The Homeowners struggle

Warren op-ed: Banking on Hypocrisy

posted by Katie Porter

Check out Credit Slips co-blogger Elizabeth Warren’s op-ed on Politico, entitled Banking on Hypocrisy. She quotes extensively from a letter that the American Bankers Association sent to banking regulators in 2006 in opposition to the proposed intra-agency guidance that would have required better underwriting of nontraditional and subprime loans. While it’s entertaining–and painful–to read just how wrong the ABA was in its assessment of mortgage risk, Professor Warren’s point is to compare the ABA’s position on consumer protection regulation in 2006 with its current stance. In the memo, the ABA decried the “marriage of inconvenience between supervision and consumer protection,” saying that it blurred “long-established jurisdictional lines.” The ABA recommended that the safety and soundness provisions be separated from consumer protection provisions. Yet, now the ABA has opposed a stand-alone Consumer Financial Protection Agency, saying that safety and soundness and consumer protection need to be performed by the same agency. The ABA reminds me of Mayor Quimby from the Simpsons: “Very well, if that is the way the winds are blowing, let no one say I don’t also blow.”  (Thanks to Bob Lawless for offering up this quote the other day in another context; it’s so apt these days!)

Redemption (of the 722 variety) for Struggling Homeowners

posted by Katie Porter

Homeowners continue to struggle, foreclosures continue to climb, and loan modification efforts continue to lag. A persistent problem, pointedly described in these letters (July 10, 2009 and March 4, 2010) from Rep. Barney Frank to the large banks, is that the banks that hold second mortgages are not modifying those loans. (Yep, these are the same banks that took TARP money). The reluctance of the second lienholders to agree to a modification gums up the process for trying to get a modification on first, and usually much larger, mortgages. The investors in the first loan somewhat sensibly resist modifications, particularly those with principal write-downs, pointing out that it doesn’t seem right that they should take a haircut, while junior lienholders refuse to modify their loans. And while the Administration announced new initiatives with HAMP and FHA to help with the second lien problem, I remain skeptical. After all back in April 2009–a year ago, they also made an announcement that they were revising their loan modification programs to deal with second liens. Hhmm . . . Deja vu? Why wait another year while servicers build a platform and train personnel, and Treasury writes regulations, etc.

Here’s a legislative solution to the second lienholder hold-out problem. Congress should amend section 722 to permit chapter 7 bankruptcy filers to be able to redeem any junior loan on a debtor’s principal residence. Current bankruptcy law permits debtors in chapter 7 bankruptcy to redeem personal property, such as cars, by paying the lienholder the value of the collateral. This redemption right exists regardless of the terms of the loan contract. The effect of the redemption is to remove the lien from the collateral. To redeem, a debtor must pay the secured party the amount of the allowed secured claim that is secured by such lien in full at the time of the redemption. If a secured party is completely underwater because the value of the first mortgage exceeds the house’s value, the debtor would file a motion to redeem under 722 and pay nothing (that’s the amount of the allowed secured claim!))  I think this legislation would provide some real leverage to get banks to agree to write down second loans.

Continue reading “Redemption (of the 722 variety) for Struggling Homeowners” »

March 30, 2010 at 6:36 AM in Mortgage Debt & Home Equity | Permalink | Comments (10)

Foreclosures: What About the States?

posted by Adam Levitin
Here’s something that’s puzzled me:  no state has yet to enact any serious foreclosure moratorium.  In the 1930s, these moratoria sprouted up all around the country, and foreclosure rates (but not default rates), were much lower than today.   California imposed a 90 day moratorium, but that’s not going to do much.  Why haven’t Nevada or Arizona enacted a more serious foreclosure moratorium?  What’s the political economy story in those states?  Any thoughts?

March 5, 2010 at 8:31 PM in Mortgage Debt & Home Equity | Permalink | Comments (14)

Produce the (Bogus?) Paper

posted by Katie Porter

In 2007, I wrote an article showing that notes and mortgages were often missing from bankruptcy mortgage claims, despite a clear rule that they should be attached. That finding did not establish that companies do not have such documentation. At that time (a long-ago era of blind faith in commercial entities), some people suggested to me perhaps creditors simply do not wish to be bothered with the time and expense to comply but that all transfers were valid. In the intervening years, story after story has emerged about mortgage servicers who brought foreclosure cases without being able to show their clients had a right to foreclose. Homeowners, desperate to stave off foreclosure while negotiating for a loan modification or waiting for HAMP to become operational, are increasingly demanding that lenders “produce the paper.” In legal terms, this means the servicer should show that it is the authorized agent of a trust or other entity that is the holder of the note and the assignee of the mortgage.

Upon challenge, many companies have been unable to show they had the paperwork, leading to their cases being dismissed (see here, here and here for some examples). The hard part has been to figure out the longer term consequences of lacking a proper chain of negotiation and assignment. What is the effect of an assignment of a mortgage in “blank”? Is this an incomplete real estate instrument that has no valid effect, similar to a deed without a grantee? Can parties go back after the fact and create assignments today to correct problems in transfers from years ago (and if so, what about when the chain of title involves a now defunct lender or bank? what about corrections to chains of title made after the debtor files bankruptcy and the automatic stay is in place?)

Lenders and their agents seem to busy churning out assignments to repair defects and create a paper trail. Of course, with all this paperwork creation, there are bound to be some slips-ups. Follow this link and click on “view image” to see the public recordation of an assignment “for good and valuable consideration” of a mortgage to “Bogus Assignee for Intervening Asmts, whose address is XXXXXX.” If this works to assign a mortgage, what is the purpose of requiring assignments at all?

February 15, 2010 at 3:07 PM in Mortgage Debt & Home Equity | Permalink | Comments (10)

Monetary Policy and the Housing Bubble

posted by Adam Levitin

A popular explanation of the financial crisis lays the blame at the feet of the Federal Reserve for lax monetary policy.  In this story, the Fed dropped interest rates starting in 2001 and kept rates too low for too long.  Low rates induced an orgy of mortgage borrowing for leveraged home speculation.

It’s a nice story.  Only problem is it doesn’t really hold up under inspection.  Low rates in 2001-2003 did fuel an amazing mortgage refinancing boom, but not a purchase boom, and the boom was mainly in conventional fixed-rate mortgages, not the exotic products later years.  Moreover, despite the refinancing boom, no housing bubble was emerging in this period.

The Fed started to raise rates in mid 2004 and continued to do so until mid-2006.  It was during this period that the bubble emerged, when rates were going up.  (To be fair, some might argue for an earlier date to the bubble, even as far back as the late 1990s.)  If we date the bubble from 2004, it’s not consistent with a rate-driven bubble story, although rates were still extremely low in absolute terms during this period.

The monetary policy story, however, really falls apart when one compares the US and Canada, as the graph below does.  Canadian interest rates, and perhaps more importantly, Canadian mortgage rates, track US rates pretty closely.  Yet the US had a housing bubble, and Canada did not.   This means we have to look somewhere other than monetary policy to explain the housing bubble.  The answer, I believe, lies in method and regulation of housing finance.

US Canadian Mortgage Comparison

Continue reading “Monetary Policy and the Housing Bubble” »

Modification Scams

posted by Katie Porter

While the loan origination fraud is largely shut down, the foreclosure crisis has spawned a whole new consumer fraud in the form of foreclosure rescue and loan modification scams. These companies offer to help consumers get a loan modification or to fend off a foreclosure in return for high, upfront fees. A great insider view of how these companies profit on the backs of desperate consumers is available in the receiver’s report in U.S. Foreclosure Relief, which was shut down in response to enforcement action by the Federal Trade Commission and the Missouri and California State Attorneys General. The receiver describes the business as a “high-pressure, cash-up-front telephone sales business targeting distressed homeowners” and gives details on just how these companies rake in incredible profits while stringing along homeowners. In the case of U.S. Foreclosure Relief, the company advertised a “90% success rate” when in fact only 11% of its clients got completed modifications (no details on whether the terms of such modifications offered any meaningful relief or not). Sales agents competed to win a Rolex watch, were told to “stop being so nice” and instead to hammer home to consumers how much worse their problems would get if they didn’t hire a modification consultant, and got paid a bonus if the consumer paid via direct deposit. How profitable was this model? Consumers paid $2950 for “assistance,” and U.S. Foreclosure had gross revenue of $5.9 million, with operating expenses of $1.7 million, producing $4.5 million in profit. Nice margin, huh?

Thinking of starting up such a business yourself but, of course, being honest and legitimate? Think again. The receiver concluded that if the business were run lawfully, profitability would be “severely challenged.” In fact, I recently asked a panel of experts on foreclosure rescue scams if they thought ANYONE, even one of them, could legitimately advertise that they provided loan modification assistance. Given the long odds in getting a loan modification, even with HAMP finally somewhat operational, perhaps the best one can offer is to take on the frustrating work of trying to get a modification. But without some chance of success, perhaps most modification assistance is a mirage.

November 12, 2009 at 6:28 AM in Mortgage Debt & Home Equity | Permalink | Comments (8) | TrackBack (0)

Subprime, Exotic or “Crap?” Mortgage Industry Lingo

posted by Katie Porter

Former Credit Slips guestblogger Max Gardner is always trying to understand the real mechanics and economics of mortgage servicing. At one of his infamous bootcamps, he had an employee at a now-deceased mortgage servicer share an insider’s perspective on default mortgage servicing. The employee used some terms of art that are pretty revealing of the serious problems in the mortgage industry. For example, servicing technicians who have to load a new set of subprime or Alt-A loans into the system call those loans “Crap of the Crop,” because even on arrival at the servicer all or almost all of the loans already have major problems such as incomplete documentation, existing defaults, etc. Another popular term is “scratch-and-dent” loans. Quite a bit more colorful, then “subprime” isn’t it?

