Cramdown Commentary

Bob scooped me on an initial post about the deal between Citigroup and Senate Democrats on pending legislation to permit bankruptcy judges to modify mortgages in bankruptcy. But I have details. And commentary. And questions.

First, the letters from Citibank to the House and Senate outlining the changes that they request be made to the legislation are available in the middle of this WSJ article. They requested three changes to S.66 or H.R. 200 (both denominated the Helping Families Save Their Homes in Bankruptcy Act of 2009). First, that the legislation be limited to loans in existence when the legislation is enacted. This gives the bill a sunset, of sorts, but it could be a long one, given some people have 30 or 40 years left on their loans. Second, only when a violation would give rise to a right of recission under the Truth in Lending Act can the claim be disallowed. Given the relative difficulty and cost of litigating such claims, this is not, in my opinion, a large concession. Consumers retain their rights under the Truth in Lending Act to bring a claim under its provisions and recovery (puny) statutory damages. Third, a reduction in a loan's principal balance is only available if the homeowner certifies they contacted the lender to modify the loan before bankruptcy. Note that the "reduction in principal" is only ONE of the options available to bankruptcy courts. Apparently, the court could freeze or adjust interest rates or extend the term of a loan even if a borrower had not contacted the lender. The only problem I see here is if lenders begin litigating whether the borrower has indeed contacted the lender. Borrowers who did so by phone won't have great records of having done so. I would advise borrowers who call to also send a written letter and keep a copy asking for a modification.

Apparently, the news of the Citi's support for the legislation traveled fast and yesterday at chapter 13 confirmation hearings around the country, debtors asked to have their hearings continued to see if the legislation passed. I also wonder what are the options for homeowners who filed chapter 13 a few years or months ago and were not able to modify their home mortgages. Can they ask the court to modify their plan if the legislation passes?

Comments

[Patches]

Need to read it, not today (Confirmation Monday is coming). But what about 13s that have already been confirmed? We have "Mendoza" (Jim Mcmillin, good friend of ours) 5th cir. that lets us Modify to include post-confirmation mortgage debt. Maybe we could modify?????

[AMC]

They putting a lot of work on the Chapter 13 Trustees and I don't see where there is going to be much increased revenue. Particularly in light of the 9th Circuit's decision in Lopez, that debtors cannot be required to make conduit mortgage payments.

One way to fund all the additional work would be, if a mortgage is being restructured, the monthly payments would have to go through the Chapter 13 Trustee, limited to either 3% or the Chapter 13 Trustee's regular percentage fee, whichever is lower.

That would bring in some revenue to deal with the issues that are sure to arise, but not saddle debtors with a 10% fee, which is what some smaller/non-conduit Chapter 13 Offices charge.

I think this would appeal to both mortgage creditors adn Chapter 13 debtors.

[Patches]

Ya, that's what the Trustee did here. We have to allow like 9% but the trustee is only getting like 4-6% something like that. A side bonus to unsecured creditors if the mortgage note is reduced in principal. More money for them in the "disposable". A likely scenario the trustees cut is that it starts high and lowers over time.

[Justin]

The sunset period won't be 30 years. Almost all loan defaults occur in the first couple of years of a loan because once you've built up some equity, you can sell or refinance (in a normal economic environment, which should return). Also, once you've built up equity, you won't be underwater on your loan, so you won't be able to use this law to reduce principal. Unless there is significant further deterioration in the real estate market, I don't think we'll be seeing a sunset period of longer than 5 years.

I don't foresee a lot of litigation on whether debtors contacted the bank unless the debtors are pro se. I do foresee a lot of litigation on valuation issues; I mean, who knows what a house is worth these days? I'm sure debtor's lawyers and bank lawyers will each be able to find favorable appraisals. Maybe the UST should get involved in the appraisal process?

[Justin]

I'm curious also as to whether this will be available for individual Chapter 11's. There have been a lot of people forced into Chapter 11 lately simply because they have a really expensive house.

