “preemption,” and the OCC regulations were upheld by the United States Supreme Court as we discussed here and here.
The continuing mortgage crisis is now making itself felt in the private mortgage industry. Fannie Mae and Freddie Mac recently announced they would cease purchasing mortgages insured by Triad Guaranty, the smallest of the seven private mortgage insurers that make up most of the market. That was a death sentence for Triad, which was unable to consummate a sale of its business. Triad has now stopped underwriting new business and is now engaged in a “run-off” (insurance-speak for “wind-down”). See here for more details on Triad’s demise and notes on another three PMI companies that could face Triad’s fate.
I’ve been puzzled why PMI insurers weren’t more vocal advocates of mortgage modification in bankruptcy. Most, (but not all) have exclusions for bankruptcy modification losses. That means PMI insurers would be required to pay out in foreclosure, but not in bankruptcy. Given that, you’d think they (and their state insurance regulators) would be pushing for legislation permitting modification of all mortgages in bankruptcy. If anyone can explain the political economy of the PMI industry’s slumber on bankruptcy modification, it’d be great to have in the comments.
Credit Slips readers will want to take a look at this article in Conde Nast’s Portfolio.com. The article describes Countrywide’s VIP program, which gave favorable loan terms to politically connected individuals. Beneficiaries of Countrywide’s largesse would receive reduced fees on their loans and were allowed a free float down of their interest rate if the market rate went down after the rate was locked in. From the beginning of the article:
Two U.S. senators, two former Cabinet members, and a former ambassador to the United Nations received loans from Countrywide Financial through a little-known program that waived points, lender fees, and company borrowing rules for prominent people.
The New York Times carried a story today about the response of Senator Dodd, one of the senators mentioned in the story.
Hat tip to my ceremonial dagger-wielding colleague for pointing my way to this story.
Well, if the comments are any indication, Tuesday’s post–where I discussed articles about problems with home equity lenders pulling their lines and errors in bond ratings–seems to have a struck a nerve. Rather than reply to each, I will reply to all in a general way.
First, a number of comments suggested that I was soft on fraudulent borrowers or too hard on the rating agencies. “Jarhead,” for example, admonished that we should “start to sue borrowers.” “AMC” doesn’t understand why lenders shouldn’t be entitled to the full benefit of their contract rights. “Orville R” claims that “nobody, I repeat nobody, for[e]saw [sic] the unprecedented 20% drop in house values.” In any case, he suggests, Moody’s mistakes were a “non-story” because Moody’s ratings simply reflected disagreements among the professionals–in particular the lawyers.
I should be clear that I have no sympathies for any particular type of stakeholder in the mortgage mess. I think no category of participant has a monopoly on cupidity, deceit or incompetence. Thus, I agree that many borrowers who probably knew better (or should have known better) should be held to the bargains they struck. But that’s exactly what we’re doing. Jarhead’s comment that we should sue borrowers ignores the fact that we are: It’s called “foreclosure,” and the rates of suit are apparently at historic highs.
According to the Mortgage Bankers Association’s Delinquency Survey, 2.47% of 1-4 family residential mortgages are in foreclosure and 6.35% are delinquent. And Credit Suisse’s prediction of 6.5 million foreclosures by 2012 still looms. Scary numbers.
Redlining was a practice that banks once used: hang a map on the wall, draw a red line around minority neighborhoods, and deny all mortgage loans inside the line. The results were devastating–depressed prices because no one could get financing to buy homes and underinvestment in African American and Hispanic communities.
But those bad old days are gone. Now some lenders seem to draw a line around minority neighborhoods, then paint a big bulls-eye on them. That’s where they target their worst mortgages. Massachusetts Attorney General Martha Coakley filed suit yesterday against Option One, the mortgage arm of H&R Block, alleging that they piled on costs for non-white families.
We tend to view credit card debt and mortgage debt in isolation, but its important to remember that the two are highly fungible. This means that when consumers leveraged up with mortgage debt in recent years, the were partially deleveraging their card debt. This means that but for the mortgage bubble, we’d be seeing much higher levels of credit card debt (and that’s where we’re headed).