The explanation for why homeowners can’t get reliable answers on loan modifications is that the default servicing technicians are “cab drivers,” when successful HAMP and other loss mitigation programs would require “cup drivers” in NASCAR parlance. The servicing industry doesn’t care much for “CRAMP,” their term for Hope Now and HAMP, which the former employee described as a vehicle designed for an 8-lane Interstate running on a two-lane country road. And those qualified written requests that consumers can use to get information on their mortgage loans? Those QWRS are “Quite a lot of Written Regurgitated S**t” because most consumers won’t know what to do with the information that the system spits out in response to the request. Depressing that the best legal tool consumers have may be aptly described with such acronym. If there is a bright spot here, it’s that folks like Max who are holding the industry’s feet to the fire are making a difference. In fact, Max got his own term. A “BCA” is a boot camp attorney, whose request means a lot of work and trouble for the unlucky servicing tech who gets such correspondence.

November 5, 2009 at 6:00 AM in Mortgage Debt & Home Equity | Permalink | Comments (11) | TrackBack (0)

How to Fail My Secured Credit Exam Two Different Ways

posted by Bob Lawless

By way of Underbelly comes this story from the Seattle Times chronicling the many failures at the now defunct WaMu. Among the stories was that a WaMu banker gave O.J. Simpson a second mortgage on his Florida home despite the existence of a huge judgment lien against Simpson arising out of his civil trial for killing his wife and her friend. Why did WaMu think it could collect the second mortgage? According to the news story, Simpson had put a note in the file saying he did not do it, and therefore the judgment was “no good.” OK, that’s pretty dumb and, for my students who read the blog, would not be a passing answer in my secured credit class.

What the reporter (but hopefully not my students) missed is that the second mortgage was likely collectible anyway. Florida has an unlimited homestead exemption that would prevent enforcement of the judgment lien against the home, assuming it otherwise met the definition of a homestead. Voluntary transfers, like a second mortgage, are not protected by the homestead statute. (If you’re wondering why that is, consider how much mortgage lending there would be if the mortgage could not be enforced because of a homestead statute.) A comment on the Daily Weekly blog (hosted by the Seattle Times) picked up on the point about the homestead exemption and the role it should have played in this lending decision.

The “note in the file” story sounds too funny to be true, and in this case, I think it probably is. Florida (and every other state) law is the reason some WaMu Florida banker thought they could enforce the second mortgage. Of course, this is just the legal part of the lending decision. As the Daily Weekly blog story asked, why was WaMu so willing to give Simpson the benefit of the doubt and extend a loan?

Risks of Reverse Mortgages

posted by Katie Porter

In a world of news stories about crippled credit markets, at least one group of Americans still faces the problem of aggressive loan marketing. Senior citizens are on pace to set a new record in 2009 for reverse mortgages, complicated financial products that enables seniors to extract equity in their homes. A new report from the National Consumer Law Center makes parallels between today’s reverse mortgage market and the subprime market of a few years ago (yes, the market that exploded the world economy). Tara Twomey, a repeat Credit Slips guestblogger describes in the report how incentives for broker compensation, a rapidly growing securitization market, and weak or non-existent regulation all expose seniors to risky transactions.

The key recommendation is the imposition of a suitability standard on lenders. That is, lenders and brokers would have to make a good faith determination of whether a loan was appropriate given a senior’s situation. The NCLC made this same recommendation for subprime loans in 2006, and it was ignored. Given the relatively modest size of the market ($17 billion), the vulnerability of the senior population, including the fact that these are once-in-a-lifetime/no-learning-curve transactions, and the collossal fallout from identical conditions in the subprime market, the reverse mortgage market seems like an ideal chance to give the suitability standard a real-life test drive. If America had a Consumer Financial Protection Agency, it might take-up that opportunity. In the meantime,it’s consumer regulation as usual, with some occasional words of warning from regulators with limited authority and pending Congressional legislation that takes aim at only the most egregious abuses.

October 7, 2009 at 6:58 AM in Mortgage Debt & Home Equity | Permalink | Comments (5)

Tenant Protections in Foreclosure

posted by Katie Porter

A foreclosure has a ripple effect, as a number of commentators have observed. Foreclosed properties often sit vacant, leading to nuisance concerns, lower property values for neighboring houses, and higher crime rates. But some properties are not vacant on the day of foreclosure, and these occupied properties generate their own externalities.

After foreclosure, the new owner (usually the lender is the purchaser at the foreclosure sale) will typically send someone to see if the property is vacant. If not, the lender files an eviction or lawful detainer action. In many instances, especially in those formerly-booming real estate markets like Florida and Nevada, the occupants are tenants, not the homeowners. Depending on state law, renters often have no right to notice of the foreclosure and no right to remain in the property. The Chicago sheriff, Thomas Dart, stopped doing evictions after foreclosure last fall because of concerns about unjust harm to tenants.

Title VII of the Helping Families Save Their Homes Act provides uniform federal protection to tenants after foreclosure–at least until the law expires on Dec. 30, 2012 (apparently the date by which someone thought the foreclosure “crisis” will have abated). The law requires the new owner of a foreclosed property to allow tenants to stay in the foreclosed property for the remainder of the lease. If there is no lease, or if the lease is terminable at will under state law, tenants must be given at least 90 days’ notice before they may be evicted. This is a floor that does not preempt more generous state law.
I’m interested in how financial institutions and tenants are going to deal with these requirements. Lenders have attorneys who routinely handle evictions after foreclosure. Being a landlord is a different task. Are tenants supposed to call the former owners’ mortgage servicer when their pipes burst? If not, how is the tenant supposed to learn exactly who is the new owner of the property? Are note holders actively hiring property management companies to comply with this rule? Perhaps more interestingly, the bill doesn’t seem to permit an eviction during the 90 days even if the tenants declare they aren’t going to pay a dime of rent!
The Office of the Comptroller of the Currency has hardly offered answers to national banks. After waiting three months after the law’s effective date, it put out a one-page release advising banks to “adopt policies and procedures to ensure compliance.” Gee, that’s helpful. I’m betting the readers of Credit Slips will have some more concrete thoughts about this.

Overspenders to Face Tax Audits?

posted by Katie Porter

A recent article in the Wall Street Journal reported on a new effort by the IRS to catch tax cheats. The IRS is going to compare data on mortgage-interest payments provided by financial institutions with homeowners’ declarations of income on tax returns. The idea is that people must have more income than they reported to the IRS if they are able to make their mortgage payments, the bulk of which for homeowners with new loans from purchase or refinance, will be payments toward interest. Using data from 2005, the Treasury inspector general said that “tens of thousands of homeowners who paid more than $20,000 in mortgage interest” reported income that appeared “insufficient” to have covered their mortgage payments and basic living expenses. I don’t doubt that fact, but I see an alternate hypothesis to explain the situation. These families are accurately reporting their income, but they are just spending more than they earn. They have houses they cannot afford, and they use Capital One to finance their basic living expenses so their income dollars can go to mortgage payments. Back in 2003-005 when these data were gathered, the credit market was loose and many families made up shortfalls in monthly living using credit cards, or in some instances, doing a cash-out refinance, and then living off the cash, expecting the housing market to sustain this strategy. Relying on debt to make ends meet has always carried risks, including bankruptcy risk. Should we add the risk of a tax audit to the reasons that families need to keep income and expenses in alignment?

September 8, 2009 at 7:40 AM in Consumerism, Mortgage Debt & Home Equity | Permalink | Comments (1)

Mortgage Modification Investor Lawsuit

posted by Adam Levitin

The District Court ruling in Greenwich Financial Services v. Countrywide, addressing the servicer safe harbor provision for doing loan modifications, is linked here.  See here for the NYTimes story.  See here for the complaint.

Quick version:  the ruling went against Countrywide, but it was a procedurally based ruling about whether the case belongs in Federal District Court or state court at this point, not on the merits.  (As an aside, I think the reason this case wasn’t removed to the Federal District Court on diversity jurisdiction grounds is because Countrywide is a “citizen” of New York, so under the Class Action Fairness Act removal isn’t possible.  28 U.S.C. 1441(b).)

What I find most fascinating about this case is that it is the only investor lawsuit related to modifications about which I know.  (But please post in the comments if I’m wrong on this.)  For a while the story we heard from servicers was one of avoiding loan mods due to the fear of litigation (of course, there could just have easily been litigation for not doing mods).  Interesting how that litigation never materialized.

August 20, 2009 at 8:13 AM in Mortgage Debt & Home Equity | Permalink | Comments (3)

Complaining to HUD about Servicing: Thunder on Deaf Ears?

posted by Katie Porter

In my own research, and frequently on Credit Slips, I’ve noted problems that homeowners face in dealing with their mortgage servicers. As a recent post from guest blogger Max Gardner explained, many of these problems are structural to the servicing industry. I think the people on the phone are good folks, trying to be helpful, but without the tools, training, and resources that they need to do so. One marker of the increasing pressure that servicers are under is the HUD complaint statistics. According to this Pro Public report, mortgage servicing issues were 31% of  complaints to HUD in 2006. Just two years later in 2008, that fraction has jumped to 78%. No surprise here. More families are in default or foreclosure and that means more friction between homeowners and servicers. And as many of us have pointed out, consumers aren’t the mortgage servicers’ customers–the mortgage note holders are. So it makes sense that consumer satisfaction (“non-customer satisfaction”, so to speak) is low in the industry.

The interesting part to me is that HUDs own complaint website doesn’t even list mortgage servicing as an area of concern. Four out of five consumers who contact HUD are frustrated with their mortgage servicer, but HUD doesn’t even acknowledge–at least in the obvious location–that it is in charge of complaints about mortgage servicing? I think this reflects a real problem in consumer protection regulation. Perhaps HUD sees mortgage servicing as just pretty far afield from its core concerns about housing discrimination and federal housing programs. HUD, more than any other agency anyway, has authority to implement the Real Estate Settlement Procedures Act (RESPA), which provides a process (a QWR) for consumers to motivate servicers to respond to problem. But historically, and still today, HUD’s oversight of mortgage servicing could generously be characterized as “thin.” Is mortgage servicing an example of the need for a Financial Product Safety Commission or will the mortgage market (when, and if, it revives itself) offer new and improved servicing models that reduce consumer frustration and improve transparency?

