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Sterling Professor Alan Schwartz of Yale holds a joint professorship in law and management, which may explain why the New York Times gives him an opportunity to take his best shot at bankruptcy cramdown. He offers three reasons it won’t work: there are too many cases and too few judges, debtors can’t win, and economic uncertainty will increase. Let’s see how Yale theorizing stacks up against practical reality.
When a family comes to see a bankruptcy lawyer, the most important thing is the budget. The lawyer and the family calculate the current income and monthly payments. The family works out how much they can pay to creditors, assuming they can cut their payments to unsecured creditors, but the mortgage payment remains the same. If they cannot pay their regular monthly expenses after those cuts, their alternative is liquidation in Chapter 11.
If cramdown were available, they could try again with a lowered house payment. The goal would be to set up a house payment that would allow minimal payments to unsecured creditors, and make it possible for them to keep their house. Once they see how much is available to pay for housing within the budget, the lawyer and the family estimate the current value of the house. If it looks low enough, they can proceed.
The first step is to get an appraisal. In my community, this might cost $250-300. The next step is to contact the lender and make an offer. In almost all cases, the contact is with a servicing company. It doesn’t have any authority, and after a 15 day waiting period required by the draft statute, H.R. 200, (link not possible) the family files a Chapter 13. They propose a formal Plan, which states the amount they will pay on each class of debt, including the house payment. If no one objects, the Plan is confirmed, and the new payments go into effect.
Suppose the servicer objects. The only grounds will be that the Debtor can’t make the payments, the price for the house is too low, or that the interest rate should be higher. If the servicer thinks the price should be higher, it gets a lawyer and its own appraiser, and files an objection to Court approval of the Plan, which is called confirmation. The Court hears the evidence from the appraisers and maybe the Debtor, which will take an hour or two. Then the Court decides. If the Debtor can make the payments at the Court’s price, with or without other modifications, the plan is confirmed; otherwise the Debtor is out of luck. Either way, it’s over. The house may be foreclosed, or it may stay with the Debtor, but that house has a value.
After a few cases, all the lawyers in the community have a pretty good idea about how the court thinks, and there will be fewer hearings. Instead, the parties will negotiate a value reasonably satisfactory to each. The Court is required to rule on whether the Debtor can actually make the payments under the Plan, which increases the certainty of payment, a value to the noteholder.
Schwartz thinks the Debtor is at a financial disadvantage. That would be true if appraising houses were complicated or expensive. It isn’t. It’s a normal process, and would be done when the house sold privately. And judges aren’t going to let this turn into a ludicrous Coleman/Franken battle.
Schwartz thinks that this process increases economic uncertainty, on the ground that the appraisal process is arbitrary, and, he says, influenced by the personal feelings of judges. He ignores the fact that Bankruptcy Judges are required by law to value real property by the Bankruptcy Code. This includes single asset commercial real estate, like apartment complexes or office buildings, where fees run $10,000 plus more for court time. Everyone realizes this process is somewhat arbitrary, but most of the time parties prefer the certainty of a decision to the alternative of foreclosure and eventual sale.
Schwartz complains that price setting is difficult today, because there aren’t enough buyers with cash and financing. The cramdown solves that problem directly: the buyer is the Debtor, and the current lender provides the financing.
Ellen Tauscher, D Banksters, thinks this should only be available for subprime loans. Did I mention interest rates in this analysis? No. The interest rate on the original loan, which is how you know the loan was subprime, is utterly irrelevant. The twin problems are that the house isn’t worth what’s owed on it, and the Debtor can’t make the payments. The first means that it’s pointless to keep paying. The second means the house is headed to foreclosure in a market where there are no buyers. Subprime or prime, these problems won’t change.
Tauscher is putty in the hands of lobbyists from the Money Branch of Government. She’s just another corporatist democrat serving her financial betters. Anybody got an explanation for Sterling Professor Alan Schwartz of Yale University? I wonder if his view is affected by the fact that the Yale Endowment dropped 25% last year, no doubt in part because of toxic waste.