The mortgage bubble of the past few years was largely a refinancing bubble, not a purchase money bubble (much less a first-time homebuyer bubble). When people refinanced, they were not just refinancing their mortgages. They were also refinancing their credit card debt. Or, more precisely, they were converting their unsecured high interest credit card debt into lower interest, but secured, mortgage debt. There was a brilliant framing in the subprime pitch—pay off your 22% CC debt with a 9% mortgage. Seems like a no-brainer when pitched that way. There were some folks who refinanced multiple times, each time paying off thousands, if not tens of thousands of dollars of credit card debt (and other non-mortgage debt).
This has an important implication that has escaped notice.
People have posted some comments to the funky mortgage story and I wondered if anyone had any experience using the doctrine of unconscionability to help ward off foreclosure and keep people in their homes. As a contracts teacher, I know the doctrine is old and tired and disparaged, but it is still out there and was used with a least some success in the days of the phony home repairs/unfavorable mortgage refinancing schemes popular in the late 90’s. See, e.g., Matthews v. New Century Mortgage Corp., 185 F. Supp. 2d 874 (S.D. Ohio 2002). The Restatement of Contracts includes one unconscionability factor that seems right on in these situations, namely that the stronger party had no reasonable believe that the weaker party would be able to receive substantial benefits under the contract, which I read to include situations where the weaker party has no chance of actually performing the contract. There also is language in the Restatement about how the weaker party is unable to reasonably protect his interests by reason of . . . ignorance, illiteracy, or inability to understand the language of the agreement. Various state consumer protection statutes invite courts to weigh similar factors. Does any of this get us anywhere, or is this just wishful thinking? Or, is this another one of those times where securitization will eliminate the defense because unconcionabilty cannot be asserted against a successor in interest? Do tell….
This site has had some fabulous posts about mortgage fees in Chapter 13 and mortgage services fraud. This is a short story about mortgage fees or funky interest rates, or perhaps just plain old fraud, in the context of the stripdown of a mobile home. Many of us know about negative amortization mortgages, ARMs that adjust up when the rate goes up, ARMs that adjust up no matter what happens, 2/28s, and a host of other exotics. I think, however, I have discovered a new type, one that has the same principal balance no matter how much money the borrower pays on the loan. I call it the magical mystery mortgage.
In the recent hearing on mortgage servicing, the Senators probed Countrywide’s chief executive for loan administration, Steve Bailey, on exactly how mortgage servicers (distinct from the owners of the mortgage) make their profits. Mr. Bailey confirmed the description in my article of the three ways that servicers earn revenue: a fee that is a percentage of the mortgage, float income from interest on temporarily-held funds, and retained fees such as late charges and other fees that are paid by borrowers. Senator Schumer described the imposition of these default costs as “piling on” and expressed a fear that a “vulture mentality” was developing among servicers as defaults rise. Mr. Bailey tried to diffuse these concerns, but Senator Schumer called him to task in attempting to deny that servicers can and do generate profit from delinquent homeowners, even when borrowers and loan holders might benefit if the family retained its home, rather than struggle to pay an avalanche of default costs. The Senator quoted from a Countrywide earnings’ call that characterized the “piling on” practice as a “counter-cyclical diversification strategy.”
Last week, I testified before a subcomittee of the U.S. Senate Judiciary committee about mortgage servicing in bankruptcy. You can read the written testimony or watch a webcast. Both the Chair of the subcommittee, Senator Schumer, and the Ranking Member, Senator Sessions had some harsh words for the current state of mortgage servicing in bankruptcy. Apparently (and encouragingly, at least to me), charging people only what they owe is a bipartisan issue.
Robin Atchley, a former homeowner from Georgia, testified about how her “bankruptcy case was a tug of war with Countrywide over our house.” It was a war that the Atchleys lost, deciding to throw in the towel when their son, Payden, insisted that the couple use his lunch money to help pay the mortgage payments. From her perspective, rather than giving them a fair chance to save their “dream home”, the bankruptcy process gave Countrywide even more opportunities to profit. The Today show profiled the Atchleys, whose case is now the subject of a lawsuit by the U.S. Trustee’s office.