August 20, 2009 at 7:30 AM in Mortgage Debt & Home Equity | Permalink | Comments (6)

Private Tax Collection

posted by Bob Lawless

The New York Times has a story today that Credit Slips readers will want to check out. It catalogs the growing trend of local governments to sell their real estate tax debts to private investors. The reporter, Jack Healy, succinctly states the opposing policy points:

Investors say the arrangement actually benefits everyone. School districts, fire departments and public parks get an infusion of cash. The investors take on a risky but potentially high-yielding investment. And taxpayers do not have to pick up the slack from scofflaw landlords or tax evaders. 

Governments, of course, can charge interest and penalties too, and they foreclose on properties for back taxes. But governments charge interest rates that are half what private investors charge — often offering no-interest payment plans — and are also more likely to be concerned about the long-term prospects of neighborhoods.

All good points, but there is nothing that the ivory tower can’t make more confusing.

Continue reading “Private Tax Collection” »

Show Me the Original Note and I Will Show You the Money

posted by O. Max Gardner III

As mortgage delinquencies rise each month, and as the number of foreclosures increase each quarter, the “new mantra” of many pro-se and represented consumers is to demand that the mortgage servicer “prove up the original note.” Is this just some new and creative gimmick that has been sold to the desperate homeowners and to a few lawyers who have attended “progressive” seminars or is there really something to it? I submit that there is really something to it.

In my last Credit Slips post, I wrote about what I call the “Alphabet Problem.” Succinctly stated, this problem arises out of the necessity for a true sale of the mortgage note and mortgage from the originator to the sponsor for the securitized trust; then from the sponsor to the depositor for the securitized trust; and finally from the depositor to the owner Trustee for the trust. These multiple “true sales” are necessary in order to make the original asset (the note and mortgage) bankruptcy-remote and FDIC-remote frin the originator in the event the originator files for bankruptcy or is taken over by the FDIC.

Continue reading “Show Me the Original Note and I Will Show You the Money” »

The Alphabet Problem and the Pooling and Servicing Agreements

posted by O. Max Gardner III

The securitization of residential mortgage notes has created a maze of complex issues and problems for the bankruptcy and foreclosure courts. One fundamental issue is who is the actual holder and owner of the mortgage note. In order to answer this question, it is necessary to dig deep into the contracts, warranties and representations that were executed in the formation of the securitized trust.

The Pooling and Servicing Agreement (PSA) is the document that actually creates a residential mortgage backed securitized trust and establishes the obligations and authority of the Master Servicer and the Primary Servicer. The PSA also establishes some mandatory rules and procedures for the sales and transfers of the mortgages and mortgage notes from the originators to the trust. It is this unbroken chain of assignments and negotiations that creates what I have called “The Alphabet Problem.”

Continue reading “The Alphabet Problem and the Pooling and Servicing Agreements” »

What Does RESPA Have to do with Consumer Bankruptcy Cases?

posted by O. Max Gardner III

I have trained over 350 attorneys at my Bankruptcy Boot Camps and to my surprise less than 10 percent know what I mean when I refer to a “QWR.” This is shocking in that a reasonable QWR can provide the attorney for the Chapter 13 debtor with some of the very best discovery outside of a contested case or Adversary Proceeding. The QWR can be used to find out how the servicer for the securitized trust is applying the debtor’s money and the disbursements on the arrearage claim from the Chapter 13 Trustee. It can also be used to identify all of the “ancillary fees” and “collateral charges” that mortgage servicers are so fond of unilaterally adding to the debtor’s mortgage account, without any notice or the right to a hearing.

The provisions of RESPA which deal with mortgage servicing are generally found in either 12 U.S.C. § 2605 or § 2609. Section 2605, known as the “Servicer Act,” requires servicers to respond to borrower requests for information and correction of account errors. The “Servicer Act” provisions are where you find the authority for a Qualified Written Request. The Servicer Act provisions in § 2605 are significant because borrowers are given the right to sue for violations based on the express private right of action found in § 2605(f).

Continue reading “What Does RESPA Have to do with Consumer Bankruptcy Cases?” »

Countrywide Sanctioned by Ohio Court Citing Porter & Twomey

posted by Bob Lawless

As many Credit Slips readers may be aware, Countrywide Home Loans (which is now part of Bank of America) has been the subject of proceedings in several bankruptcy courts because of the shoddy recordkeeping behind their claims in bankruptcy cases. Judge Marilyn Shea-Stonum of the U.S. Bankruptcy Court for the Northern District of Ohio recently sanctioned Countrywide for its conduct in these cases. Having previously found Countrywide to have committed sanctionable conduct, the question for Judge Shea-Stonum was the appropriate penalty.

The resulting opinion makes extensive reference to Credit Slips regular blogger Katie Porter and guest blogger Tara Twomey’s excellent Mortgage Study that documented the extent to which bankruptcy claims by mortgage servicers were often erroneous and not supported by evidence. Specifically, the court adopted Porter’s recommendation from a Texas Law Review article that mortgage servicers should disclose the amounts they are owed based on a standard form. Judge Shea-Stonum found that such a requirement would prevent future misconduct by Countrywide. All of Countrywide’s claims now or hereafter pending in this court have to be supported by the form attached to the end of the opinion.

If you look at the form and wonder “Weren’t mortgage servicers disclosing this information anyway?” The answer is that they often were not. Hence the need for such a form. Although the issue before the court was only what do to with Countrywide, we should move toward this sort of form as a requirement nationally for all mortgage servicers. (Hat-tip to Professor Marianne Culhane for pointing me toward this opinion.)

HAMP–Is It Really All About the Money?

posted by O. Max Gardner III

Are mortgage servicers really refusing to modify mortgage loans solely because of all of the “ancillary fees” they can generate from a completed foreclosure? Is the problem really all about the money or is there something more to it?

The New York Times reported about ten days ago that the HAMP mortgage servicers were reluctant to engage consumers in modifications because the companies collect such lucrative fees on delinquent mortgage loans. There is certainly a substantial body of evidence to support the “lucrative fees” disincentive theories. For example, the Federal Reserve Bank of Boston recently shed some light on this problem with a new study that concluded that only 3% of the seriously delinquent mortgages had been modified due to the “the simple fact that the lenders expect to recover more from a foreclosure that from a modified loan.” And, the number of reported bankruptcy cases where mortgage servicers have been sanctioned for imposing unlawful, illegal and unreasonable “collateral and ancillary fees” is substantial and perhaps monumental in their numbers.

Continue reading “HAMP–Is It Really All About the Money?” »

Truth in Lending or Truth in Ownership of Residential Mortgage Notes

posted by O. Max Gardner III

During my last two Bankruptcy Boot Camps, one of the topics we have discussed has been the recent amendments to the Truth in Lending Act, brought about by Section 404 of Public Law 111-22. Specifically, our interest has been focused on the new statutory requirement that a consumer-borrower must be sent a written notice within 30 days of any sale or assignment of a mortgage loan secured by his or her principal residence. Violations of this Section provide for statutory damages of up to $4,000 and reasonable legal fees. The amendments also clearly provide that the new notice rules are enforceable by a private right of action. 15 USC 1641.

Continue reading “Truth in Lending or Truth in Ownership of Residential Mortgage Notes” »

Mortgage Servicing Update

posted by Katie Porter

Complaints about mortgage servicers are piling up almost as fast as foreclosures. Yesterday CNN reported that the GAO has concluded that the Obama Administration’s HAMP and HARP programs to do loan modifications are off to a very, very slow start. The programs were announced in February, and to date we have 180,000 people in three-month trial modifications. That’s a far cry from the 3-4 million people the Administration believed would be helped. Consumer advocates say that servicers remain unresponsive to requests for loan modifications, citing the same stories of incompetent or inadequate personnel, lack of follow-up, and refusal to modify unless a homeowner is in default.

At the same time, judicial criticism of mortgage servicing is picking up steam. A good example is Bankruptcy Judge Diane Weiss Sigmund’s opinion, In re Taylor, released in April. The thoughtful opinion sheds light on the underbelly of mortgage servicing. She details the relationship between local and national counsel, Lender Processing Services (formerly d/b/a Fidelity National), and the mortgage servicer. Among other things, she finds that the attorney signing the proof of claim, a legal document filed with the court, reviewed a “sample” of 10% of the claims that his own signature was affixed to. In Taylor the proof of claim had the entirely wrong person’s note attached to it (I wonder about a privacy violation here as bankruptcy documents are public), and an incorrect payment amount.

On a monthly basis, Tara Twomey and I post an updated version of our Mortgage Servicing Resources document to our Mortgage Study website, which also contains our papers on the subject. We are grateful to colleagues from around the country who forward us interesting cases that we collect in this document, but we wish studying mortgage servicing wasn’t such a growth industry. We hope the Obama Administration can find a way to shape up mortgage servicers in time to help Americans keep their homes.

Can You Judge an Industry By a Few Blog Comments?

posted by Bob Lawless

I’m annoyed this morning. OK, for those of you who know me, I’ll make the necessary correction — I’m annoyed more than usual. And, yes, I’ve had my morning cup of coffee.

It seems that we are getting more and more of these sorts of comments on the blog: “Very informative post.” /s/ Friendly Mortgage Modifiers.com. Of course, the signature is always hyperlinked to a web page where someone purports to want to help people save their homes. These comments are a transparent attempt to draw traffic to these sites and always will be deleted pursuant to our policy against commercial marketing in the comments.

Continue reading “Can You Judge an Industry By a Few Blog Comments?” »

July 24, 2009 at 10:18 AM in Blog Stuff, Mortgage Debt & Home Equity | Permalink | Comments (2)

Is Bankruptcy Mortgage Modification Back?

posted by Bob Lawless

As I write this, the Senate Judiciary Committee’s Subcommittee on Administrative Oversight and Courts is holding a hearing entitled, “The Worsening Foreclosure Crisis: Is It Time to Reconsider Bankruptcy Reform.” The witnesses include Credit Slips‘s own Adam Levitin.

After the Senate failed to support changing the Bankruptcy Code to allow judges to do mortgage modifications, it appeared to be a dead issue. The hearing is great news and hopefully an indication there may be some interest in moving the legislation forward. There have been increasing reports (e.g., here) recently that lenders are not doing voluntary mortgage modifications in the numbers that need to happen. Yeah, I know — who could have possibly foreseen the possibility that a solely voluntary system would not work? There need to be carrots that encourage lenders to do the modifications. The change in the bankruptcy law is the missing piece — the stick that makes the program work.