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What isn’t getting any traction or discussion is the WHY vacation homes, etc. CAN be written down (crammed down) in a bankruptcy but one’s personal residence can’t be (at this point).
hmmm…. or could it be that having a judge involved might, well, um, be a little dangerous for someone if the loan docs can’t be found? or even more interesting, if they can and fraud was involved?
i’m all for the cram downs as a way to limit foreclosures. but the icing on the cake is that some third party would be reviewing the loan docs because if fraud is as common as black thinks, things could get really interesting…
I think it is good to read this post in conjunction with BooRadley’s on the failure of banks that wrote securities on mortgages to actually get possession of the underlying mortgage documents from companies that have since gone bankrupt and disappeared or never prepared them properly in the first place. So for a lot of mortgages and the securities that were written off them there is nothing legally binding on the homeowner. At a minimum new law needs to clarify how these should be dealt with and old law should put those in bank leadership who allowed this to happen behind bars.
Alan Schwartz can bite me. There is one point I would raise in refinancing mortgages for which those pesky loan tapes actually do exist. The real estate markets have not yet bottomed out. I have been using an average figure of about 40% depreciation in price from the height of the bubble to bring home values back to pre-bubble levels. So when mortgages are rewritten this factor needs to be taken into account. In fine tuning cramdowns, the country can be split up into markets and the size of the cramdown can be adjusted to fit local markets. For some of the hotter real estate markets for example the cramdown should be closer to 50%.
A final factor that should be factored in is that if dithering on the economy continues, depression will deepen and a deflation factor would also have to be worked in. This would take prices below pre-bubble levels but that’s what we get for not addressing bubble and the meltdown earlier and more responsibly.
The problem with people like Schwartz is that the only thing they are really good at is being wrong. What we have in economics at the moment are a couple generations worth of what are essentially frauds and charlatans. It is as if alchemists took over the chemistry departments of our universities, or creationists the biology departments. These people may have nifty sounding titles and be tenured into their positions but they simply do not have anything worthwhile saying or being heard in those areas where they are supposed to have expertise.
Link to BooRadley’s diary:
http://oxdown.firedoglake.com/diary/3947
The big problem with notes is not that they don’t exist, but that the lenders can’t find them, or can’t find properly endorsed copies to show the Chapter 7 Trustee. We continue to look for them in our practice, and are having some luck.
masaccio
I think you mean Chapter 7 here. Chapter 11 is for corporations.
Right. Chapter 7.
Schwartz bio at Yale:
http://www.law.yale.edu/faculty/ASchwartz.htm
Schwartz was also a critic of the 2005 bankruptcy law.
Now here’s something fascinating, the Mortgage Bankers Association has a brief on cramdown here. I leave the following as a debunking exercise for readers, answer will be provided in the next comment:
Ooops here’s the link to the MBA briefing paper.
In comment 9, I left a little exercise for readers. Here’s how it looks to me. First, the point of the preference for secured debt isn’t because of some fundamental principle of secured credit. It is done because people need houses and cars, and Chapter 13 is designed to enable them to keep those things that are normally collateral for secured debt. This is an incentive to get them to pay into a Chapter 13 Plan for five years instead of dumping off all their debt, in which case only the secured creditors get anything. There is rarely anything left for unsecured creditors in Chapter 7 cases. On the other hand, in Chapter 13 cases, unsecureds get money most of the time, and some is better than none.
More important, the Bankruptcy Code has a provision that says that if you have collateral for your debt, you are secured only to the extent of the fair market value of the collateral, and unsecured for the balance. Cramdown is derived from this perfectly sensible rule. Any other rule unfairly discriminates against unsecured creditors: the Debtor would pay more to the secured creditor than the secured creditor would get if it foreclosed on the collateral and sold it for fair market value.
Suppose you have a car on which you owe $10,000. If the car is worth $6,000, the creditor with a lien on the car is secured to the extent of $6,000, and unsecured for the remaining $4,000. Lawyers tell clients in this position to dump the car. Why pay $10,000 plus usurious interest for a $6,000 car that won’t be worth that when you finally pay it off? If the client does this anyway, that means that unsecured creditors won’t get the $4,000. Why is that fair to them?
The same is true for a house. Why pay more that it is worth?
The Mortgage Bankers Association says:
That is a lie. The Debtor is paying the secured portion. And the Debtor pays something on the unsecured portion just like all of the other unsecured creditors. Too bad the secured creditor didn’t have enough collateral, but at least they got what they bargained for.
