Put Down the Crow over AHM Escrows

Loren Steffy, a business reporter for the Houston Chronicle, headlines a recent blog post with a suggestion that he'll eat crow over his previous commentary on American Home Mortgage. A reader had inquired whether his escrow payments were safe with bankruptcy-filer AHM. Steffy had responded that AHM's bankruptcy should have no effect on his reader's escrow. A few news stories have since appeared that AHM was bouncing checks to local taxing authorities, but, Mr. Steffy, I think you can put down that crow. The problem now seems to be fixed and attributable (I hope) to a temporary glitch involving the far-flung banking operations of a complex financial company.

Still, the story got me thinking a little bit about the consequences of AHM's bankruptcy filing on its escrow accounts.

Steffy was absolutely right in describing the legal effect of bankruptcy on the escrow accounts. Under state and federal law, AHM is required to keep the escrow accounts separate from its other funds. AHM holds the funds to pay the taxes and insurance for its loan customers; it does not own the funds in any way. A bankruptcy filing does not change that relationship. At the moment of filing, the bankruptcy estate is said to come into existence, but the bankruptcy estate only gets what the debtor had. Applying these basic principles to the AHM situation means that the bankruptcy estate does not include any funds the company held in escrow. Reading between the lines of the news reports, the bounced AHM checks appear to be a misunderstanding of these basic legal principles--the bank holding the escrow funds froze all of AHM's accounts on the mistaken belief that these accounts were AHM's property.

Legal principles are great, but what happens if a bankrupt mortgage company has dissipated the money in the escrow accounts? The money simply would be gone. Obviously, the customers would have a claim against the company, which would not be worth very much given the company would be in bankruptcy. Who is responsible in this case? There is no reason to suspect anything other than a glitch was responsible for AHM's recent problems, but with all the recent concerns over mortgage companies it is a reasonable question to ask hypothetically. Unfortunately, we can only answer that question generally because a lot would depend on the specifics of a particular case.

There are regulatory systems in place to ensure that escrow accounts are not violated. I would think that it would be difficult to circumvent these regulatory systems without some outright fraud by the mortgage company insiders. These individuals most likely would be facing criminal penalties. But, individuals who had relied on the mortgage company to hold the escrow would be out of luck. As the property owners, they would remain responsible for the taxes or insurance on the property. They could pursue the corporate insiders who had committed any fraud, but they would be unlikely to find much money for compensation. Fortunately, my sense is that it would be very difficult and hence unlikely that a mortgage company could simply deplete its escrow accounts. I would be interested in hearing from readers whether they share that sense.