Does Securitization Affect Loan Modifications?

posted by Adam Levitin

A few days ago I wrote a long and detailed critique of a Boston Federal Reserve staff study that argued, among other things, that securitization was not a factor in the paucity of loan modifications.  The study reached this conclusion based largely on the similar rate of modifications for portfolio and securitized loans.  Although the study controls for the effect of the modification in terms of monthly payment, it otherwise assumes all modifications are created equal.  But clearly they are not.  There is a significant difference in redefault rates for securitized and portfolio loans, and the securitized loan mods perform much worse.  This is something the Boston Fed’s study cannot explain other than if there is (1) unobserved heterogeneity in the loans or (2) differences in the loan mods.

The nature of unobserved heterogeneity in data is that it can’t be observed, so all that can be said of (1) is that it is a possibility.  But assuming that there isn’t a heterogeneity problem about the unmodified loans, what about the mods?  Is there heterogeneity problem in mods that makes comparisons of mod rates a poor measure for evaluating the impact of securitization.  It appears that there is.
The Boston Fed study did not control for the effect of the loan modification on the homeowner’s equity. It does have controls for LTV and negative equity, but those don’t seem to have been applied to the serviced/portfolio distinction, at least in the paper.  I’m not sure whether there is sufficient data to do this, but what the study could have controlled for, but did not, was whether the modification involved a reduction in the unpaid principal balance.  In this aspect, there is a significant difference between portfolio and securitized loans.
OCC/OTS Mortgage Metrics Data for the first quarter of 2009 indicates that very few loan modifications have involved principal balance reductions.  In fact out of 185,186 loan modifications in Q1 2009, only 3,398 (1.8%) involved principal balance reductions.   All but 4 of those 3,398 principal balance reductions were on loans held in portfolio.  The other 4 are quite likely data recording errors.  This means that there is heterogeneity in loan mods between securitized and portfolio loans.
The difficulty in doing principal reduction mods for securitized loans is quite important because to the extent that negative equity is driving foreclosures (and there is significant evidence that it is), principal reduction modifications are the tool for eliminating negative equity (with an shared appreciation clawback or not).  The quality of loan modifications matters, and securitization affect the quality.
There is also a major difference in the ability of portfolio lenders and Fannie/Freddie/Ginnie servicers to extend the term of a mortgage that private-label servicers don’t have.  Not all securitization is the same.   Private label servicers can usually stretch out the term of a loan by no more than a year or so because the servicing contracts prohibit the extension of the term beyond the last maturity date of any loan in the pool, and pools are usually of similar vintage and duration loans.  Fannie/Freddie/Ginnie loans can be bought out of a pool and modified, making them more like portfolio in this regard.  Thus 49.2% of portfolio loan mods, 50.8% of Fannie, 61.2% of Freddie, and 17.2% of Ginnie mods involved term extensions, but only 3.9% of private-label securitization mods.
Quite likely there is other heterogeneity that cannot be as easily discerned.  This makes sense–portfolio lenders are much less constrained in modifications than securitization servicers.  Attempts to quantify servicers’ constraints by looking at contract language are inherently limited, as there are structural and functional constraints that are not apparent from an examination of the face of the servicing agreements. Moreover, securitization servicers are adverse to principal write-downs because that affects their compensation far more than an interest rate reduction.  The agency problem just doesn’t exist for portfolio loans.

Finally, the study has a very strange observation that there is a moral hazard problem in principal balance reductions, but apparently not for interest rate reductions:  “Balance reductions are appealing to both borrowers in danger of default and those who are not.”  Therefore, borrowers might default to get principal reductions.  Sure, that’s right, but everyone would also like a lower interest rate too.  I don’t see why a principal reduction presents a different level of moral hazard from an interest rate reduction.  In terms of net present value, principal and interest rate are interchangeable (yes, there’s an interest deduction, and a principal reduction changes the ability to refinance, but that’s not the distinction at issue).  The bigger factor pushing against principal reductions (other than servicer compensation) is an accounting issue.  A principal reduction shows up on the balance sheet immediately.  A reduction of interest just reduces future income.

The take-away here is that even if the Boston Fed staff is right that securitization doesn’t affect the prevalence of loan modifications, it clearly affects the quality of those modifications, and that is every bit as important, not least because the performance of past modifications is the basis for servicers’ calculation of the redefault risk that the Boston Fed staff emphasizes as constraining modifications.  If servicers do bad mods and have high redefaults, that will make them more adverse to doing mods in the future because they will think that the mods don’t work.

July 22, 2009 at 12:57 PM in Mortgage Debt & Home Equity | Permalink | Comments (9)

Is Redefault Risk Preventing Mortgage Loan Mods?

posted by Adam Levitin

There’s a very interesting new study on mortgage loan modifications out from the Boston Federal Reserve staff.  This sort of study is long-overdue and from an academic standpoint, there’s a lot I really like about this study.  But the study is going to get a lot of policy attention, and I think it’s important to point out some of the problems with the study that limit its ability to serve as a policy guide.

Continue reading “Is Redefault Risk Preventing Mortgage Loan Mods? ” »

July 16, 2009 at 2:03 PM in Mortgage Debt & Home Equity | Permalink | Comments (19)

Skin in the Game

posted by Adam Levitin

The proposed skin-in-the-game requirement for securitization strikes me as misguided, no matter how its structured. Different industries use securitization for different purposes, and while skin in the game might not have much of an impact in some, it runs contrary to the (legitimate) purposes of securitization in others.

Some industries securitize primarily to gain off-balance sheet and immediate revenue-booking accounting benefits and because it is a cheaper funding source than other methods. Industries like these often have significant skin in the game (e.g., the credit card industry, where a 7% vertical slice is the typical minimum requirement and it’s usually much higher). Other industries, like non-GSE mortgages securitize primarily to shift credit risk. The whole point of securitization is not to have skin in the game.The skin in the game requirement is being driven by the experience in mortgage securitization, not other types of securitization, and imposing a skin in the game requirement probably won’t do much to non-mortgage securitization, where there might already be more than 5% retained interest. But for housing finance, skin in the game is really counter productive. 

Continue reading “Skin in the Game” »

AP Launches the Economic Stress Index

posted by Bob Lawless

The Associated Press has launched the Economic Stress Index. Credit Slips readers will find it very useful and interesting. For a dataphile like myself, it’s just plain cool. OK, it’s not cool at all because it shows the tremendous depth and breadth of middle America’s suffering. But, it shows what someone with real data know-how and computer graphic skills can do.

The Economic Stress Index “weighs three economic variables — unemployment, foreclosures and bankruptcy — to produce a score on a scale of 0-100 that measures how the recession is affecting a county compared to all others.” You can scroll over each county and get a separate measure for each of the components or for the composite Economic Stress Index. The press release indicates the index and data will be updated monthly. Check it out.

Does Anybody Know If Credit or Foreclosure Counseling Helps?

posted by David Lander

The infusion of millions of dollars to pay “counselors” to forestall foreclosures on behalf of consumers who are delinquent on their mortgage payments seems as American as apple pie and should perhaps help some homeowners. These dollars are split among neighborhood non profits, specialized housing counseling organizations and a considerable amount has flowed to providers that have historically spent most of their time counseling consumers with credit card delinquencies. A group of United Way supported family and children service agencies also receive some of these funds.

Anecdotal reports indicate that the housing counselors are a cut above the historic credit card counselors. The credit card counseling industry agencies were mostly begun by creditors and their funding has always been supported by payments from creditors. The housing counseling organizations began with funds from HUD and the Ford Foundation and the extensive new dollars have come from the Federal government through a central organization called Neighbor Works. The neighborhood organizations obtain their funding all over the lot. The cultures of the various organizations differ a good deal among themselves and between the various types of providers.

Continue reading “Does Anybody Know If Credit or Foreclosure Counseling Helps? ” »

Mortgage Modification Vote in Senate

posted by Bob Lawless

Credit Slips has featured a lot of articles about a legislative proposal to give bankruptcy judges the power to modify home mortgages in chapter 13 (here, here, here, here, and here for a just a few examples). Heck, we were blogging about back this idea back in 2007. In March, the House passed H.R. 1106, the Helping Families Save Their Homes Act of 2009, which would enact this proposal into law. Since then, it has faced an uncertain future in the Senate. Yesterday, CongressDaily reported that Senate Majority Leader Harry Reid will bring the mortgage modification proposal for a floor vote in the Senate. Although this might seem like good news for supporters of the legislation, close observers of the political scene seem to be predicting defeat. Two Democratic Senators (Ben Nelson of Nebraska and Jon Tester of Montana) and Republican Senator Bob Corker of Tennessee are quoted in the CongressDaily article as being against the legislation, with Corker going so far as to say “Cram-down is dead.”

If you support the legislation, however, now would be a good time to tell that to your senators — or, in the case of Minnesota, senator. It’s not over until the fat lady lets the horses out of the barn.

Mortgage Symposium at Pepperdine

posted by Bob Lawless

On Friday, Pepperdine University School of Law is hosting a symposium entitled, “Bringing Down the Curtain on the Current Mortgage Crisis and Preventing a Return Engagement.” As the announcement notes, the Pepperdine Law Review is bringing top scholars and Bob Lawless to campus. OK, it doesn’t actually say that explicitly, but I’ve always wanted such an announcement to say something like that. Besides myself, the speakers include Ann Burkhart, Rick Caruso, Deborah Dakin, Wilson Freyermuth, Sam Gerdano, Melissa Jacoby, Alex M. Johnson, Jr., Timothy Mayopoulos, Grant Nelson, Mark Scarberry, and Dale Whitman. Truly trivial question: which four were once colleagues at the University of Missouri School of Law?

The papers will be published in the Pepperdine Law Review. My contribution has been co-authored by my research assistant extraordinaire, Jeff Paulsen. Before he goes off for a two-year clerkship with Judge Jack Schmetterer in the bankruptcy court in Chicago, I wanted to take advantage of his talent work with Jeff on a scholarly piece. We have a working title of “The Missing History of Bankruptcy Mortgage Modification.” The short version is that the current rule against modifying mortgages in bankruptcy is not the considered policy choice as it is often portrayed. Rather, like many things, the history is much messier, and path dependence explains a lot of it. When we have a version for SSRN, I’ll post a more detailed summary.