Yale, like Berkeley, sometimes makes mistakes in choosing its faculty. The tell might be in his joint position with Yale’s “also ran” school of management. It’s less impressive among its brethren leaguers than its rowing and choral teams. But it’s equally in thrall to the corporate interests that endow its professorships and hire its graduates.
Pity about the Times view of “balanced”. It’s as right-hand dominant as most golf clubs.
Could it be that yachts and vacation homes are confections for the wealthy?
Cramming their reduced market value down the throat of a lender is palatable; it’s a professional courtesy to one’s peers. The bulk of troubled mortgages are owned by those who can barely pay the rent on a simple dwelling. At that they skimp on food and medicines. When they lose a job or take one at half their previous wage, when they or their kids get sick or the spouse loses the second job that made ends meet, or when they get divorced, even mortgage payments get missed.
That’s happening in swaths across neighborhoods, driving down the value of entire communities and collectively, of states. Everything from schools to libraries to local and nationally-owned businesses are affected. But let nothing stand between the Beltway and its banks; add in lobbyists and pundits and a few working girls, and it’s what makes the Village go round.
I imagine that the point, as with the bank bail-out, is to immunize banks from the risks of their bargain. Only the hoi poloi need pay.
“Lawmakers balk at proposal to change bankruptcy law to allow judges to adjust mortgage terms – a measure central to Obama’s foreclosure effort.”
WTF do we need to do to get it through Congress’ head that ‘we’re mad as hell and not going to take it anymore !’
Thanks massacio.
There are probably no valid mortgages. There are 4 problems (or defects) which can make a mortgage invalid:
1. Fraud in the application – Truth in Lending violations
2. Fraud in the Funding – Real Estate Settlement Procedures violations
3. Unconscionable advantage in signing loan docs
4. Loss of ownership in transfer on Notes (this was nailed in the Ohio case, where to ownership of the note was lost).
I live in CA, a snon-judicial foreclose state. I got advice on (4) – because foreclosures in CA don’t go to court. I was advised that to demand all the docs, one needs to file a lawsuit – which is what happens in bankruptcy, and one hope one’s lawyer demands all docs looking for (1), (2) or (4) – and these violations are widespread.
The Banks do not want judicial scrutiny of the mortgages, because I believe they are all invalid due to the four reasons above. The banks would not like that, they’d become liable to their bond holders for the errors, and possibly open to fraud, negligence and whatever else could be thrown at them.
Ohio: Invalid mortgages linky:
http://iamfacingforeclosure.co…..n-nothing/
Thank you for saying that so succinctly.
The recent interview with former World Bank employee by Scott Pelley of CBS 60 Minutes and an article in Toledo Blade (on Marcy Kaptur’s call for all homeowners facing foreclosure to demand the notes be presented) alluded to the likelihood of all mortgages over the last 10 years being fraudulent in some way.
This boggles the mind, that our entire banking system could be so riddled like Swiss cheese. The banks are doing everything possible to avoid answering for this mess, including trying to remove the rights of homeowners in any mortgage renegotiation legislation, because they know they will be on the hook.
Some of these big executive bonuses should be seen as advances on legal fees — or hush money.
Yikes, even if half the mortgages are fraudulent wouldn’t all the people involved in the process such as the lawyers and the mortgage broker be guilty of fraud? It sounds like a mob deal but they all know, or should have known that the contract is pure hooey and not enforceable.
This would be the whole house of cards collapsing.
It’s becoming clear that much of what was done / is done by financial institutions is bordering on criminal or fraud or actually fraud and criminal.
How about a class action suit taken by mortgage holders to have their counter party “contracts” declared fruadulent and perhaps null and void?
Hi Masaccio — these are the changes that Chris Bowers says Ellen Tauscher has worked out with the Judiciary Committee:
Was wondering what your assessment of these modifications are.
re fraud – black quotes from a fitch report:
He ignores the fact that unless we do something more homes will go on the market. This will drive home values down further and increase the amount of future bank write offs.
The only way the status quo works is if the economy were to skyrocket quickly.
I think he wants the banks to wait things out ask for more bailout money as people lose their homes and then blame Obama not the banks.
He wants a Shock Doctrine but the same conditions that created Hitler created Stalin and FDR. 2 out of three of these outcomes do not favor the GOP.