[Katie Porter]

As currently written, the legislation would NOT be available for individual chapter 11s. While I do not doubt that high-cost homes force some consumers into chapter 11, I think it is a hard sell politically to provide additional relief for people whose secured debts exceed $1 million.

[robert]

[ Also, once you've built up equity, you won't be underwater on your loan, so you won't be able to use this law to reduce principal.]

So, you're basically adopting the same assumptions that helped lead to this mess: appreciation is no longer on auto-pilot.

[FJP]

Curious -- no one is talking much about the provision that allows cramdown only for mortgages in existence as of the date of the bill's enactment. OK, this was the quid for the quo of the lenders' support, I get that. But do we really believe that there will never be another predatory mortgage loan? Or that there will never be another downturn in which too many borrowers find themselves underwater? What happened to the complementary ideas that (a) allowing cramdown encourages responsible lending by creating a risk that the overextending lender will get crammed down, and (b) requiring borrowers to file bankruptcy to get a principal reduction will encourage responsible borrowing, because people will know that there is a burden associated with a cramdown and also at the same time will have an incentive to try to save their homes rather than walk away. For that matter what happened to the value of stability in the law? We are getting to be like tax lawyers, constantly changing everything.

[AMC]

"I'm curious also as to whether this will be available for individual Chapter 11's. There have been a lot of people forced into Chapter 11 lately simply because they have a really expensive house."

Here is a link to a summary of the bill:

http://lawprofessors.typepad.com/bankruptcyprof_blog/2009/01/s-61---senator.html

Section 2 of the summary states:

Section 2. Eligibility for Relief. Bankruptcy Code section 109(e) sets forth secured and unsecured debt limits to establish a debtor's eligibility for relief under chapter 13, currently equal to just over $1 million of secured debts and abotu $330,000 of unsecured. Section 2 amends this provision to provide that the computation of of these debt limits does not include the secured or unsecured portions of debts secured by the debtor's principal residence, if:

First, the current value of the debtor's principal residence is less than the secured debt limit.

Second, if the debtor's principal residence was sold in foreclosure or the debtor surrendered such residence and the current value of such residence is less than the secured debt limit.

_______________________________________________________

So, it may be that many debtors who are now required to file Chapter 11s because they exceed the debt limits, will be able to qualify for Chapter 13 relief despite their jumbo mortgage.

[Martha Sherwood]

I am concerned about what happens when the debtor contacts the lender and is offered a mortgage modification inferior to what would be available in Bankruptcy, that temporarily forestalls foreclosure. Fannie Mae recently announced a foreclosure prevention program involving rewriting mortgages to include negative amortization of interest. Could the bankruptcy court refuse cramdown because the debtor had turned down such an offer? There is a similar situation with student loans where people in pretty dire circumstances are refused a hardship discharge because they did not take advantage of an income contingent repayment plan (which involves capitalized interest) or, alternatively, because they are in such a plan and the ongoing hardship still imbedded in the plan isn't dire enough.

I think it likely that if this bill passes, mortgage servicers will be quick on the ball with workout agreements that postpone foreclosure, first aggressively pushing them on borrowers who might be contemplating bankruptcy, and then, if the borrowers balk, arguing in court that refusal of the workout agreement makes the borrower ineligible for a court-imposed restructuring.

[Patches]

Great point Martha. I would like to know as well.

[Martha Sherwood]

The sunset provision may also contain a booby trap. If the lender structures a workout as a new loan rather than a modification, it would render the modification ineligible for future bankruptcy relief. All lenders have to do to circumvent the consumer-friendly provisions of this bill is to aggressively offer new mortgages, touted as loan modifications, that temporarily solve the unaffordable payment problem without providing any net long-term benefit to the homeowner. For a peek at what such a modification might look like, see the recent Fannie Mae Streamlined Modification Program (https://www.efanniemae.com/sf/servicing/smp/index.jsp) and its guidelines for servicers, which urge loan modifications involving negative amortization. I find it significant that Fannie Mae now has such a close relationship with the Federal Government and is pursuing a course that has the potential to rob the American consumer of a supposed legislatively-conferred benefit.