How to Start to Get Trillions in Lost Wealth Back

posted by Christian E. Weller

The fact that wealth is rapidly declining deserves public policy attention. Wealth serves critical functions in the U.S. economy that relies heavily on individual initiative. It is primarily an insurance against a range of economic risks. The more such insurance exists for the typical family, the less a family has to worry about their basic necessities and the more they can focus on longer-term economic growth. A family that has the basics covered can take more chances by sending their kids to college and letting them choose a degree that suits their abilities. Also, family members can more easily switch jobs to match their particular skills. And, a family with enough wealth is in a better position to let their creative side take hold and start a business. The entire economy wins from letting people gain more skills and apply those skills most effectively in their job or by starting a business.

Recommending what the government should and should not do about rebuilding family wealth has become as ubiquitous as real estate ads in the mid-2000s and dot-com IPO discussions in the late 1990s. Here are just a few principles that will likely guide the reform debate.

Continue reading “How to Start to Get Trillions in Lost Wealth Back” »

Our House in the Middle of Our Street is no Longer Our House

posted by Christian E. Weller

Here’s a news flash: The housing market is bad. Actually, it is really bad, historically, woefully bad. And, the bad news won’t stop coming. Housing wealth is dropping precipitously, families own ever smaller shares of their own homes, and home owners are falling behind in their mortgages in record numbers.

According to data from the Federal Reserve, housing wealth has taken a nose dive for two years. In December 2006, housing values reached a peak of $18.9 trillion (in 2008 dollars). By December 2008, they had fallen by $3.9 trillion to $15.1 trillion.

This reflects a historically fast depreciation of housing wealth. Over the past two years, real housing wealth dropped by 20.5%, a record for any two-year period since 1952. In fact, before this crisis occurred, there had never been a two-year period when real housing value fell by more than six percent.

Continue reading “Our House in the Middle of Our Street is no Longer Our House” »

Great New Reading on Mortgage Modification

posted by Jason Kilborn

It’s not all just fun and games with old credit cards at Katie Porter’s house!  She and a couple of co-authors have a great new paper on SSRN describing the history of the anti-modification provision for principal residence mortgages, an empirical study of home mortgage burdens in Chapter 13 plans, and some comments on how reasonable forced modifications of those burdens could save not only these folks’ homes, but Chapter 13 in general.  This had not occurred to me (I admit), but the 66% failure rate for Chapter 13 plans must be in large part explained by the burden of bloated mortgage obligations. Katie’s paper more or less confirms this suspicion empirically. Reducing that burden to a reasonable level would therefore not only help people to stay in their homes, but it could result in a much higher plan-completion rate in Chapter 13 generally. This would be a great double-whammy. The paper deserves a close look by anyone interested in this hot topic.

In other related news, another CreditSlips blogger has released a particularly high-profile paper on the subject of addressing mortgage foreclosure woes. Elizabeth Warren heads the Congressional Oversight Panel looking into foreclosure mitigation practices, and the panel released its report last Friday. I can only assume the report was authored in large part by Elizabeth–it has the tell-tale signs of her incredibly lucid and incisive writing style, backed up by a wealth of empirical knowledge about how struggling with mortgages and other debts really looks in practice. Check it out!

March 11, 2009 at 11:37 AM in Mortgage Debt & Home Equity | Permalink | Comments (3)

Congressional Oversight Panel Foreclosure Report

posted by Adam Levitin

The Congressional Oversight Panel‘s foreclosure report will be out tomorrow.  I’m hoping it advances the discussion on foreclosures and foreclosure mitigation efforts and helps focus what is still a rather amorphous debate in which there seems to be too little common ground.

March 5, 2009 at 6:00 PM in Mortgage Debt & Home Equity | Permalink | Comments (4)

Bankruptcy Bill Passes in the House

posted by Adam Levitin

H.R. 1106, the Helping Families Save Their Homes Act of 2009, which will allow modification of all types of mortgages in Chapter 13 bankruptcy, passed the House today by a vote of 234-191.

I haven’t found a link yet with the vote breakdown or any other details, but will post more when I do. 

March 5, 2009 at 5:56 PM in Mortgage Debt & Home Equity | Permalink | Comments (3)

Bankruptcy Mortgage Modification Getting More Attention

posted by Bob Lawless

You know the steam is starting to pick up for the horses to close the barn door before the barn burns done while we’re counting our chickens when …. let me try that again.

Bankruptcy mortgage modification is moving beyond the specialty blogs such as this. David Abromowitz over at The Huffington Post has a post up advocating passage of a bankruptcy mortgage modification bill. I’m hoping the fact that the bill is getting broader attention means the train is about to sail.

BS Bankruptcy Numbers

posted by Adam Levitin

We’ve already seen a lot of bs numbers in the cramdown debate. The Mortgage Bankers Association keeps pushing its ridiculous figures. And now Todd Zywicki has joined the fray with an op-ed in the Wall Street Journal a couple of weeks ago.

Professor Zywicki that claimed that “A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform.”

One little problem. That’s not what the Fed staff report found. Professor Zywicki was off by 250 basis points (a doozy of a mistake!), as well inserting a causal link not supported (and arguably contradicted) by the Fed staff’s study. The study states that “The decline in the average auto loan spread was 15 basis points lower after BAR for unlimited exemption states, a 5.7 percent decline relative to the mean over all states (265 basis points).” In other words, the average rate spread is 265 bp. The decline in rates, to which Zywicki was referring was only 15bp, and that was only in states with an unlimited homestead exemption.  That it was not 265 bp was abundantly clear from the regression tables.

But that’s not all. It’s not as if Professor Zywicki simply mistook a 15 bp drop for a 265 bp drop.  That 15 bp isn’t what it appears to be.  The study used two statistical specifications and looked at states with limited and states with unlimited homestead exemption to see what impact there was on auto loan rates post-BAPCPA, which enacted an anti-auto cramdown provision (the infamous “hanging paragraph” that says that there’s no bifurcation of claims for cars purchased primarily for personal use in the previous 910 days).

In one specification it found nothing with statistical significance regardless of the homestead exemption level, which means that it couldn’t rule out the possibility that the change in rates was random.

In the other specification, post-BAPCPA there was a marginally statistically significant 15 bp drop in five-year auto loan rates in states with unlimited homestead exemptions. There was no statistical significance in the drop in other states. What’s funny about this is that homestead exemptions have no bearing in Chapter 13–exemptions are only available in Chapter 7. So if the study had aggregated all states for its regression, it seems unlikely that it would have gotten stronger statistical significance.

So we have at best very weak evidence of a 15bp drop in rates. But it doesn’t follow that the drop was due to the anti-auto-cramdown provision. The study also found a significant decline in auto-loan delinquencies in the short period after BAPCPA. The most plausible story, I think, is that surge in bankruptcy filings before BAPCPA’s effective date cleared out the pipeline of troubled loans so that post-BAPCPA auto loan default rates were lower. My guess is that they’ve climbed right back up.  Notice that this has nothing to do with cramdown. This has to do with moving forward some filings that would have happened later. So we have a 15bp drop that might not even be statistically significant and only in some specifications and only for states with unlimited homestead exemptions, and it probably isn’t attributable (or at least most of it) to the anti-cramdown provision, but instead to BAPCPA causing a filing pile-up. So where did Professor Zywicki get this 265 basis point number from? That’s the spread that exists between five year auto loans and five year Treasuries. It has nothing to do with bankruptcy.

Sometimes a little common sense is needed when looking at numbers, too. In December 2005, auto loan rates were at around 6.63% (663 bp). If 265 bp was right, it would have been a 40% decrease in auto loan rates! Whatever impact bankruptcy has on credit costs, I don’t think there’s anyone who could honestly argue that 40% of the cost of auto loans is due to the ability to cram down loans on cars purchased primarily for personal use within the previous 910-days with a purchase money security interest. There just aren’t that many folks filing for Chapter 13 bankruptcy, much less who fit into this particular set of circumstances, to have this kind of impact on pricing, regardless of the loss severities.

Yet another case of baloney numbers shaping the bankruptcy debate. I hope the WSJ runs a correction on this.  Now there’s some fact-checking for you.

[Update 3.6.09: Based on correspondence with Don Morgan, one of the NY Fed study’s authors and Professor Zywicki, a few new points emerge:

First, I misread the study too.  The 15bp finding is in a regression that measure the “difference-in-differences” in the spread between auto loans and Treasuries pre- and post-BAPCPA for states with and without unlimited homestead exemptions.  The study does not report the post-BAPCPA rate drop in auto loan rates.  The author, however, tells me that it turns out to be 46-56 bps, and to have strong statistical significance. So let the record stand corrected on this.

Second, regardless of whether the number is 15, 46, 56, or 265bps, the finding of a correlation does not mean there’s causation.  But that’s precisely what Professor Zywicki was pushing in the WSJ.   Unfortunately, it’s just not a tenable claim.

It’s possible that BAPCPA resulted in lower auto loan rates.  But in order to make a reasonable causation argument, one must first explain the similar or larger rate drops in 2000-2001 and in 2003 and in 2007 that have nothing to do with BAPCPA.  Otherwise, the causal argument is reduced to the fallacious post hoc ergo propter hoc variety.

The chart below, taken from the NY Fed study shows with the solid and dotted lines the spread between auto loan rates and Treasury’s for states with and states without unlimited homestead exemptions.  They move in sync, and they clearly fall after BAPCPA.  But they also fall equally sharply before and after BAPCPA.  Auto loan rate spreads over Treasury jump around a lot, and the mere fact that they fell after BAPCPA doesn’t prove anything.

(fwiw, Chart 5 appears to be incorrectly labelled in the study.  The study says that the Left axis measures interest rate on new automobile loan (5 year) minus rate on government bond (5 year).” If so, then 15bps would appear to be roughly the right measure.  Instead, the rate spread must be the right axis in bps, and the left axis must be measuring the difference in the auto-loan-treasury spread between limited and unlimited homestead exemption states.)