Plus in the inevitable war a world wide economic collapse causes the right wing Kaiser WW1, Hitler Ultra Right wing and also the military aggressors lost.
I’m hoping we can get the world out of this mess without a war this time.
I am hoping that Man as a group can learn.
What, he thought the 2005 bankruptcy law was too lenient for debtors? /s
The mortgage brokers are only responsible if they knowingly lie on the loan application (form 1003). With stated income loans this gets very difficult. With the classical full documentation loans, if the documentation is not forged, it’s very hard for the mortgage broker to lie.
The banks set the underwriting standards, and are responsible for evrything in the process. The demand control, and thus get the liability.
As for a class action lawsuit, here’s my thoughts:
http://agonist.org/synoia/2008…..ry_lawsuit
this is bullshit:
5) Specify that in addition to a phone call requesting a loan modification, the debtor must certify that he/she provided income, expenses, and debt to the holder of the mortgage.
Not providing this was specifically the purpose of Stated (SISA, SAVA, NINA, NIVA, NISA) loans, and this inofrmation was not provided by design. These laons were the laons that are at utmose risk, and most of the defaults. Full doc loan default rate is predictable low, as they were properly underwritten.
RICCO act Prosecution? Might be possible politically if things get bad enough people will be looking for someone to blame.
Our side will go after the guilty the GOP will blame dark people for the problems.
Trust me things will get worse but will they get that bad is the question?
FYI, New post up at the mother-ship
Professor Schwartz serves on the board of Cleveland Cliffs, Inc., a New York Stock Exchange Corporation. He currently is Chair of the Cliffs Finance Committee and serves on its Audit Committee. Professor Schwartz has served on the Board of Rohn Industries, a telecom company whose shares traded on NASDAQ. He has chaired the Rohn Audit Committee and, for a short while, also chaired its Board. Professor Schwartz consults as an expert in corporate, bankruptcy, and commercial transaction cases.
from http://www.law.yale.edu/faculty/schwartzbio.htm
He’s prfoud to be a minor league running dog corporatist taint lapper.
Curious, does it mean that they had to provide the information at the time the loan was made, or that they had to provide it when requesting modification? I was reading it as the latter, but you seem to be reading it as the former, which as you say has a whole host of implications.
“Knowingly lying” is a limited Rovian description. It fails to cover the full range of deceit possible in the marketing practices adopted to place predatory loans with poor credit risks. That’s the business model that fueled the lucrative (in the short-term) securitization engine. The self-created bubble of likely defaulters became “necessary” to Wall Street when the pool of traditional credit risk borrowers dried up.
Jane, this “The definition of a qualified loan modification is kicked to the Administration and the regulators.” is one those ‘the devil is in the details’ type of phrase that could be construed to keep people from getting a mod.
As towards FHA appraisal Guidelines, see here.
Who will be making this determination of appreciation? “Clawback (shared appreciation) – Increase in the percentage for the 1st 5 years”
Seems to me the banks were pretty successful in their lobbying.
1.
2.
3. I think my post makes it clear that this is just silly.
4. This isn’t a problem
1) Clawback (shared appreciation) – Increase in the percentage for the 1st 5 years
2) Improvements to mitigate the effect of the legislation on FHA insured and VA guaranteed loans
3) Ensure that judges use FHA appraisal guidelines in determining the fair market value of the property rather than on an ad hoc basis
4) Mandate that the debtor make equal monthly payments when restructuring debt (predictability in payouts)
5) Specify that in addition to a phone call requesting a loan modification, the debtor must certify that he/she provided income, expenses, and debt to the holder of the mortgage.
6) Judge must deny judicial modification in cases where the debtor can afford the loan. The loan has to be unaffordable and not just underwater, which prevents wealthy people from taking advantage of falling real estate prices.
7) Ensure the debtor receives credit counseling, which can occur after filing bankruptcy, but has to happen before the judge approves the workout plan.
8) A GAO study to see whether this is working and the effect it could have on debtors, access to credit, etc.
9) Make sure that a judge considers whether a qualified loan modification was offered. The definition of a qualified loan modification is kicked to the Administration and the regulators.
10) Extend the pre-filing requirement to request a modification from 15 days to 30 days.