The problems with Professor Zywicki’s causality argument don’t end there.  Any causality argument must also distinguish between general impacts of BAPCPA (e.g, delinquency pipeline cleared out) and the auto-cramdown provision.  This type of event study cannot provide support for that.  The rate drop could be due to the hanging paragraph, but there’s no responsible way to make that claim without addressing these other factors, and the NY Fed study doesn’t attempt to do that. The fact that Professor Zywicki was off by 209-219 bps, rather than by a full 250 bps (something he couldn’t have known from the study) doesn’t absolve him of making an untenable causal claim.

The  bankruptcy policy debate should happen on the basis of the best possible evidence.  If more restrictive bankruptcy laws result in cheaper credit, that’s a very important policy consideration, and for the integrity of the policy debate, we need to be working off the best numbers available. I’ve updated this post to make sure that the correct numbers are clear.  I’m still hopeful that Professor Zywicki will make clear that he doesn’t stand by either his 265 bp claim or his untenable claim of causality.]

[Updated 3.7.09

Professor Zywicki has corrected on the 265 bp claim.  He still seems to be making causal assertions, however, such as that the study finds “the impact of eliminating cramdown was a reduction in interest rates of 56 or 46 basis points.”  That’s not quite right.  The study can’t test the elimination of cramdown; it can only test the impact of BAPCPA as a whole.  In fairness, Zywicki later refers to the study finding the impact of BAPCPA, rather than the specific cramdown provision.  Regardless, Professor Zywicki still has no response to all of the equally large jumps up and down in the auto loan rate to Treasuries before and after BAPCPA, which casts serious doubt on any causal story.]

A Note on Notes

posted by Bob Lawless

When you’re in court, you have to provide evidence of your case. When you’re a creditor, that proof includes the fact the debtor owes the money due and should include the contract (the “note” in legalese) that the debtor signed. Bankruptcy specialists have been following this issue for a while now, and it has made its way into the New York Times today in Gretchen Morgenson’s column. I recommend it as a read. And, congrats to Judge Sam Bufford and attorney R. Glen Ayers for their mention in the column. It’s not often that a paper prepared for a professional meeting ends up in the New York Times, but they accomplished just that with a paper on the somewhat arcane rules that govern proof in such matters.

H/T to reader Mike Dillon for bringing the article to my attentiion.

March 1, 2009 at 5:30 PM in Mortgage Debt & Home Equity | Permalink | Comments (1)

Responding to Schwartz on Mortgage Modification

posted by Bob Lawless

Professor Alan Schwartz of Yale University has an op-ed in today’s New York Times arguing against the proposals to give bankruptcy judges the power to modify home mortgages. For our readers who do not know him, Professor Schwartz is a respected academic and bankruptcy expert, but with all due respect, I think he just gets this wrong. He makes three principal points, but none of them are a good reason not to move forward with this much-needed legislation.

First, Schwartz says that the proposal would swamp the bankruptcy courts and the nation’s 300 bankruptcy judges. That seems empirically dubious given that my forecast of 1.4 million filings this year is below the number of filings in 2002 – 2004, when the annual filing rate was around 1.6 million filings and we had about the same number of bankruptcy judges. Even if the mortgage modification bill resulted in hundreds of thousands of extra filings in the short term, we still would be below the 2 million bankruptcy cases in 2005 when filings surged ahead of the draconian new bankruptcy law. The bankruptcy system survived those filing levels and should handle any increases that would come from mortgage modification.

Continue reading “Responding to Schwartz on Mortgage Modification” »

Waiting for H.R. 1106 (a.k.a. H.R. 200/S. 61)

posted by Jason Kilborn

The comment thread from the previous post raises an important point that deserves treatment in its own post: what’s the deal with the House version of the mortgage lien stripping bill (H.R. 1106), a vote on which has been postponed due to fears from pushback from “Blue Dog” and “new” Democrats.

First, my two cents: I believe (1) limiting application of this relief to property “that is the subject of a notice that a foreclosure may be commenced” is foolishly short-sighted and a significant restriction that has not gotten much press, but (2) relieving these folks of the idiocy of pre-filing credit counseling is to be roundly praised (perhaps we can be rid of this requirement for all filers in the not-too-distant future, as Sweden did in its 2007 reform of consumer bankruptcy law), (3) the balance of interests is impressive and eminently fair, allowing for reasonable modification of interest rates, extension of repayment term, and a reasonable strip-down of the secured claim, but also allowing for recapture of a declining portion of that loss if values rebound and the home is sold for a profit within 5 years. The big question will be valuation, and I fully expect the banks to push back hard on that question in any future case, probably irrationally, as I’ve complained elsewhere. As usual in bankruptcy discussions, people just don’t get that this law doesn’t create losses, it forces banks to acknowledge already existing losses, which is an important prerequisite to getting us out of this financial crisis. Banks’ arguments that this law will reduce lending are subject to only two appropriate responses, in my view: if banks reduce lending in response to this law, that would indicate either (1) yet more irrational mismanagement by banks, which makes me feel like nationalization of the home mortgage industry is a more attractive option, along the lines of the full nationalization of the student lending industry in President Obama’s budget proposal, or (2) a proper reevaluation of the risk of lending to uncreditworthy borrowers–forcing the banks to engage in the sort of responsible risk management that was needed all along. Heads we win, tails we win. The only losers here are irresponsible banks, who deserve to lose given their mismanagement, and they should no longer be allowed to externalize the negative consequences of their mistakes onto debtors, their families and communities, and society at large. Internalizing negative externalities from irrational creditor action is the primary reason why country after country in Europe adopted consumer bankruptcy systems in the 1980s and 1990s, as I’m writing in an article on the Danish system now.

Second, though I hope and expect this bill will pass next week, the “Blue Dog” Democrats appear to have fallen prey to the Jedi mind tricks of the lending industry lobbying juggernaut. This reminds me of a portion of the late 1980s Eddie Murphy Raw monologue, in which Eddie recounts an exchange with Mr. T. Eddie explains that he had been making fun of Mr. T in an earlier monologue and was accosted by Mr. T when Mr. T found out about this: “I heard you been saying @#$% about me,” Mr. T accused. Eddie explains in Raw that, fearing reprisal from impressively scary Mr. T, he decided to use his “Jedi mind trick”: he responded calmly, “It wasn’t me.” When Mr. T retorted that he had heard Eddie saying these things about him, Eddie simply repeated, “It wasn’t me.” Finally, Mr. T conceded, “Well, well . . . I guess it wasn’t you. I pity the fool who’s been telling me them lies!” The Bankers Association apparently saw Raw and has effectively applied Murphy’s Jedi mind trick on the Blue Dog Democrats (no offense is intended to Mr. T through my comparison between him the weak-minded Blue Dogs).

Comments are wide open–what do you think about H.R. 1106?

February 27, 2009 at 11:29 AM in Mortgage Debt & Home Equity | Permalink | Comments (14)

Mortgage Database

posted by Katie Porter

The National Mortgage Data Repository is making its data available to a select group of applicants to conduct mortgage resarch. The Repository is a joint project of the National Consumer Law Center and the University of Connecticut School of Lawand includes data from 750 loans made in 10-15 states between 1994 and 2007. While the database isn’t as comprehensive as HMDA or Loan Performance, it has a unique collection of data and the data are free. For each loan, the researchers have gathered the loan application, the truth in lending disclosure, the good faith estimate, the HUD-1 Settlement Statement, and the loan note. These are the core documents in a mortgage origination, making this a great dataset to study the costs of mortgage credit and underwriting decisions.

Research proposals of 2 single-spaced pages are due by March 31, 2009. Submissions are welcome not only from academics but also from advocates, attorneys, and other professionals interested in mortgage issues. (Having teamed up with guest blogger Tara Twomey for our Mortgage Studyof bankruptcy and homeownership, I encourage my scholarly colleagues to consider the many virtues of collaborating on research with attorney/practitioners). Authors whose projects are selected will present their work at a symposium in Spring 2010 at Valparaiso University School of Law. The full call for papers is here: Download Investigating Lender Practices in the Subprime Mortgage Market . Thanks to former guest blogger Pat McCoy for sharing this opportunity with Credit Slips.

Some Good News for Homeowners

posted by Angie Littwin

JPMorgan Chase and Citigroup have announced a weeks-long moratorium on foreclosures while they await the release of the Obama administration’s forthcoming plan to deal with the issue. J.P. Morgan said its moratorium will apply to loans it owns and services, while Citi is including its own loans as well as those on which it has reached agreements with the relevant investors. For both banks, this is an expansion on similar past efforts. It remains to be seen exactly how many troubled home loans this will cover.

February 13, 2009 at 1:46 PM in Mortgage Debt & Home Equity | Permalink | Comments (7) | TrackBack (0)

What a Surprise, the Ability to Pay Matters on Mortgage Modifications, Too.

posted by Kathleen Keest

Last week the Center for Responsible Lending posted a foreclosure ticker on its web site that counts projected new foreclosure filings as they occur: a new one every 13 seconds in 2009.  That puts it at nearly 276,000 as I write this post.  (You can check out your state’s share on the map.)

Cool as technology is, the figures are as depressing as the slow pace of response to the crisis is puzzling. In a December guest blog,  Tara Twomey lifted the veil on the OCC’s report of disappointing re-default rates on modification.  Professor Alan White’s analysis of remittance reports from loan servicers found that only 35% of modifications reduced the homeowner’s monthly payment, while 20% stayed the same.  The largest share– 45%–actually increased payments.

Yesterday, Fitch Ratings released a report that says (you heard it here first) “the key to a successful loan modification program is that the modification is sustainable.” The modifications with 10-20% increases in principal and interest (P&I) payments had a 49% re-default rate within 6 months, more than double the re-default rate for modifications to a 20% or greater reduction in P&I payment (21%). Imagine that!

The Fitch report notes that payment reduction, at least so far, has a more direct impact on re-default than principal reduction. (They also, though, believe principal reductions that give homeowners equity are also likely to improve sustainability.) Fitch projects a high rate of re-defaults unless servicers start focusing more on – (ahem) – long-term ability to pay.

Seems that we’ve come full circle: Hey, guys, maybe you should think about whether people can make the payments when you originate the loan. Hey, guys, maybe you should think about whether they can make the payments when you try to fix the loan.

Should it really be this hard?

February 11, 2009 at 9:05 AM in Mortgage Debt & Home Equity | Permalink | Comments (12)

Mortgage Servicing Problems for Prepayments

posted by Adam Levitin

With all the problems in the mortgage industry caused by defaults, it’s easy to forget that the traditional bugbear of mortgage lenders isn’t credit risk, but prepayment risk.  If a lender contracted for a 6% return and the loan is prepaid, there’s a chance that the best return the lender can get now is say 4.5%.

As it turns out, prepayments can cause just as many problems for servicers as defaults.  Recently, one of my relatives laid into me with this story about her problems getting her servicer to correctly credit her prepayments.  The servicer has been crediting them all to interest, not to principal, so the loan balance isn’t getting paid down (and the servicer is making more money that way, at the expense of the investors).  What’s worse, is that the servicer says it can’t correct the problem because some of the prepayments were made before it acquired the servicing rights.  And, the servicer says that if it corrected the problem, it would result in the account being listed as 30-days late and credit reported because the servicer did not make an automatic withdrawal one month because it treated the prepayment as a regular (but partial) payment (even though the total prepayments should put the loan way ahead on its original amortization schedule).

Put another way, the servicer is saying that they cannot produce an accurate payoff balanceand that if the homeowner demands one it will result in her being credit-reported incorrectly.

This aggrevating situation illuminates what a mess the mortgage servicing world is in.  For all of the attention justly paid to mortgage servicing problems with defaulted homeowners and servicing fraud in the context of default, my relative’s case makes me wonder whether the rot in the servicing industry extends all the way up the tree, to an inability to properly handle transferred servicing rights and an inability to properly handle prepayments.

And here’s the real problem: consumers trust financial institution creditors to be competent and fair.  They trust that balances are right, that APRs are properly applied, that amortization schedules are correct, etc.  Without that trust, the entire system of financial intermediation cannot work.  Financial institutions trade in trust.  Absent that trust, every consumer would have to subject every credit card bill, auto loan bill, mortgage bill, and student loan bill, etc. to a forensic accounting.  That would be astonishingly inefficient.  We shouldn’t want consumers to have to be so careful.  It’s one thing to expect consumers to look at their bills to make sure that there are no unauthorized line items.  It’s another to expect them to run interest and amortization calculations.

For the most part the system works, as it’s all highly automated.  But when it doesn’t, the power imbalance between the financial institution and the consumer puts the consumer at a serious disadvantage.  We really need a better system for resolving consumer disputes with financial institutions.  I’m not sure what it is, but maybe the trick is to avoid the disputes by making sure the FIs get things right. The least cost avoider of the errors is the financial institution, and we should really have stronger incentives for FIs to get it right.

The Good, the Bad and the Ugly of Mortgage Servicing and Implications for Mortgage Modification

posted by Jean Braucher

It looks as if the mortgage cramdown–er, modification–legislation will be sitting around for a while, at least until the stimulus package gets through Congress. So it seems worth talking about its reference to making “payments of such modified loan directly to the holder of the claim” instead of through the Chapter 13 trustee. Although this language was still in the manager’s version of the bill (H.R. 200) as of last week, apparently discussions continue in Washington about whether this is the best policy approach.

A big reason for needing trustees in the picture is to keep track of mortgage payments, because servicers make a lot of errors. There are apparently new servicing companies that are trying to avoid the problems that have been rampant in the industry in the past—dare we hope that some good servicers are coming on line? But no doubt there are still many of the bad (careless) and the ugly (those who are deliberately charging unreasonable or illegal fees during bankruptcy). I’d be interested to hear whether anyone is seeing improvement in this industry since the new focus on its shortcomings.

As a policy matter, the argument for payment of mortgage obligations through the Chapter 13 trustee, rather than directly, is that this approach likely makes it easier for debtors to complete their plans and keep their homes without an expensive fight at the end about whether they are up to date on payments. Putting Chapter 13 trustees in charge of disbursements gives debtors the benefit of their superior record-keeping ability and understanding and their leverage with servicers because of their continuing relationships. While lawyers in areas that have not had a practice of conduit payment of regular mortgage amounts through the trustee often oppose that approach on the assumption that trustee fees will make plans infeasible, the evidence seems to be that conduit payments result in the percentage fee going down. Most trustees already top out on the compensation they are allowed by law. Lower percentage fees in conduit trusteeships may mean that most debtors do not have a problem with feasibility, although unsecured creditors may get paid less. There may be some debtors at the margin who won’t be able to afford a plan if they have to pay trustee fees, but courts could make exceptions in such cases on feasibility grounds (feasibility can cut in different directions depending on the case).

Continue reading “The Good, the Bad and the Ugly of Mortgage Servicing and Implications for Mortgage Modification” »

February 4, 2009 at 6:19 PM in Mortgage Debt & Home Equity | Permalink | Comments (13)

What’s in a word (or 2?) Cramdown

posted by Katie Porter

Last Sunday’s New York Times Magazine’s feature, On Language, discussed the etymology and signification of the word “cramdown.” (Or is it “cram down?” That’s a separate debate that professors have with law review editors every year).

William Safire observes that cramdown is coming into popular parlance as bankruptcy becomes an everday topic and the debate continues about the mortgage modification legislation. Credit Slips guestblogger, the Honorable Eugene Wedoff, found a use of the term in a 1948 law review article and a 1944 judicial opinion. The term has a general use as a verb to indicate forcing unwanted treatment on creditors. In today’s bankruptcy context, the term refers to at least two specific types of such treatment: 1) reducing a creditor’s secured claim to the value of the collateral and 2) confirming a chapter 11 plan over the objection of a class of dissenting creditors. Law students often become confused when their professors use the terms in these two different contexts. I try to use cramdown only to mean the chapter 11 voting override provision and instead speak of “lien stripping” to refer to the writedown of a secured claim under section 506 of the Bankruptcy Code. (Of course, lien stripping is a misnomer, since the the lien remains on the collateral and should not be confused with lien avoidance. What is being “stripped” in part is the value of the claim.)

Safire suggests that the ugly connotations of the word cramdown may be hindering legislative efforts to pass mortgage modification. Senator Durbin’s spokesman said that the appropriate term to describe his proposed legislation is “judicial modification.” While not as colorful as cramdown, it has the virtue of reminding people that a write down in principal is NOT the only feature, and may not even be the most beneficial or widely used feature, of the legislation. Depending on property values where you live, when you bought your house, the type of loan, and future interest rates, debtors may find reductions in interest rate or reamortizations of their loans to be more helpful in reducing their monthly payments and avoiding foreclosure. Using cramdown as shorthand to describe the bill gives short shrift to its potential benefits when all the term may invoke for many people is the specific ability to reduce a mortgage to the value of a house.

Mortgage Cramdown–Layering On Complexity

posted by Jean Braucher

Chapter 13 is already too complicated, and cramdown legislation will make it more so and lead to a new round of litigation and expense that will stand in the way of keeping people in their homes. By all means, Congress should enact mortgage cramdown, but it should take up bankruptcy simplification immediately after that if it really wants people to hold on to their homes in chapter 13.

Katie Porter has already noted the problem of high noncompletion rates in chapter 13 as a reason for suspecting that mortgage cramdown will not “save” many homes. See Cramdown Controversy #2–Will I “Succeed?” The problem is that the impact of the pending cramdown legislation could be small given the messy state of bankruptcy law since the 2005 changes.

The 2005 law has substantially increased the expense of bankruptcy, deterring and delaying its use among the worst off. The chapter 13 filing fee has gone up to $274.  “No look” attorneys’ fees of at least $3,000 are the norm in chapter 13 (see http://www.gao.gov/new.items/d08697.pdf at 25-26), and this is a bargain price considering what lawyers are expected to do under the new law.

Mortgage cramdown will add the difficulty of a valuation hearing, with experts engaging in a swearing contest about the value of a home for which, in many cases, there currently is no market. Cars have various “book” values that can be used to set default measures of value in bankruptcy, but there is no similar simple approach to valuing homes to save on litigation costs.

The bills add a lot of complexity of various sorts. S. 61 and H.R. 200 both would layer on a ridiculous, unnecessary third “good faith” test in chapter 13. The debtor already must file in good faith and propose a plan in good faith, yet the bill’s drafters felt compelled to add an additional requirement that the modification be in good faith. This would stoke litigation over whether it is bad faith to pay the value of the home if the debtor could “afford” more (“afford” always being a malleable concept), with an open question about what other expenses should be taken into account when deciding what the debtor has available to pay for an underwater home.

It would be much better for Congress to explicitly state what it wants—for example, whether just paying the home’s value is fine, with excess disposable income (if any) going to other secured debts (such as cars) and then unsecured debts.  Furthermore, it would be a good idea for Congress to state that if home and car payments use up all the available income over regular expenses, it is not “bad faith” to pay zero to unsecured creditors.  Congress should be heading off the inevitable arguments that just paying for collateral in chapter 13 is not good faith.  If chapter 13 is going to be a mechanism to save homes from foreclosure, many debtors will have nothing left to pay old unsecured debts.  Unfortunately, some judges and trustees have used a good faith test to push for rule-of-thumb amounts of unsecured debt repayment in chapter 13 whether or not that is feasible, contributing to a high noncompletion rate (historically, about two-thirds of chapter 13 cases).

I agree with Katie Porter that the provision in the bills for direct payments by debtors to claim holders is a mistake.  It is unclear whether this would always be required, or whether this language just gives courts discretion to allow direct payment.  In most cases, Chapter 13 trustees are needed to make sure that payments actually get credited appropriately to debtors’ accounts.  If the problem is feasibility of plans due to paying trustee fees on mortgage amounts, Congress could provide for a lower trustee fee on those payments. Without the trustees involved in record-keeping, debtors will face huge cost and difficulty at case closing to try to show that they really are current on their mortgages.  Most trustees now make it a default practice that mortgage payments be made through them, and this has saved on trouble for debtors, trustees and judges.

Another aspect of the bills that is troublesome is that the debtor must have already received a notice of foreclosure in order to cramdown.  This prevents debtors from taking charge of a hopeless situation and getting it resolved; they would have to wait for the lender to send a foreclosure notice before they could make use of chapter 13 to modify their mortgages.