I was talking to a friend who is involved in the process. He loves it, but it is driving me up a tree to hear how the legislature knuckles under to industry, especially in this area, where everything that has happened is their fault.
Can one of these wonderful economist types who’s against cramdowns explain to us, in simple terms, why foreclosure is so much better than cramdowns?
Masaccio,
My wife is going through this now (we got married in September, and I’ve only known her a little more than a year.) She’s got an upside down house mortgage in southern California (Riverside county, high foreclosure rates there). I’ll spare you the personal details, but now the house is occupied by her daughter, who can’t afford the mortgage (neither can we). The house is in foreclosure, with trustee sale scheduled for March 17. I’m arriving late on the scene in terms of my knowledge of the situation.
One thing you didn’t mention explicitly that’s pretty significant: in foreclosure, the mortgagee has personal liability for mortgage foreclosure deficiency judgments. But this is a complicated business about whether or not the bank will seek such judgment. How does this figure into your summary, or did you include it implicitly in some of what you wrote? And how are deficiency judgments affected by Chapter 7(!) and Chapter 13 bankruptcies?
Thanks for your analysis of these matters.
Bob in HI
Don’t know, it’s not clear. I expect the banks to wriggle out somehow. This would be one way to wriggle.
Bob
1. Get a lawyer.
2. See post @16.
You can stop the foreclosure if you file for CH 13 bankruptcy. This is a big step. Get legal advice.
I’m not a lawyer.
“the mortgagee has personal liability for mortgage foreclosure deficiency judgments.”
This is not true for a purchase money loan, as these are non-recourse loans in CA. Personal liablity is true for HELOC (2nd loans), taken out after the house was purchased.
You are correct. The proper term is “comitting fraud”. My apologies.
You HAVE got to be kidding. Talk about advantage to the Rich. Good Lord what a nasty mess.
Fantastic explanation. You would have been more complete to delve into the fluctuating value of housing, but that might have taken a few books to explain. Lenders are supposed to be good at valuing these assets and if they want to ignore the bubble or that housing value can go down that’s their choice. Doesn’t mean it’s a smart choice, but they get paid the big bucks to make it and they gotta take their lumps if they get it wrong.
Of course, we all suffer when something this big is destroying the world economy. To ignore that aspect of this is the ultimate self-delusion. We’ve got to fix these mortgages…simple as that.
Thanks– I somehow missed your #16. For cases like this the homeowner needs to get a lawyer licensed in the state where the home is, don’t they?
Bob in HI
I’m gonna add my two bits on this. Just try and stop me! Heh.
The HOPE program does this, so they might look at that legislation for the details to follow. It seems pretty reasonable.
I’m not familiar with that.
This sounds like a great idea, though the varied effects of the housing bubble might make it not so great in practice during this particular crisis. they might start with Tauscher’s idea and add additional guidance on the regionalized effects of the bubble.
Sounds good, though a requirement of this kind should be appealable by the Lender if the Debtor’s income/means should signficantly change, much as one might appeal to a judge for changes to alimony.
What? This is confusing.
Yes, that is the prime reason for this and should obviously be in the law.
Credit counseling is largely a crock. If somebody is living paycheck to paycheck they aren’t going to be helped by it. It’s like health care ER, too little too late. Teach ‘em in school before they get a barrage of credit card applications.
Good.
What is this?
What is this?
Standardization, with some flexibility, is good.
Consistency with pre-existing housing rules is good.
A clearly stated goal or goals should be stated.
Oversight is obviously required.
These rules are mostly good, but a couple need clarification or a little extra work.
In the past a cramdown was superior, but since the advent of Credit Default Swaps (insurance of a kind) it’s possible they’d do better with a default where they can claim the ‘insurance’ to get full restitution. After a cramdown they’re guaranteed of only partial payoff.
This ‘benefitting from disaster’ is one key to the Bushie economy which is very very very troublesome.
Terrific article, masaccio, thanks for writing it. When I really began noticing and thinking about this whole mortgage business in late 2006 (some r.e. econ background, and already familiar with the S&L version last time) I felt absolutely countersunk. The ramifications of this article help explain why, not only the monstrous size of the problem in dollars, but even more the matter-of-fact deliberateness of the thinking that had to have been involved in cooking it up.
Maybe you can do a version of this and get it published as an op-ed somewhere?