The elimination of credit counseling for debtors who have received a notice of foreclosure is a step in the right direction, but if Congress paid attention to GAO reports, it would repeal the credit counseling requirement entirely. http://www.gao.gov/new.items/d07778t.pdf It represents a cost in money ($50 per debtor) and inconvenience way in excess of very minimal benefit.

Mortgage cramdown would also add to the complexity of other issues currently making their way through the appellate system, particularly issues concerning means testing and treatment of car loans.  (For more discussion of these issues, see my recent paper, A Guide to Interpretation of the 2005 Bankruptcy Law at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1307250.)

Means testing allows above-median-income debtors in either chapter 7 or chapter 13 to include their secured debt obligations as part of their expenses, yet with cramdown on a home possible, the debtor might not have to pay the full secured debt in chapter 13.  This will lead to a new round of litigation over additional layers of means testing, whether under the “good faith” or “totality of the circumstances” tests in chapter 7 or the “projected disposable income” or various “good faith” tests in chapter 13 when the debtor might be able to cramdown.

And then there will be the ironies of allowing cramdown on underwater home mortgages while perhaps not allowing cramdown on seriously underwater car loans, particularly the most risky subprime ones.  If the car lender rolled in a big wad of debt from the last car (known as “negative equity”), making the debt severely undersecured from the outset, it doesn’t make a lot of sense to treat that debt as fully secured under the “hanging paragraph” while cramming down a similarly undersecured home loan.  I am among those who think it is ridiculous—both as a matter of law (see http://www.nacba.org/s/45_50fc1f2acc4e329/files/PeasleeSupportBrief.pdf) and policy—to treat paying off your last car as part of the purchase money for your next one. As a policy matter, this is very risky credit, and it does not deserve preferred status (disallowing cramdown).

All this is to suggest that we desperately need a fresh start for bankruptcy reform, and layering mortgage cramdown on the 2005 mess will just make this more apparent.  The complexity of the law stands in the way of its use at an affordable price and makes it hard to mobilize the bankruptcy system for this crisis.

January 26, 2009 at 12:31 AM in Mortgage Debt & Home Equity | Permalink | Comments (16)

Bankruptcy Modification and the Emperor’s New Clothes

posted by Adam Levitin

A new argument being advanced against bankruptcy modification is that it will result in trillions of dollars of losses and the collapse of the financial system.  This is the “the sky will fall” argument.

Leaving aside the grossly inflated numbers, let’s be really clear that these are not losses that would be caused by bankruptcy modification.  These losses exist with or without bankruptcy modification.  All bankruptcy modification does is force these losses to be recognized now, rather than at some point down the road.  Bankruptcy modification doesn’t change the underlying insolvency of many financial institutions.  One way or another, there are a lot of financial institutions that have to be recapitalized.
Financial institutions want to delay loss recognition as long as possible.  Maybe they’re hoping that the market will magically rebound.  Maybe they think that 2006 prices are the “real” prices and “2009” prices are a very short-lived aberration.  But here’s the crucial point:  homeowners bear the cost of delayed loss recognition by financial institutions.  Delayed loss recognition means homeowners floundering in unrealistic repayment plans and then losing their homes in foreclosure.  Delayed loss recognition means frozen credit markets because no one trusts financial institutions’ balance sheets.  Delayed loss recognition means magnifying, shifting, and socializing losses.  We only make matters worse when we try to pretend that these losses don’t exist.
We all know the story of the Emperor’s New Clothes, and how everybody plays along with the emperor’s conceit until a little boy points out that the emperor is stark naked.  To suggest that widespread financial institution insolvency would be caused by bankruptcy modification is akin to blaming the little boy for the emperor’s nudity.

Cramdown and Future Mortgage Credit Costs: Evidence and Theory

posted by Adam Levitin

I’ve written extensively (see here, here, e.g.) on why permitting modification of mortgages in bankruptcy would generally not result in higher credit costs or less credit availability. As the debate over bankruptcy reform legislation to help struggling homeowners and stabilize our financial system moves to the fore, it’s worth repeating some of the key points and making some new ones.

(1) The key comparison is bankruptcy modification versus foreclosure. Opponents of bankruptcy modification often misframe the issue, whether deliberately or ignorantly. It is not a question of bankruptcy losses versus no losses, but bankruptcy losses versus foreclosure losses. If bankruptcy losses are less than foreclosure losses, the market will not price against bankruptcy modification. This is an empirical question, and to date, my work with Joshua Goodman is the only evidence on it. Opponents of bankruptcy modification have only been able to respond with plain-out concocted numbers (e.g., the Mortgage Bankers Association) or insistence on applying economic theory that looks at the wrong question.

(2) Economic theory tells us that cramdown is unlikely to have much impact on mortgage credit costs going forward. The ability to cramdown a mortgage (reduce the secured debt to the value of the property) is essentially an option borrowers hold to protect themselves from negative equity. It is a costly option to exercise–it requires filing for bankruptcy, and that has serious costs and consequences. More importantly, though, cramdown is typically an out-of-the-money option. It is only in-the-money when (1) property values are falling enough that there’s negative equity and (2) likely to remain depressed in the long-term. Long-term declining residential property values have been the historical exception. What this means is going forward there really isn’t much for creditors to worry about with cramdown–homeowners can’t exercise an out-of-the-money option.

Moreover, because the likelihood of the cramdown option being in the money is Instead, it is an option that is more likely to be valuable when default is imminent, at which point the loan is in the secondary market. So to the extent that the cramdown option does cost creditors, it is the secondary market, and the effects on credit availability and cost to homeowners would be diffused.

(3) Arguments about bankruptcy court capacity and bankruptcy transaction costs are made by people who have no experience with the actual bankruptcy system. A serious misconception about bankruptcy modification is the belief that the bankruptcy judge would decide how to rewrite the mortgage. That’s not how bankruptcy works.  The debtor (and debtor’s counsel) would propose a repayment plan that includes a mortgage modification. The judge either confirms or denies the plan, depending on whether it meets the necessary statutory requirements. This means that bankruptcy judges can actually handle significant consumer bankruptcy case volume. If you want proof that the bankruptcy courts can handle a huge surge in filings, look at what happened in the fall of 2005, before BAPCPA went effective. The courts survived that flood of filings. Today the bankruptcy courts are better prepared; there are more bankruptcy judges (thank you BAPCPA) than in fall 2005. Nor would there be tremendous time and money lost in valuation disputes. After there are a handful of cases decided in a district, all the attorneys know what the likely outcomes would be in future cases and settle on valuations consensually. Court capacity and excessive transaction cost arguments are made by people who have never stepped foot into bankruptcy court.

(4) There’s no other serious option on the table. Permitting bankruptcy modification of mortgages will not by itself solve the finance crisis. It will not stop all foreclosures. But it will help stop some uneconomic foreclosures, which benefits homeowners, investors, communities, and the financial system. And, more importantly, whatever imperfections bankruptcy modification has as a solution, it’s the only real option on the table.

There is no other detailed legislative proposal. There are various economist pipedream proposals around, but even the best of them fail, either because they are politically unrealistic or because they are too rooted to a belief that the private market can solve problems with a tweak here and there. I believe that people and institutions respond to incentives, but market-based solutions haven’t worked to date. How many times do we have to be burned by “market-based” solutions before we try something else? The unfortunate truth is that no one understands enough about various mortgage market players’ incentives to properly align them. We can’t follow all the trails of servicing contracts, insurance, reinsurance, credit derivatives, overhead, and litigation risk and know what incentives look like. Even if we did, it would take serious time for the market to correct itself and start doing large-scale loan modification. That’s time that families don’t have, and I don’t think that anyone who is advocating a market-based solution is also pushing a foreclosure moratorium to allow the market to get its act together. Bankruptcy modification is the only game in town, and to pretend otherwise is disingenuous cover for opposing it in the name of “studying all the options.”

January 24, 2009 at 12:03 AM in Mortgage Debt & Home Equity | Permalink | Comments (19)

Shared Appreciation Clawbacks

posted by Adam Levitin

As bankruptcy modification of mortgages (a/k/a Chapter 13 “cramdown”) looks more and more likely to become law, it’s worth considering what the final legislation might look like.  Already there have been some compromises in order to get Citibank’s support.

One issue that might be raised is a clawback of principal for creditors if there is future appreciation on a mortgage, the secured amount of which has been reduced in bankruptcy.  The question of shared appreciation emerged last year when bankruptcy modification failed to pass Congress and is one that has bedeviled many mortgage modification plans, including the Hope for Homeowners Act, not just bankruptcy modification.

Leaving aside the thorny question of how a clawback would work, I think it’s important to consider whether there should be a clawback.  How one views this issue, I think, depends heavily on framing.  If the comparison is between a modification involving a principal write-down and a loan that performs at its original terms, then permitting an appreciation clawback as part of the modification seems quite fair.   In this framework, it makes sense to try to give the creditor as close to its original bargain as possible; otherwise would be a windfall for the debtor.

But if the comparison is between a modification involving a principal write-down and foreclosure, then an appreciation clawback in the modification would result in a windfall for the creditor.   When a creditor forecloses on a house, the creditor doesn’t benefit from any future appreciation in the property’s value after the foreclosure sale.  The whole idea behind loan modifications, in bankruptcy or voluntary, is that they are value enhancing.  If a loan will perform at 75% of original value when modified, that’s a lot better than a 50% recovery in foreclosure.  If a creditor is already benefitting from a loan modification relative to foreclosure, why should the creditor then also receive a share of the property’s future appreciation?  Wouldn’t that be a windfall to the creditor?

Another way to see this is whether the modification is a temporary or contingent one or whether it is a life of the loan modification.  The danger with a temporary mod is that it just kicks the can down the road.  Requiring an appreciation clawback raises the question of modification sustainability.  Any which way, this is an issue that is likely to pop up again.

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About timothymccandless

Attorney at law, specializing in litigation, labor law overtime, criminal record expungement, partnership dissolution, and Real Estate workout solutions. Employment law claims and Wage and Hour claims Wrongful termination
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